Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019    
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from________to________
Commission file number 001-35944

POWER SOLUTIONS INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in its Charter)

Delaware
 
33-0963637
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
201 Mittel Drive, Wood Dale, IL
 
60191
(Address of Principal Executive Offices)
 
(Zip Code)
(630) 350-9400
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 and Section 15(d) of the Act.   YES  ¨
NO   x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ¨     NO   x
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    YES  x     NO   ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer
 
¨
 
Accelerated filer
 
¨
 
Non-accelerated filer
 
x
 
Smaller reporting company
 
x
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES ¨   NO x


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The aggregate market value of 5,028,139 shares of Common Stock held by non-affiliates of the registrant as of June 30, 2019 was $49.0 million based on the last reported sale price on the over-the-counter (“OTC”) market on June 30, 2019 (although the total market capitalization of the registrant as of such date was approximately $222.4 million). Shares of the registrant’s Common Stock held by each executive officer and director and by each person who holds 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
As of April 22, 2020, there were 22,857,602 outstanding shares of the Common Stock of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s amendment to this Form 10-K (the “Amendment”) to be filed with the United States Securities and Exchange Commission (the “SEC”) are incorporated by reference into Part III of this Annual Report on Form 10-K to the extent stated herein. The Amendment was to be filed with the SEC no later than 120 days after the close of the registrant’s fiscal year ended December 31, 2019. On April 29, 2020, relying on the SEC’s Order under Section 36 of the Securities Exchange Act of 1934, Modifying Exemptions from the Reporting and Proxy Delivery Requirements for Public Companies, dated March 4, 2020 and amended March 25, 2020 (Release Nos. 34-88318 and 34-88465) (collectively, the “Order”), the registrant filed a Form 8-K extending the Amendment’s filing deadline by 45 days to June 15, 2020.


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TABLE OF CONTENTS
 
 
Page
PART I
 
Forward-Looking Statements
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
PART III
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
PART IV
Item 15.
Exhibits, Financial Statement Schedules
Item 16.
Form 10-K Summary
 
Signatures




EXPLANATORY NOTE
As previously disclosed on Power Solutions International, Inc.’s (the “Company”) Form 8-K filed with the SEC on March 30, 2020, the filing of this Annual Report on Form 10-K for the period ended December 31, 2019 (the “2019 Annual Report”) was delayed due to circumstances related to the novel coronavirus (“COVID-19”) and its impact on the Company’s operations. The disruptions in transportation, staffing, and technology systems to both the Company and the Company’s professional advisors resulted in limited support from the Company’s staff and professional advisors due to the COVID-19 outbreak. In particular, COVID-19 has caused disruptions in the Company’s day-to-day activities and impaired the Company’s ability to perform necessary work on the 2019 Annual Report and to file the 2019 Annual Report by its March 30, 2020 due date. The Company relied on the SEC’s Order Under Section 36 of the Securities Exchange Act of 1934 Modifying Exemptions From the Reporting and Proxy Delivery Requirements for Public Companies, dated March 4, 2020 and amended March 25, 2020 (Release Nos. 34-88318 and 34-88465), to delay the filing of this 2019 Annual Report.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K that are not historical facts are intended to constitute “forward-looking statements” entitled to the safe-harbor provisions of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements may involve risks and uncertainties. These statements often include words such as “anticipate,” “believe,” “budgeted,” “contemplate,” “estimate,” “expect,” “forecast,” “guidance,” “may,” “outlook,” “plan,” “projection,” “should,” “target,” “will,” “would” or similar expressions, but these words are not the exclusive means for identifying such statements. These forward-looking statements include statements regarding the Company’s projected sales and potential profitability, strategic initiatives, future business strategies, warranty mitigation efforts and market opportunities, improvements in its business, remediation of internal controls, improvement of product margins, and product market conditions and trends. These statements are not guarantees of performance or results, and they involve risks, uncertainties and assumptions. Although the Company believes that these forward-looking statements are based on reasonable assumptions, there are many factors that could affect the Company’s results of operations and could cause actual results, performance or achievements to differ materially from those expressed in, or implied by, the Company’s forward-looking statements.
The Company cautions that the risks, uncertainties and other factors that could cause its actual results to differ materially from those expressed in, or implied by, the forward-looking statements include, without limitation: the factors discussed in this report set forth in Item 1A. Risk Factors; management’s ability to successfully implement the Audit Committee’s remedial recommendations; the timing of completion of steps to address, and the inability to address and remedy, material weaknesses; the identification of additional material weaknesses or significant deficiencies; variances in non-recurring expenses; risks relating to the substantial costs and diversion of personnel’s attention and resources deployed to address the financial reporting and internal control matters; the ability of the Company to accurately budget for and forecast sales, and the extent to which sales result in recorded revenues; changes in customer demand for the Company’s products; volatility in oil and gas prices; the impact of the U.S. tariffs on imports from China on the Company’s supply chain to source products; the impact of the investigations being conducted by the SEC, and the criminal division of the United States Attorney’s Office for the Northern District of Illinois (the “USAO”) and any related or additional governmental investigative or enforcement proceedings; any delays and challenges in recruiting key employees consistent with the Company’s plans; the impact the recent outbreak of a new strain of coronavirus (“COVID-19 outbreak”) could have on the Company’s business and financial results; any negative impacts from delisting of the Company’s common stock par value $0.001 (the “Common Stock”) from the NASDAQ Stock Market (“NASDAQ”) and any delays and challenges in obtaining a re-listing on a stock exchange.
The Company’s forward-looking statements are presented as of the date hereof. Except as required by law, the Company expressly disclaims any intention or obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise.
AVAILABLE INFORMATION
The Company is subject to the reporting and information requirements of the Exchange Act, and as a result, it is obligated to file annual, quarterly and current reports, proxy statements and other information with the SEC. The Company makes these filings available free of charge on its website (http://www.psiengines.com) as soon as reasonably practicable after it electronically files them with, or furnishes them to, the SEC. Information on the Company’s website does not constitute part of this Annual Report on Form 10-K. In addition, the SEC maintains a website (http://www.sec.gov) that contains the annual, quarterly and current reports, proxy and information statements, and other information the Company electronically files with, or furnishes to, the SEC.


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PART I
Unless the context indicates otherwise, references in this 2019 Annual Report to “Power Solutions,” “PSI,” “the Company,” “Corporate,” “it,” “its” and “itself” mean Power Solutions International, Inc. and its wholly-owned subsidiaries. References herein to “2019,” “fiscal 2019” or “fiscal year 2019” refer to the fiscal year ended December 31, 2019. References herein to “2018,” “fiscal 2018” or “fiscal year 2018” refer to the fiscal year ended December 31, 2018.
Item 1.    Business.
General Business Overview
Power Solutions International, Inc., incorporated under the laws of the state of Delaware in 2011, designs, engineers, manufactures, markets and sells a broad range of advanced, emission-certified engines and power systems that are powered by a wide variety of fuels, including natural gas, propane, gasoline, diesel and biofuels, within the energy, industrial and transportation end markets. The Company manages the business as a single segment.
The Company’s products are primarily used by global original equipment manufacturers (“OEMs”) and end-user customers across a wide range of applications and equipment that includes standby and prime power generation, demand response, microgrid, combined heat and power, arbor equipment, material handling (including forklifts), agricultural and turf, construction, pumps and irrigation, compressors, utility vehicles, light- and medium-duty vocational trucks, and school and transit buses.
The Company provides highly engineered, comprehensive solutions designed to meet specific customer application requirements and technical specifications, including those imposed by environmental regulatory bodies, including the U.S. Environmental Protection Agency (“EPA”), the California Air Resources Board (“CARB”) and the People’s Republic of China’s Ministry of Ecology and Environment (“MEE,” formerly the Ministry of Environmental Protection), as well as regulatory bodies within the European Union (“EU”).
The Company’s products include both sourced and internally designed and manufactured engines that are engineered and integrated with associated components. These comprehensive power systems are tested and validated to meet quality, safety, durability and global environmental standards and regulations.  
Through advanced research and development (“R&D”) and engineering capabilities, the Company is able to provide its customers with highly optimized, efficient, durable and emissions-compliant products that enhance their competitive position.
The Company’s business is diversified across end markets and applications and also includes extensive aftermarket and service parts programs. These programs consist of (i) internal aftermarket service parts programs with worldwide sales and distribution capabilities and (ii) internal OEM-developed service parts programs for components and products supplied by the Company.

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The Company’s end markets, product categories and equipment are as highlighted in the following table:
End Market
Product Categories
Equipment/Products
Energy
Electric
Power Generation
Mobile and Stationary /
Standby and Prime Power
Demand Response
Microgrid
Combined Heat and Power (“CHP”)
Large Custom Generator Set (“Genset”) Enclosures
Electric Power Generators
Grid Connectivity
Solar and Wind
Industrial
Material Handling
Agricultural/Arbor Care
Irrigation/Pumps
Construction
Compressors
Other Industrial
Forklifts
Wood Chippers
Stump Grinders
Sweepers/Industrial Scrubbers
Aerial Lift Platforms/Scissor Lifts
Irrigation Pumps
Oil and Gas Compression
Oil Lifts
Off Road Utility Vehicles
Ground Support Equipment
Ice Resurfacing Equipment
Pump Jacks
Transportation
Trucks
Buses
Fuel Systems and Tanks
Class 2 - 7 Vocational Trucks and Vans
School Buses (Type A and Type C)
Transit Buses
Terminal and Utility Tractors
Products
The Company’s sourced and internally designed and manufactured engine blocks are engineered and integrated with associated components in a range of configurations that includes basic engine blocks integrated with appropriate fuel system parts as well as completely packaged power systems that include combinations of front accessory drives, cooling systems, electronic systems, air intake systems, fuel systems, housings, power takeoff systems, exhaust systems, hydraulic systems, enclosures, brackets, hoses, tubes, packaging, telematics and other assembled componentry. The Company also designs and manufactures large, custom-engineered integrated electrical power generation systems for both standby and prime power applications. The Company’s comprehensive power systems are tested and validated to meet quality, safety, durability and global environmental standards and regulations.
The Company’s engines and power systems include both emission-certified compression and spark-ignited internal combustion engines ranging from 0.99 liters (“L”) to 53L of displacement, which run on a wide variety of fuels, including natural gas, propane, gasoline, diesel and biofuels within the energy, industrial and transportation end markets.
Uncertain Impact of COVID-19 and Oil and Gas Market Price Volatility
In January 2020, the World Health Organization (“WHO”) announced a global health emergency because of the COVID-19 outbreak and the risks to the international community as the virus spreads globally. In March 2020, the WHO classified the COVID-19 outbreak as a global pandemic (the “COVID-19 pandemic”), based on the rapid increase in exposure globally. The COVID-19 pandemic has resulted in the implementation of significant governmental measures to control the spread of the virus, including quarantines, travel restrictions, business shutdowns and restrictions on the movement of people in the United States and abroad.
In addition, the global economy has experienced substantial turmoil including impacts from the world financial markets, which have experienced a period of significant volatility and overall declines. As of the date of this 2019 Annual Report, due to unprecedented decreases in demand, an oil price war, and economic uncertainty resulting from the COVID-19 pandemic, crude oil prices have declined precipitously. A significant portion of the Company’s sales and profitability is derived from the sale of products that are used within the oil and gas industry. While the Company has yet to experience significant supply chain interruptions or material cancellations of orders, the potential impact of future disruptions, continued economic uncertainty, and continued depressed crude oil prices, and declining rig count levels may have a significant adverse impact that may result in the recognition of material impairments or other related charges.


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These factors, in turn, may not only impact the Company’s operations, financial condition and demand for the Company’s goods and services, but its overall ability to react timely to mitigate the impact of these events. The timing and execution of the strategic initiatives and growth strategies discussed below may be adversely impacted by the COVID-19 pandemic including the related significant price volatility in the oil and gas markets.
Strategic Initiatives/Growth Strategies
The Company has initiated a comprehensive set of business objectives aimed at improving profitability, streamlining processes, strengthening the business and focusing on achieving growth in higher-return product lines. Key elements of these objectives and other initiatives are highlighted below.
Improve profitability
The Company has implemented a plan focused on enhancing profitability through the review of its customer and product portfolio. To date, this has resulted in strategic price increases in certain areas of the business, along with product redesign and the re-sourcing of certain components, to support improved margins. This program is a multi-year effort and will entail a strategic assessment of certain areas in which profitability does not meet established thresholds. The Company is also seeking opportunities to improve its profitability through the initiation of programs to improve manufacturing efficiency and working capital efficiency. It has also been investing heavily in the expansion of its heavy-duty engine product line, which has historically provided better margins. Further, the Company is in the early phases of production of certain products and anticipates potential benefits as it gains improved economies of scale through greater volumes. Lastly, since mid-2016, the Company incurred substantial costs related to its restatement of prior financial statements and efforts toward remediation of its material weaknesses. The Company saw a meaningful reduction in certain of these costs with the completion of the restatement of its prior financial statements in May 2019 and expects to see further reductions now that all delinquent periodic reports are filed and as it continues to remediate its material weaknesses.
Warranty expense mitigation efforts
The Company aims to curtail its warranty expense through various mitigation efforts.  As part of this, the Company is developing reimbursement and commercial remedies from key suppliers, where applicable.  Also, the Company is undergoing a continued evaluation and improvement of its engineering validation and reliability programs for products and applications.  The Company also continues to make investments in technology to further enhance its tools and processes.
Streamlining of business processes
The Company has an ongoing program to review and identify cost reductions throughout the organization. As part of this program, the Company continues to adopt tighter controls, monitors major areas of spending and is centralizing certain business processes.
Strengthening of business through the optimization of business systems and technology
The Company is working to strengthen its business through the optimization of its business systems and technology to support the remediation of internal controls, improve processes, drive greater operational efficiencies and provide better and timelier decision making across the organization. As part of this initiative, the Company is working on the upgrade and reimplementation of its Enterprise Resource Planning system.
Increased emphasis on energy product offerings through new product development and investments
The Company has been a major participant in the energy market for many years as a supplier to several of the world’s leading power generation companies and through its large custom Generator Set (“Genset”) enclosure business. Building on its broad product offering, in March 2018, October 2018, and October 2019, the Company received EPA certification for its 32L, 40L, and 53L heavy-duty engines, respectively. These heavy-duty engines provide a natural-gas-fueled power range from 500 kilowatt-electric (“kWe”) to 1.25 megawatt (“MW”), which is well above the Company’s prior capabilities, allowing it to serve a greater portion of the demand response, microgrid, combined heat and power, and oil and gas markets. Additionally, in September 2019, the Company received EPA emergency standby certification for its 20L, 40L and 53L diesel engines, which provide a power range of 550 kWe to 1.65 MW. These diesel engines are largely designed for energy market applications including emergency power, wastewater treatment, and oil and gas exploration and production. Also, the engines can handle mission critical customer operations in the health care, data center, hospitality and transportation industries. In addition to dedicating significant R&D resources within the energy market, the Company has also strategically invested in expanding its management, sales and operations staff to support these efforts. The Company’s heavy-duty engines have historically provided better margins.

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Capitalize on key market trends
The Company’s breadth of products and solutions will enable it to capitalize on numerous market trends that it believes have the potential to drive customer demand for its products and contribute toward its long-term growth. Further, the Company’s R&D activity is largely focused on expanding its solutions to further address trends in these areas. The key trends include the following:
the worldwide growth of intermittent sources of energy, such as wind and solar, and an aged electric grid in the United States, coupled with power outage activity due to weather or power shutdowns, which is driving increased demand for generators, microgrids and demand response equipment;
increasingly stringent regulations and growing efforts to reduce emissions, which are driving demand for alternatives to diesel power engines (e.g., EPA Tier 4 emission standards, CARB regulations, MEE policies in China), in particular, in several markets such as the power generation market for oil and gas, school bus, arbor care and the China bus market, among others;
growth in e-commerce activity around the world, which is driving demand for last-mile delivery vehicles; and
the availability of automotive engines that are suited for industrial application.
New product expansion by leveraging deep industry experience
Throughout the Company’s history, it has evolved from a provider of diesel power systems to become a major supplier of power systems fueled by alternatives to diesel, including gasoline, propane, and natural gas, among others. By leveraging the deep industry experience of its engineering and new-product development teams, the Company is continuing to take steps to broaden the range of its power system product offerings, including engine classes, power ratings and the OEM and direct user market categories into which it supplies products. The Company plans to capitalize on its technologically sophisticated, in-house design, prototyping, testing and application engineering capabilities to further refine its superior power system technology.
Leverage the Company’s relationship with Weichai
In March 2017, the Company executed a share purchase agreement (the “SPA”) with Weichai America Corp., a wholly owned subsidiary of Weichai Power Co., Ltd. (HK2338, SZ000338) (herein collectively referred to as “Weichai”). Under the terms of the SPA, Weichai invested $60.0 million in the Company (the “Weichai Transactions”) by purchasing a combination of newly issued Common Stock and preferred stock, par value $0.001 (the “Preferred Stock”), as well as a stock purchase warrant, which significantly strengthened the Company’s financial condition and contributed to the subsequent extinguishment of a $60.0 million term loan. The Company and Weichai also entered into a strategic collaboration agreement (the “Collaboration Agreement”) under which they have been working together to accelerate market opportunities for each company’s respective product lines across various geographic and end-user markets.
The Collaboration Agreement provides the Company with strategic benefits and opportunities, including the ability to leverage Weichai’s strengths and capabilities in R&D, manufacturing, procurement and distribution and its widespread sales channels in China and other emerging markets. This collaboration has already enabled the Company to broaden its existing product portfolio, improve material quality, decrease costs, accelerate the development of new products and bring them to market, and expand access and exposure to new markets.
Among other things, the Collaboration Agreement establishes a joint steering committee, permits Weichai to second a limited number of certain technical, marketing, sales, procurement and finance personnel to work at the Company and establishes several collaborations, including with respect to stationary natural gas applications and Weichai diesel engines. The Collaboration Agreement also provides for the steering committee to create different subcommittees with various operating roles, and it otherwise governs the treatment of intellectual property of the parties prior to the collaboration and the intellectual property developed during the collaboration. The Collaboration Agreement had a term of three years that was set to expire in March 2020. On March 26, 2020, the Collaboration Agreement was extended for an additional term of three years.
The Weichai stock purchase warrant, as last amended (the “Weichai Warrant”), was exercisable commencing on April 1, 2019 for such number of shares of the Company’s Common Stock as was sufficient to provide Weichai with majority ownership of the Company’s Common Stock. On April 23, 2019, Weichai exercised the Weichai Warrant resulting in the Company issuing 4,049,759 shares of the Company’s Common Stock. See Note 1. Summary of Significant Accounting Policies and Other Information–Stock Ownership and Control in Part II. Item 8. Financial Statements and Supplemental Information, for additional information. Weichai is currently the Company’s largest stockholder, holding 51.4% of the Company’s outstanding Common Stock as of April 22, 2020.
Expand global business
Through the expansion of its product lineup and the entry into new markets, the Company has a history of growing its product offerings internationally beyond North America. The Company sees long-term opportunity in continuing to grow its business worldwide with further R&D investment including new-product development and offerings.

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Strengthened engine development and testing capability
In April 2018, the Company acquired the assets of Chicago Technical Center R&D facility from Ricardo, Inc. This transaction has allowed the Company to significantly strengthen and expand its testing capabilities and increase its capacity to meet current and future engine development, certification and durability testing needs. The advanced R&D facility immediately provided three strategic benefits for the corporate engine programs: (i) increased speed to market response, (ii) greater ability to innovate and optimize product performance and reliability, and (iii) lower cost of product development through direct control of in-house EPA and CARB-certified testing cell operations, scheduling and management of the industry-leading engine testing center.
Sales and Marketing
The Company employs a direct sales and marketing approach to maintain maximum interface with and service support for its OEM customers. This direct interface incorporates the corporate internal technical sales representatives. The Company complements its direct OEM relationships with a localized, independent sales and product support organization. This localized sales and support organization provides the necessary knowledge of local customs and requirements while also delivering immediate sales assistance and customer support.
The Company has invested in and is focused on capturing aftermarket sales of the value-added components that are included in its power systems. With a significant portion of the selling prices of the Company’s power systems coming from value-added components, this is a large, continuing growth opportunity for its aftermarket business.
Customers
The Company’s customers primarily include global OEMs and direct end-users across a wide range of applications that demand high product quality, best-in-class engineering support and on-time delivery. Within several applications for which the Company provides solutions, it maintains supplier relationships with two or more customers, which are often among the largest in that category.
The Company’s largest customers, based upon its consolidated net sales in 2019, included the following subsidiaries/affiliates of Daimler AG: Freightliner Custom Chassis Corporation, Thomas Built Buses and FUSO Company (collectively, “Freightliner”) and Hyster-Yale Materials Handling Group. Freightliner and Hyster-Yale Materials Handling Group represented 17% and 13% of 2019 consolidated net sales, respectively. The largest customers change from time to time as a result of various factors, including prevailing market conditions, customers’ strategies and inventory of the Company’s power systems.
Competition
In each of the Company’s end markets there are a variety of competitors, including engine manufacturers, independent suppliers and distributors of engines, fuel systems and component providers, manufacturers of power generation equipment, engine packagers and integrators, and the in-house operations of certain OEMs, some of which have longer operating histories, strong brand recognition and significantly greater financial and marketing resources.
Notwithstanding significant competition, the Company believes that the following factors provide it with a differentiated value proposition that allows the Company to compete effectively:
fuel-agnostic strategy;
demonstrated expertise in on- and off-road applications;
ability to leverage Weichai’s strengths and capabilities;
completeness and comprehensiveness of engines and power systems;
expansive product integrations, including electronics, controls, fuel systems and transmissions;
commonality of technology platform spanning all product lines;
emissions regulation compliance and certification;
breadth and depth of advanced engineering disciplines;
industry-leading product and application engineering;
competitive pricing/cost;
ability to tailor power systems to specific customer needs;
performance and quality;
speed to market; and
customer support and service.
Manufacturing
The Company manufactures and assembles its products at facilities in suburban Chicago, Illinois, and Darien, Wisconsin, and customizes its power systems to meet specific requirements of OEM applications and the needs of its OEM customers. The Company has invested in precision computer numerical control (“CNC”) machining equipment to finish its internally designed engine blocks and cylinder heads, which are cast by various suppliers. The manufacturing lines in the Company’s production facilities are

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technologically sophisticated, lean, agile and flexible, and the Company allocates production capacity on its mixed model manufacturing lines to accommodate the demand levels and product mix required by its OEM customers.
The Company focuses on safety, people, quality, on-time delivery, cost and environment in its manufacturing operations. The Company is certified to the most recent International Organization for Standardization (“ISO”) standard, ISO 9001: 2015. The ISO 9000 family of quality management standards, which must be met in order to become ISO certified, is designed to help organizations monitor and improve the quality and delivery of their products and/or services to their customers. The Company also uses tools such as Six Sigma, Lean Manufacturing, 80/20, Value Stream Mapping and other manufacturing engineering strategies to help manage its business, build quality, and drive performance and a continuous improvement culture within the manufacturing operations’ teams. The Company also uses a customer relationship management database to help collect customer feedback and to track overall quality performance at its OEM customers. Structured staff training is a constant priority and includes closed-loop quality monitoring and feedback systems.
Research, Development and Engineering
The Company’s research, development and engineering programs are focused on new product development, enhancements to current products, quality improvements and material cost reductions across its product lines. Its efforts are market driven, with the sales team identifying and defining market requirements and trends and its engineering and new-product development groups reviewing existing power system portfolios and developing new solutions that build upon the technology within that portfolio. To further enhance the Company’s research, development and engineering programs, the Company finalized the purchase of emissions testing assets and the sublease of an emissions testing facility from Ricardo, Inc., a subsidiary of the strategic engineering and environmental consultancy, Ricardo Plc., for $5.6 million in cash in April 2018. See Note 4. Property, Plant and Equipment in Part II. Item 8. Financial Statements and Supplemental Information for further discussion.
The Company’s product and application development engineering teams include in-house mechanical and electrical engineering functions. Internal resources are supplemented with engineering outsourcing relationships for design, development and product testing. In addition to these engineering outsourcing relationships, the Company benefits from the design, development and testing capabilities of its supplier base. The Company staffs its engineering support activities associated with released product and component sourcing programs with dedicated internal engineering personnel.
Research, development and engineering expenditures include salaries, contractor fees, building costs, utilities, testing, information technology and administrative expenses and are expensed, net of contract reimbursements, when incurred. From time to time, the Company enters into agreements with its customers to fund a portion of the research, development and engineering costs of a particular project. These reimbursements are accounted for as a reduction of the related research, development and engineering expenditure. The Company’s net research, development and engineering expenditures for 2019 and 2018 were $24.9 million and $28.6 million, respectively.
Supplier Relationships
In addition to producing its own engines, the Company has established relationships with its suppliers for certain engines that are integrated into its comprehensive power systems, the most significant of which are Doosan Infracore Co., Ltd. (“Doosan”), a subsidiary of Doosan Group, Shenyang Aerospace Mitsubishi Motors Engine Manufacturing Co., Ltd. (“SAME”), General Motors Company (“GM”) and Weichai. The Company also sources other power system components and coordinates design efforts with third-party suppliers for some of its key components. In general, the prices at which the Company purchases engines, components and other raw materials are based on market factors, including the prices offered by other suppliers operating in the same market and the prevailing market prices of raw materials.
The Company aggregates product sourcing efforts across its large and diverse OEM customer base and across industry categories, capitalizing on volume, economies of scale and global supply opportunities. The Company’s customers benefit from the aggregation of its global sourcing, procurement, and assembly and services, obtaining cost benefits that they might not obtain if they were to rely on their own internal resources, capabilities and more limited demand requirements. Through this process, customers are able to streamline their supply base by consolidating procurement and assembly efforts down to a single part number product supplied by the Company. The Company delivers this assembly to its customer’s production line ready to install into the customers’ product.
The Company is party to a supply agreement with Doosan, under which it purchases and distributes, on an exclusive basis, specified Doosan engines within a territory consisting of the United States, Canada and Mexico. On October 1, 2019, the supply agreement with Doosan was amended and extended to December 31, 2023, after which the agreement will automatically be extended for additional one-year terms unless a notice of termination is provided by either party six months prior to the scheduled expiration. The addendum also includes minimum product purchase commitments for the period 2019 through 2023, subject to reductions based on market declines in oil prices and defined prescribed payments to Doosan triggered by shortfalls in purchases made by the Company during each annual calendar period. Given the significant market declines in oil prices in early 2020, the Company is currently evaluating the impact of potential future purchasing volume reductions. As of December 31, 2019, no liability has been established for any possible purchasing shortfall payments to Doosan.

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The Company was also party to a supply agreement with GM through December 31, 2019 for the exclusive purchase and distribution of the 6.0L engine to OEMs for usage in the on-road market, which includes the Company’s sale of this engine to its customer, Freightliner. With the GM announcement that it will discontinue its production of the 6.0L engine, the Company has been conducting last-time buys of this engine to ensure adequate supply to Freightliner and other customers. The Company does not have a supply agreement with GM for its successor product to the 6.0L engine. However, it is actively exploring opportunities to identify engine alternatives for this product.
The Company is also party to a supply agreement with SAME through December 31, 2020 for the exclusive purchase and distribution of engines around the world, with the exception of China (including Hong Kong, Macao and Taiwan), within the forklift and marine markets. The agreement, which automatically extends for an additional one-year term on an annual basis, unless either party provides notice of termination at least 180 days before the expiration date, includes minimum purchase commitments.
Product Support
The Company’s dedicated team of product and application engineers enables it to deliver high-quality, responsive technical support to its OEM and end-user customers. The Company provides technical support and training to its customers, including in-plant training and support through web- and phone-based field service. The Company further supports its customers by engaging regional providers to perform warranty services and offer support for its power systems. The Company also leverages its technical resources to provide service and support functions for its power systems sold to OEM customers.
Backlog
Backlog generally is not considered a significant factor in the Company’s business.
Employees
As of December 31, 2019, the Company’s workforce consisted of approximately 900 full-time employees. None of the members of the Company’s workforce are represented by a union or covered by a collective bargaining agreement.
Impact of Government Regulation
The Company’s power systems are subject to extensive statutory and regulatory requirements that directly or indirectly impose standards governing exhaust emissions, evaporative emissions, greenhouse gas (“GHG”) emissions and noise. The Company’s power systems are subject to compliance with regulatory standards imposed by the EPA, state regulatory agencies in the United States, including the CARB, and other regulatory agencies around the world, such as the MEE. Since its engines are sold into both off-road and on-road markets, the Company must ensure certification to the specific regulations within the applicable statutory segment. For products sold into the U.S. market, both EPA and CARB have imposed specific regulations on engines used in both off-road equipment and on-road vehicles. These regulations generally serve to restrict exhaust emissions, with a primary focus on oxides of nitrogen, hydrocarbons and carbon monoxide. Exhaust emission regulations for engines used in off-highway industrial and power generation equipment vary based upon the use of the equipment into which the engine is incorporated (such as stationary power generation or mobile off-highway industrial equipment) and the type of fuel used to drive the power system. Similarly, on-road regulations from the EPA and CARB focus on the same exhaust constituents as well as sophisticated requirements to meet on-board diagnostic (“OBD”) system regulations. Emissions of GHGs such as carbon dioxide, methane and nitrogen dioxide are also regulated, with more stringent regulatory requirements starting in 2021. The Company continues to make significant investments into the necessary intellectual property that supports full compliance of the Company’s engines now and into the foreseeable future.
The first EPA emissions regulations adopted for diesel engines, known as Tier 1, applied to diesel engines used in mobile off-highway applications in the U.S., and similar standards for diesel engines, known as Stage I regulations, were implemented thereafter in the EU. The EPA and applicable agencies in the EU have continued to develop emissions regulations for diesel engines in the U.S. and the EU, respectively, and have adopted more restrictive standards. The current diesel engine emission requirements in the U.S are known as Tier 4 and are applicable to off-road diesel engines used in industrial equipment. Similarly, the EU has adopted more restrictive standards under its Stage V regulations. Tier 4 and Stage V regulations call for reductions in levels of particulate matter and oxides of nitrogen.
The Company’s entry into the transportation end market began in 2013 with the development of its 8.8L power systems targeted for 2015 regulatory standards. In 2014, the EPA and CARB certified the Company’s new engine as a Model Year 2015 product for liquid propane gas (“LPG”) and compressed natural gas (“CNG”) fuels, and in 2015 the Company launched its first propane-fueled engine for on-road applications. To assist the adoption of alternative-fueled vehicles in the marketplace, the EPA and CARB granted alternative-fueled engines an exemption from OBD regulations until 2018 (CARB)/2019 (EPA). The Company has leveraged this exemption on its 8.8L certifications to date. Gasoline engines are not exempt from OBD regulations, therefore, in 2017, the Company achieved full OBD certification for its 2018 and beyond gasoline 6.0L and 8.8L products. The knowledge gained from this gasoline OBD development was applied to the Company’s alternative-fueled engines for 2019 after all OBD

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exemptions ended as of December 31, 2018. In 2016, the EPA launched new Phase 1 GHG emission regulations. New EPA Phase 2 GHG emission regulations begin in 2021.
Historically, the Company’s 6.0L and 8.8L gasoline engines qualified for the small manufacturer exemption for Phase 1 GHG under Title 40 of the Code of Federal Regulation Section 1036.150(d). Starting in 2020, as a result of the Weichai ownership change in April 2019, those products no longer qualify for the exemption and must meet Phase 1 GHG standards. The Company has developed and is implementing plans to address the impact of the transition of its emission regulation requirements in 2020 and 2021 through licensing of its technology to a third-party small manufacturer to produce and certify the 6.0L gasoline engine and utilization of averaging, banking, and trading compliance provisions for the sale of its 8.8L gasoline engine.
The initial and ongoing certification requirements vary by power system application and market segment. Each application must undergo a series of rigorous and demanding tests to demonstrate compliance with regulatory standards, including useful life, zero hours and durability testing. Once a power system is certified, regulatory agencies impose ongoing compliance requirements, which include testing newly produced power systems on a regular quarterly schedule to ensure ongoing compliance with applicable regulations. In addition, there are field audit requirements, which require the removal of power systems from service at specified stages of their useful lives to perform confirmatory exhaust emissions testing and/or OBD system audits and testing. All of the Company’s emission-certified power systems meet existing exhaust emission standards of the EPA and CARB. Failure to comply with these standards could result in adverse effects on the Company’s future financial results.
Information about the Company’s Executive Officers
The following selected information for each of the Company’s current executive officers was prepared as of May 4, 2020.
Name
 
Age
 
Executive Officer Since
 
Present Position with the Company
John P. Miller
 
62
 
2017
 
Chief Executive Officer and President
Charles F. Avery, Jr.
 
55
 
2017
 
Chief Financial Officer
Kenneth J. Winemaster
 
55
 
2017
 
Executive Vice President
Jason Lin
 
66
 
2019
 
Chief Technical Officer
Donald P. Klein
 
46
 
2018
 
Corporate Controller
Lance Arnett
 
49
 
2019
 
Chief Commercial Officer
John P. Miller was appointed as the Company’s Chief Executive Officer and President effective May 17, 2017. From 2008 until 2016, he served in operational and financial management positions of increasing responsibility at Navistar International Corporation, a global manufacturer of commercial and military trucks, school buses, diesel engines and provider of service parts for trucks and diesel engines, and, most recently, from 2014, as a Senior Vice President of Operations and Corporate Finance. Mr. Miller’s prior positions at Navistar included Vice President and General Manager for specialty business as well as Vice President and Chief Financial Officer for engine and parts. Prior thereto, he served in the role of Chief Financial Officer of Laidlaw Education Service, a provider of public transportation services, Chicago Metallic Corporation, a global manufacturer of suspended ceiling and metal products, Fleetpride, Inc., a distributor of heavy-duty truck parts, and Peapod, an online grocery delivery company.
Charles F. Avery, Jr. was appointed as the Company’s Chief Financial Officer on July 31, 2017. From 2013 until 2016, he served as Chief Financial Officer, Vice President of Finance and Treasurer, at FreightCar America, Inc., a designer and builder of railroad freight cars, supplier of railcar parts and provider of railcar leasing. Prior to that role, from 2005 until 2013, he served in financial and information technology leadership positions, including as Vice President, Corporate Controller and Chief Information Officer, at Federal Signal Corporation, a global designer and manufacturer of safety, signal and communications equipment and environmental and firefighting vehicles, serving governmental and commercial customers. Earlier in his career, he served in financial and information technology leadership roles at Home Products International, Inc. and in audit and business advisory roles at Arthur Andersen LLP.
Kenneth J. Winemaster was appointed as Executive Vice President on November 28, 2017. Mr. Winemaster served as the Company’s Senior Vice President from 2001 to 2017 and also served as the Company’s Secretary from 2001 to 2013. In addition, Mr. Winemaster served as a Director of the Company from 2001 to 2011.
Jason Lin was appointed as the Company’s Chief Technical Officer on June 14, 2019. Prior to this appointment, Mr. Lin served as a member of the Company’s Board of Directors (the “Board”) from May 2017 until June 2019. Mr. Lin is responsible for the oversight and management of various research and development and engineering groups including the Advanced Product Development, Design Engineering, Applied Engineering, Emissions & Certification, and On-highway Engineering groups. He also has oversight over certain aspects of program management and product strategic planning. From 2009 to July 2016, Mr. Lin served as Chief Executive Officer and President of Société Internationale des Moteurs Baudouin, a France-based marine engine manufacturing subsidiary of Weichai Power Co., Ltd. During this tenure, he also served as an Executive Technical Director and

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adviser to the Chairman of Weichai Power Co., Ltd. From February 2001 to July 2006, Mr. Lin was employed by International Truck and Engine Corporation, a truck, bus and diesel engine manufacturer subsidiary of Navistar International Corporation, in engineering management positions. Earlier in his career, Mr. Lin was employed in engineering positions by Cummins Engine Company and worked in Japan for Komatsu-Cummins Engine Company as Vice President.
Donald P. Klein has served as the Company’s Corporate Controller and Principal Accounting Officer since May 14, 2018. Prior to joining the Company, he served as Assistant Corporate Controller at Littelfuse, Inc., a publicly traded company, with customers in the electronics, automotive and industrial markets with products that include fuses, semiconductors, polymers, ceramics, relays and sensors. Prior to that role, from 2008 to 2017, Mr. Klein served in various positions of increasing responsibility within finance and accounting, including most recently as Assistant Corporate Controller, at Navistar International Corporation. Prior to Navistar, he worked for Hewitt Associates as manager of external reporting and at Ernst & Young LLP as a senior manager of assurance and advisory services.
Lance Arnett has served as the Company’s Chief Commercial Officer since November 18, 2019. Prior to joining the Company, from January 2009 to November 2019, he worked at Cummins Inc., a publicly traded company that designs, manufactures, distributes and services a broad portfolio of power solutions. During his tenure, he served in various capacities for Cummins Central Region in Minnesota, most recently serving as director and chief of staff of their North American OEM Performance Cell. In this capacity, he oversaw direct strategy for their North American business including sales, engineering, assembly and upfit, pricing, marketing, and customer support. His previous roles at Cummins Central Region include serving as interim president, vice president of OEM business, vice president of OEM and customer care and executive director of operational effectiveness. Prior thereto, from 2006 to 2009, he worked as business development manager for PreVisor, Inc. and, from 2001 to 2006, he served as director, franchise sales and development at Mighty Distributing System of America (Mighty Auto Parts). Earlier in his career, he served in management and sales roles within the staffing industry.
Item 1A.    Risk Factors.
The Company’s business and results of operations are subject to various risks, including those listed below, many of which are not within the Company’s control, which may cause actual financial performance to differ materially from historical or projected future performance. New risks may emerge at any time, and the Company cannot predict those risks or estimate the extent to which they may affect its results of operations.

Risks Related to the Company’s Delay in Filing Timely Reports with the SEC, the Restatement of Prior Consolidated Financial Statements, Accounting and Internal Controls, the Company’s De-listing from NASDAQ, and Litigation Related to These Aforementioned Items

The Company is the subject of a formal investigation by the SEC and a parallel criminal investigation by the USAO. Any adverse outcome of these continuing investigations could have a material adverse effect on the Company.
The Company is fully cooperating with the SEC and the USAO in their investigations. Such investigations and the outcome of such investigations could have a material adverse effect on the Company, the trading prices of its securities and its ability to raise additional capital. If the SEC or the USAO determines that the Company violated federal securities or other laws and institutes civil enforcement or criminal proceedings, the Company may become subject to civil or criminal sanctions, including, but not limited to, civil or criminal charges, fines, other monetary penalties, injunctive relief and compliance conditions imposed by a court or agreement, which may have a material adverse effect on the financial condition or results of operations of the Company.
The restatement of the Company’s previously issued consolidated financial statements and the delays in the Company’s filing of consolidated financial statements has resulted in shareholder lawsuits that could have a material adverse effect on the Company’s financial condition, results of operations and cash flows.
The Company has been subject to various shareholder lawsuits arising from matters related to the errors identified in the restatement of its previously issued financial statements. The Company may encounter additional such lawsuits. The Company has devoted and may be required to continue to devote significant time, attention and resources to these matters, and the outcome of these lawsuits cannot be predicted. Substantial damages or other monetary remedies assessed against the Company could have a material adverse effect on its business, financial condition, results of operations and cash flows. See Note 10. Commitments and Contingencies, included in Part II, Item 8. Financial Statements and Supplementary Data, for additional information regarding these matters.



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Limitations of the Company’s Directors and Officers liability insurance and potential indemnification obligations will have a material adverse effect on the Company’s financial condition, results of operations and cash flows.
Under its bylaws and certain indemnification agreements, the Company has obligations to indemnify current and former officers and directors and certain current and former employees. Based on cumulative legal fees and settlements incurred, as of April 22, 2020, the Company has fully exhausted its primary directors and officers insurance coverage of $30 million. Additional expenses currently expected to be incurred and that may occur in the future and/or liabilities that may be imposed in connection with actions against certain of the Company’s past and present directors and officers and certain current and former employees who are entitled to indemnification will be funded by the Company with its existing cash resources. Such expenses could have a material impact on the Company’s financial condition, results of operations and cash flows.
As a result of the Company’s delayed filings, NASDAQ delisted the Company’s Common Stock in April 2017. The continued delisting of its Common Stock could have a material adverse effect on the Company.
The failure to timely file its periodic reports with the SEC resulted in the Company not being in compliance with NASDAQ Listing Rule 5250(c)(1), which requires listed companies to timely file all required periodic financial reports with the SEC, and triggered the delisting of the Company’s Common Stock. The Company’s delisting and potential inability to remediate failures to comply with applicable NASDAQ rules to be relisted could have a material adverse effect on the Company by, among other things, reducing:
the liquidity of its Common Stock;
the market price of its Common Stock;
the number of institutional and other investors that will consider investing in its Common Stock;
the number of market makers in its Common Stock;
the availability of information concerning the trading prices and volume of its Common Stock;
the number of broker-dealers willing to execute trades in shares of its Common Stock;
the Company’s ability to obtain equity financing for the continuation of its operations;
the Company’s ability to use its equity as consideration in any merger transaction; and
the effectiveness of equity-based compensation plans for its employees used to attract and retain individuals important to the Company’s operations.
The Company has identified material weaknesses in its internal control over financial reporting that have not been fully remediated. If its remediation measures are insufficient to address the material weaknesses, or if the Company otherwise fails to establish and maintain an effective system of internal control over financial reporting, it may not be able to accurately report financial results, timely file periodic reports, maintain its reporting status or prevent fraud.
In connection with the Company’s assessment of the effectiveness of its internal control over financial reporting as of December 31, 2019, the Company concluded that there were material weaknesses in its internal control over financial reporting. See Item 9A. Controls and Procedures, included in Part II, for additional information regarding these matters.
The Company’s management may identify other material weaknesses in its internal control over financial reporting in the future. The existence of internal control material weaknesses could harm its business, the market price of its Common Stock and its ability to retain the Company’s current, or obtain new, lenders, suppliers, key employees, alliance and strategic partners or require the implementation of certain undertakings with the SEC. In addition, the existence of material weaknesses in the Company’s internal control over financial reporting may affect its ability to timely file periodic reports under the Exchange Act. The inability to timely file periodic reports could result in the SEC revoking the registration of the Company’s Common Stock, which would negatively impact the Company’s ability to re-list its Common Stock on the NASDAQ or any other stock exchange.
The Company has incurred significant costs in connection with the restatement of previously issued consolidated financial statements and its failure to timely file prior periodic reports and will continue to incur significant costs to remediate material weaknesses in internal control.
The Company has incurred, and will continue to incur, significant expenses, including audit, legal, consulting and other professional fees, and lender and noteholder consent fees, related to the restatement of its previously issued consolidated financial statements and the ongoing remediation of material weaknesses in its internal control over financial reporting. The Company has taken a number of actions, including adding significant internal resources and implementing a number of additional procedures and controls, in order to strengthen its accounting function and reduce the risk of future material misstatements in its financial statements. To the extent that these actions are not successful, the Company may be forced to incur additional time and expense towards further remediation efforts and incremental substantive procedures, which could have a material adverse effect on its results of operations.

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The Company’s historical failure to timely file its periodic reports with the SEC could materially and adversely affect its prospective results of operations and may limit it from accessing the public or capital markets to raise debt or equity capital, which may limit the Company’s ability to access debt capital financing, which in turn may limit its ability to pursue one of its potential strategies.
Any failure to make timely filings of one or more future periodic reports could result in further defaults and breaches and further negatively impact the Company’s creditworthiness, each of which could have an adverse impact on its ability to obtain financing in the future, the cost of future financings and its results of operations.
Any failure by the Company to make timely filings with the SEC or other failure to remain compliant with reporting requirements of the SEC may inhibit its ability to access the public or capital markets to raise debt or equity capital. The inability to access capital may limit the Company’s options to finance its business and may substantially limit its ability to finance potential acquisitions or other strategies. As needs arise, the Company may seek additional borrowings or alternative sources of financing; however, difficulties in borrowing capital or raising financing could have a material adverse effect on its operations, planned capital expenditures and ability to fund further growth.

Risks Related to the Company’s Business and Industry

The Company is unable to predict the impact of COVID-19 on the Company including its business, results of operations and financial condition.
Any outbreaks of contagious diseases and other adverse public health developments could have a material and adverse effect on the Company’s business, results of operations and financial condition. The COVID-19 pandemic has resulted in the implementation of significant governmental measures to control the spread of the virus, including quarantines, travel restrictions, business shutdowns and restrictions on the movement of people in the United States and abroad. These factors, in turn, may not only impact the Company’s operations, financial condition and demand for the Company’s goods and services, but its overall ability to react timely to mitigate the impact of the COVID-19 pandemic. The Company is aggressively beginning the execution of contingency actions as a result of the expected significant negative impacts of these factors. The Company is reviewing operating expenses as part of the contingency planning process, including prioritizing certain R&D investments in support of the Company’s long-term growth objectives. As of the date of this 2019 Annual Report, the Company has implemented the following temporary cost reduction measures designed to mitigate the operating and financial impact of the COVID-19 pandemic on its business:
reduced the hours of operations of the Company’s production facilities;
reduced the work week for all office employees;
reduced pay for salaried employees by between 10% and 30%, depending on the employee’s position;
suspended the Company’s 401(k) plan match;
deferred spending on certain R&D programs;
implemented a hiring freeze;
restricted all non-essential travel; and
minimized discretionary expenses and consulting services.
Depending on the severity and longevity of the COVID-19 pandemic, the Company’s business, employees, customers, suppliers and stockholders may experience a significant negative impact. As such, the impact the COVID-19 pandemic may have on the Company’s business, results of operations and financial condition cannot be reasonably estimated at this time, but the impact may be material. In addition, due to the speed with which the COVID-19 situation is developing and evolving, there is uncertainty around its ultimate impact on public health, business operations and the overall economy; therefore, the negative impact on the Company’s business, results of operations and financial condition cannot be reasonably estimated at this time, but the impact may be material.
The Company’s management has concluded as of the filing of this 2019 Annual Report that, due to uncertainty surrounding the Company’s ability to extend or refinance its current debt agreements and uncertainty as to whether it will have sufficient liquidity to fund its business activities, substantial doubt exists as to its ability to continue as a going concern. The Company’s plans to alleviate the substantial doubt about its ability to continue as a going concern may not be successful, and it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
The consolidated financial statements included herein have been prepared assuming the Company will continue as a going concern. As of December 31, 2019, the Company had debt outstanding under its credit agreement between the Company and Wells Fargo Bank, N.A. (“Wells Fargo”) (the “Wells Fargo Credit Agreement”) and its $55.0 million unsecured senior notes due June 2020 (the “Unsecured Senior Notes”). On April 2, 2020, the Company closed on its new senior secured revolving credit facility pursuant

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to that certain credit agreement, dated as of March 27, 2020, between the Company and Standard Chartered Bank (“Standard Chartered”), as administrative agent (the “Credit Agreement”). The Credit Agreement, which allows the Company to borrow up to $130 million, matures on March 26, 2021, with an optional 60-day extension subject to certain conditions and payment of a 0.25% extension fee. The Credit Agreement is secured by substantially all of the Company’s assets and includes certain financial covenants as well as a change of control provision. On April 2, 2020, the Company borrowed $95.0 million under the Credit Agreement and utilized the funds to (i) fully repay the outstanding balance of $16.8 million on the Wells Fargo Credit Agreement, (ii) to fully redeem and discharge $55.0 million in aggregate outstanding principal amount of the Unsecured Senior Notes and pay related interest, and (iii) for general corporate purposes. The Wells Fargo Credit Agreement was terminated in connection with repayment of the outstanding balance. Due to the Credit Agreement‘s current maturity date, the Company will need to extend or refinance the Credit Agreement on or before March 26, 2021.
The Company’s ability to continue as a going concern is dependent on generating profitable operating results, having sufficient liquidity, maintaining compliance with the covenants and other requirements under the Credit Agreement and refinancing or repaying the indebtedness outstanding under the Credit Agreement.
There can be no assurance that it will be able to complete a financing on acceptable terms or repay this outstanding indebtedness, when required or if at all. If the Company does not have sufficient liquidity to fund its business activities, it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
Furthermore, if the Company cannot raise capital on acceptable terms, it may not, among other things, be able to do the following:
continue to expand the Company’s research and product investments and sales and marketing organization;
expand operations both organically and through acquisitions; and
respond to competitive pressures or unanticipated working capital requirements.
The Company has experienced substantial net losses in recent fiscal years and may continue to experience net losses.
While the Company generated net income in fiscal year 2019, it experienced substantial net losses in fiscal year 2018 and has an accumulated deficit as of December 31, 2019. The net losses experienced in 2018 were principally attributable to unfavorable gross margin levels resulting from manufacturing productivity challenges, increased warranty claims on certain product lines, failure to pass cost increases on to customers through pricing actions and significant unrecovered costs associated with the transportation product line, along with a noncash valuation loss associated with the issuance of the Weichai Warrant, substantial legal and professional expenses associated with efforts to restate the Company’s prior financial statements, respond to the government investigations and defend the lawsuits related to the restatements, high outstanding debt, and borrowing costs. The Company expects that many of these costs will remain significant in future periods. Continued losses could reduce cash available from operations to service or refinance the Company’s indebtedness as necessary, as well as limit the Company’s ability to finance future growth in its business and implement its strategies.

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The Company has a significant amount of indebtedness and is highly leveraged. Its existing debt or any potential new debt could adversely affect its business and growth prospects.
As of December 31, 2019, the Company’s total debt obligations including indebtedness under the Wells Fargo Credit Agreement, and the Unsecured Senior Notes were approximately $95 million in the aggregate, with available borrowing capacity of approximately $15 million under the Wells Fargo Credit Agreement. On April 2, 2020, the Company borrowed $95.0 million under the Credit Agreement and utilized the funds to (i) fully repay the outstanding balance of $16.8 million on the Wells Fargo Credit Agreement, (ii) to fully redeem and discharge $55.0 million in aggregate outstanding principal amount of the Unsecured Senior Notes and pay related interest, and (iii) for general corporate purposes. The Company has a significant amount of indebtedness and is highly leveraged. The Company’s debt arrangements contain and may contain in the future certain requirements, including specific financial and other covenants or restrictions. The failure or the inability to meet such obligations under existing debt or any new debt could materially and adversely affect the Company’s business and financial condition. In addition, the Company’s debt obligations could make it more vulnerable to adverse economic and industry conditions and could limit its flexibility in planning for or reacting to changes in its business and the industries in which it operates. The Company’s indebtedness and the cash flow needed to satisfy its debt obligations and the covenants contained in current and potential future debt agreements could have important consequences, including the following:
limiting funds available for borrowing through the imposition of availability blocks;
limiting funds otherwise available for financing capital expenditures by requiring dedication of a portion of cash flows from operating activities to the repayment of debt and the interest on such debt;
limiting the ability to incur additional indebtedness;
limiting the ability to capitalize on significant business opportunities, including mergers, acquisitions and other strategic transactions;
making the Company more vulnerable to rising interest rates or higher interest rates; and
making the Company more vulnerable in the event of a downturn in its business.
The Company’s Credit Agreement places limitations on its ability to make acquisitions and restricts its ability to incur additional indebtedness. Any future failure by the Company to comply with the financial covenants set forth under the Credit Agreement, if not cured or waived, could result in the acceleration of debt maturities or prevent the Company from accessing availability under the Credit Agreement. If the maturity of the indebtedness is accelerated, the Company may not have sufficient cash resources, or have the ability to obtain financing through alternative resources, to satisfy its debt and other obligations, and the Company may not be able to continue as a going concern.
The introduction of new products, including new engines that the Company develops, and the continued expansion of products in the energy and transportation markets may not succeed or achieve widespread acceptance.
The Company’s growth depends on its ability to develop and/or acquire new products and/or refine existing products and power system technology, to complement and enhance the breadth of its power system offerings with respect to engine class and the OEM market categories into which the Company supplies its products. The Company will generally seek to develop or acquire new products, or enhance existing products and power system technology, if it believes such acquisitions or enhancements will provide significant additional sales and favorable profit margins. However, the Company cannot know beforehand whether any new or enhanced products will successfully penetrate target markets. There can be no assurance that newly developed or acquired products will perform as well as the Company expects, or that such products will gain widespread adoption among the Company’s customers.
Additionally, there are greater design and operational risks associated with new products. The inability of the Company’s suppliers to produce technologically sophisticated components for new engines and power systems, the discovery of any product or process defects or failures associated with production of any new products, and any related product returns could each have a material adverse effect on the Company’s business and its results of operations. If new products that the Company expends significant resources to develop or acquire are not successful, or such products do not achieve the required production volume and scale, its business could be adversely affected.
The Company’s strategy includes production of in-house developed and manufactured engines used by OEM customers, including large transportation OEMs. The costs and regulations involved with developing and certifying an engine for transportation applications are significant and may be higher and more stringent than expected. Additionally, the stresses and demands on engines and power systems used for transportation applications could result in unexpected issues. The discovery of any significant problems with these engines could result in recall campaigns, increased warranty costs, potential product liability claims, and reputational and brand risks. Sales of the Company’s internally developed engines could lead to significantly higher warranty costs to service these engines if they do not perform to expectations.

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The Company could incur restructuring and impairment charges as it evaluates its portfolio of assets and identifies opportunities to restructure its business in an effort to optimize its cost structure.
The Company continuously evaluates its portfolio of assets and its operational structure in an effort to identify opportunities to optimize its cost structure including as a result of the COVID-19 pandemic. These actions could result in restructuring and related charges, including but not limited to asset impairments and employee termination costs, any of which could be significant and could adversely affect the Company’s results of operations.
The Company has substantial amounts of long-lived assets, including goodwill and intangible assets, which are subject to periodic impairment analysis and review. Identifying and assessing whether impairment indicators exist, or if events or changes in circumstances have occurred, including market conditions, operating results, competition and general economic conditions, including as a result of the COVID-19 pandemic, requires significant judgment. Declines in profitability due to changes in volume, market pricing, cost or the business environment could result in charges that could have an adverse effect on the Company’s results of operations.
The Company is dependent on third-party suppliers, and the partial or complete loss of one of these key suppliers, or the failure to find replacement suppliers or manufacturers in a timely manner, could result in supply shortages.
The Company sources engines, components and replacement parts used in the assembly of its power systems and aftermarket sales from various third-party suppliers. Much of the technology incorporated into the components that the Company sources from a limited number of suppliers is technologically sophisticated, and the Company does not believe that its competitors have access to some of this sophisticated technology. The Company’s business could be harmed by adverse changes in its relationships with these suppliers, including through the management of the timing of payables, or if its competitors gain access to such technology. The viability of certain key third-party suppliers, or the exiting by certain suppliers of certain business lines, could require the Company to find other suppliers for materials or components. Furthermore, the COVID-19 pandemic has resulted in work stoppages at certain suppliers that are part of the Company’s supply chain. As of the date of this filing, the Company has not experienced any significant production or delivery delays to customers as a result of the interruptions, but if future work stoppages were to be prolonged or expanded in scope, there could be resulting supply shortages, which could impact the Company’s ability to deliver its products to customers on schedule. Some components cannot be quickly or inexpensively re-sourced to another supplier due to long lead times and contractual commitments that might be required by another supplier in order to provide the components or materials. Any extended delay in receiving engines or other critical components, or the inability of third-party suppliers to meet the Company’s quality, quantity or cost requirements, could impair or prohibit the Company’s ability to deliver products to its OEM customers.
The loss of certain of the Company’s exclusive supply and distribution agreements, coupled with the Company’s inability to manufacture or source alternative products, could have a material adverse impact on its financial results.
The Company is the exclusive supplier and distributor of certain engine products sourced from certain engine manufacturers. The agreements provide the Company with the exclusive rights to distribute the associated products in certain geographic regions. The Company may not be able to extend the agreements or may not achieve acceptable pricing. For example, the Company was an exclusive supplier of the GM 6.0L engine to OEMs and GM is discontinuing the engine. The Company does not have an agreement with GM to supply on-highway OEMs with GM‘s successor product to the 6.0L engine. If the Company is not able to maintain the arrangements or achieve competitive pricing, then it may need to find alternative products through either alternative supply sources or the design and manufacture of competitive products to meet customer demands. The loss of the any of the exclusive supply agreements and failure to source alternative products could have a materially adverse impact on the Company’s financial results. In addition, the exclusive agreements often include minimum purchase requirements. The failure to reach the minimum purchase requirements could result in financial penalties or the loss of exclusivity that could be material to the Company.
The Company may be impacted by volatility of oil and gas prices and/or fuel price differentials.
The prices of various fuel alternatives are subject to fluctuation, based upon many factors, including global supply and demand, changes in resource base, pipeline transportation capacity for natural gas, refining capacity for crude oil, and government excise and fuel tax policies. The price differential among various fuel alternatives can impact OEMs and their decisions on which, if any, power systems they purchase from the Company. Furthermore, if OEMs do decide to purchase the Company’s power systems, relative fuel prices may affect which power systems they purchase, and the margins can vary significantly among the Company’s various power systems.
The Company may be affected by the price of oil and gas. For example, when the price of oil declines, oil becomes a more favorable source of fuel in the short term, and alternative fuel and energy producers suffer as a result. This volatility, as with any commodity, will occur from time to time and may adversely affect the Company’s business.
Also, a significant portion of the Company’s sales and profitability is derived from sales of products that are used in the oil and gas industry, primarily in support of operating wells. At times of severely depressed energy prices, as is currently being experienced in the market, oil and gas producers have curtailed capital expenditures, sometimes sharply. In addition, oil and gas producers may

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cease or suspend production at well sites that have or are likely to become unprofitable. As a result, sales of the Company’s products could be severely impacted during periods of a prolonged depression in energy prices, which could have a material adverse effect on the Company’s results of operations. The Company estimates that approximately $105 million and $85 million of its 2019 and 2018 net sales, respectively, were attributable to the sale of products used within the oil and gas industry. While the Company has yet to experience significant supply chain interruptions or material cancellations of orders, the potential impact of future disruptions, continued economic uncertainty, and continued depressed crude oil prices and declining rig count levels may have a significant adverse impact that may result in the recognition of material impairments or other related charges.
The Company is exposed to political, economic and other risks, in addition to various laws and regulations that arise from operating a multinational business.
The Company sells products internationally and sources a significant amount of materials from suppliers outside of the U.S. Accordingly, the Company is subject to the political, economic and other risks that are inherent in operating a multinational company, including risks related to the following:
general economic conditions;
the imposition of tariffs and other import or export barriers;
compliance with regulations governing import and export activities;
import and export duties and restrictions;
currency fluctuations and exchange restrictions;
transportation delays and interruptions;
potentially adverse income tax consequences;
political and economic instability;
terrorist activities;
labor unrest;
natural disasters; and
public health concerns including the potential negative impacts to suppliers, customers or the Company’s business as a result of the COVID-19 pandemic.
Any of these factors could have a material adverse effect on the Company’s business and results of operations.
The COVID-19 pandemic is expected to negatively impact the Company’s business in 2020 and beyond and the extent and duration of such impacts over the longer term remain uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of the coronavirus, the extent and effectiveness of containment actions taken, including mobility restrictions and work restrictions, and the impact of these and other factors on the Company’s customer base, suppliers, and general commercial activity.
Also, the Company is subject to, and may become subject to, various state, federal and international laws and regulations governing its business, environmental, labor, trade and tax practices. These laws and regulations, particularly those applicable to the Company’s international operations, are or may be complex, extensive and subject to change. The Company needs to ensure that it and its OEM customers and suppliers timely comply with such laws and regulations, which may result in increased operating costs. Other legislation has been, and may in the future be, enacted in other locations in which the Company manufactures or sells its products. If the Company or its component suppliers fail to timely comply with applicable legislation, its customers may refuse to purchase its products, or it may face increased operating costs as a result of taxes, fines or penalties. In connection with complying with such environmental laws and regulations as well as with industry environmental initiatives, the standards of business conduct required by some of its customers and its commitment to sound corporate citizenship in all aspects of its business, the Company could incur substantial compliance and operating costs and be subject to disruptions to its operations and logistics. In addition, if the Company were found to be in violation of these laws or noncompliant with these initiatives or standards of conduct, it could be subject to governmental fines, liability to its customers and damage to its reputation and corporate brand, any of which could cause its financial condition or results of operations to suffer.
Lastly, the Company’s overseas sales are subject to numerous stringent U.S. and foreign laws, including the Foreign Corrupt Practices Act (“FCPA”) and comparable foreign laws and regulations, which prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. and other business entities for the purpose of obtaining or retaining business. Safeguards that the Company implements to discourage these practices could prove to be ineffective, and violations of the FCPA and other laws may result in severe criminal or civil sanctions, or other liabilities or proceedings against the Company, including class action lawsuits and enforcement actions from the SEC, the USAO and overseas regulators. Any of these factors, or any other international factors, could impair the Company’s ability to effectively sell its power systems, or other products or services that it may develop, outside of the United States.

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The Company utilizes a global supply chain to source products, including engines, components and materials, which may subject it to tariffs, including U.S. tariffs imposed on imports from China. The Company also sells its products on a global basis, and therefore its export sales could be impacted by tariffs.
Several of the Company’s products are sourced internationally, including from China, where the United States has imposed tariffs on specified products imported from China. These tariffs have an impact on the Company’s material costs and have the potential to have an even greater impact, depending on the outcome of future trade negotiations and policies. The Company is evaluating U.S. government policy, which is subject to change in the current negotiating environment, pricing, its supply chain and its operational strategies to mitigate the impact of these tariffs; however, there can be no assurances that any mitigation strategies employed will remain available under government policy or that the Company will be able to offset tariff-related costs or maintain competitive pricing of its products. Further, the imposition of tariffs on imports from China and other countries has the potential to materially and adversely impact the Company’s sales, profitability and future product launches. The Company also sells its products on a global basis; and, therefore, its export sales could be impacted by the tariffs. Any material reduction in sales may have a material adverse effect on the Company’s results of operations.
The Company and its products are subject to numerous environmental and regulatory policies, including emission and fuel economy rules.
The Company’s business is affected by government environmental policies, mandates and regulations around the world, most significantly with respect to emission standards in the United States. Examples of such regulations include those that (i) restrict the sale of power systems that do not meet emission standards and (ii) impose penalties on sellers of noncompliant power systems.
The Company generally must obtain product certification from both the EPA and the CARB to sell its products in the United States. The Company may attempt to expand sales of its certified power systems to OEMs that sell their products in other countries, which may also have stringent emissions requirements. Accordingly, future sales of the Company’s products will depend upon its products being certified to meet the existing and future air quality and energy standards imposed by the relevant regulatory agencies. While the Company incurs significant research and development costs to ensure that its products comply with emission standards and meet certification requirements in the regions in which its products are sold, the Company cannot provide assurance that its products will continue to meet those standards. The failure to comply with certification requirements would not only adversely affect future sales, but could result in the recall of products or the imposition of civil or criminal penalties.
The adoption of new, more stringent and burdensome government emissions regulations, whether at the foreign, federal, state or local level, in markets in which the Company supplies power systems may require modification of emission certification and other manufacturing processes for its power systems. The Company might incur additional and/or unanticipated expenses in meeting future compliance requirements, and it may be required to increase its research and product development expenditures. Increases in such costs and expenses could necessitate increases in the prices the Company charges for its power systems, which could adversely affect demand for such power systems. There are no assurances that the Company will have adequate financial or technical resources in the future to maintain compliance with government emissions standards.
Historically, the Company’s 6.0L and 8.8L gasoline engines qualified for the small manufacturer exemption for Phase 1 GHG under Title 40 of the Code of Federal Regulation Section 1036.150(d). Starting in 2020, as a result of the Weichai ownership change in April 2019, those products no longer qualify for the exemption and must meet Phase 1 GHG standards. The Company has developed and is implementing plans to address the impact of the transition of its emission regulation requirements in 2020 and 2021through licensing of its technology to a third-party small manufacturer to produce and certify the 6.0L gasoline engine and utilization of averaging, banking, and trading compliance provisions for the sale of its 8.8L gasoline engine. New EPA Phase 2 GHG regulations will start in 2021 and the Company’s engines will need to meet Phase 2 GHG standards. Future changes to the regulations and/or failure of the Company to comply with the regulations could have a material adverse effect on the Company’s results of operations.
The Company is subject to price increases in some of the key components in its power systems.
The prices of some of the key components of the Company’s power systems are subject to fluctuation due to market forces, including changes in the costs of raw materials incorporated into these components. Such price increases occur from time to time due to spot shortages of commodities, increases in labor costs or longer-term shortages due to market forces. In particular, the prices of certain precious metals, such as palladium and rhodium, used in emissions-control systems fluctuate frequently and often significantly. Substantial increases in the prices of raw materials used in components that the Company sources from suppliers may result in increased prices charged by suppliers. If the Company incurs price increases from suppliers for key components in its power systems, production costs will increase, and given competitive market conditions, the Company may not be able to pass all or any of those cost increases on to OEM customers in the form of higher sales prices. To the extent that its competitors do not suffer comparable component cost increases, the Company may have even greater difficulty passing along price increases, and the Company’s competitive position may be harmed. As a result, increases in costs of key components may adversely affect the Company’s margins and otherwise adversely affect its results of operations.

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The market for alternative-fueled spark-ignited power systems may not continue to develop as expected.
The continued growth of the market for efficient alternative-fueled spark-ignited power systems, including natural gas, propane and gasoline, is a key tenet of the Company’s growth strategy. The impact of diesel emission regulations is expected to increase the cost and complexity of diesel power systems, but this may not materialize to the expected extent or at all. Also, customers, or potential customers, may not substitute natural gas-, propane- and gasoline-powered power systems for diesel power systems in response to these regulations. In addition, to the extent that diesel power system manufacturers develop the ability to design and produce emission-compliant diesel power systems that are more competitive than the Company’s alternative-fueled power systems, customers and potential customers may be less likely to substitute alternative-fueled power systems for diesel power systems. Furthermore, if alternative-fueled power systems are substituted for diesel power systems, there can be no assurance that the Company’s power systems would capture any portion of the potential market increase. If the industrial OEM market generally, or more specifically any of the OEM categories that represent a significant portion of the Company’s business or in which it anticipates significant growth opportunities for its power systems, fails to develop or develops more slowly than the Company anticipates, its business could be materially adversely affected.
Many of the Company’s power systems involve long and variable design and sales cycles.
The design and sales cycle for customized power systems, from initial contact with potential OEM customers to the commencement of shipments, may be lengthy. Customers generally consider a wide range of solutions before making a decision to purchase power systems. Before an OEM commits to purchase power systems, they often require a significant technical review, assessment of competitive products and approval at a number of management levels within their organization. During the time the Company’s customers are evaluating its products, the Company may incur substantial sales and marketing, engineering, and research and development expenses to customize the power systems to the customer’s needs.
Failure to keep pace with technological developments may adversely affect the Company’s operations.
The Company is engaged in an industry that will be affected by future technological developments. The Company’s success will depend upon its ability to develop and introduce, on a timely and cost-effective basis, new products, applications and processes that keep pace with technological developments and address increasingly sophisticated customer requirements. The Company may not be successful in identifying, developing and marketing new products, applications and processes, and product or process enhancements. The Company may experience difficulties that could delay or prevent the successful development, introduction and marketing of product or process enhancements or new products, applications or processes. The Company’s products, applications or processes may not adequately meet the requirements of the marketplace and achieve market acceptance. If the Company were to incur delays in developing new products, applications or processes, or product or process enhancements, or if its products do not gain market acceptance, its results of operations could be materially adversely affected.
The Company currently faces, and will continue to face, significant competition.
The market for the Company’s products and related services is highly competitive, subject to rapid change and sensitive to new-product and service introductions and changes in technical requirements. New developments in power system technology may negatively affect the development or sale of some or all of the Company’s power systems or make them uncompetitive or obsolete. Other companies, some of which have longer operating histories, greater name recognition and significantly greater financial and marketing resources than the Company, are currently engaged in the development of products and technologies that are similar to, or may be competitive with, certain of the Company’s products and power system technologies. If the markets for its products grow as the Company anticipates, competition may intensify, as existing and new competitors identify opportunities in such markets.
The Company faces competition from companies that employ current power system technologies, and it may face competition in the future from additional companies as new power system technologies are adopted. Additionally, the Company may face competition from companies developing technologies such as cleaner diesel engines, biodiesel, fuel cells, advanced batteries and hybrid battery/internal combustion power systems. The Company may not be able to incorporate such technologies into its product offerings, or it may be required to devote substantial resources to do so. The success of its business depends in large part on its ability to provide single assembly, integrated, comprehensive, technologically sophisticated power systems to its customers. The development or enhancement by its competitors of similar capabilities could adversely affect the Company’s business.
The Company could suffer warranty claims or be subject to product liability claims, both of which could materially adversely affect its business.
The Company’s power systems are sophisticated and complex, and the success of the power systems is dependent, in part, upon the quality and performance of key components, such as engines, fuel systems, generators, breakers, and complex electrical components and associated software. The Company may incur liabilities for warranty claims as a result of defective products or components, including claims arising from defective products or components provided by its suppliers that are integrated into its power systems.

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The provisions the Company makes for warranty accrual may not be sufficient, or it may be unable to rely on a warranty provided by a third-party manufacturer or recover costs incurred associated with defective components or products provided by its suppliers. The Company may recognize additional expenses as a result of warranty claims in excess of its current expectations. Such warranty claims may necessitate a redesign, re-specification, a change in manufacturing processes and/or a recall of its power systems, which could have a material adverse impact on the Company’s financial condition and results of operations and on existing or future sales of its power systems and other products. Even in the absence of any warranty claims, a product deficiency such as a manufacturing defect or a safety issue may necessitate a product recall, which could have a material adverse impact on the Company’s financial condition and results of operations and on existing or future sales.
The Company is exposed to potential product liability claims that are inherent to natural gas, propane, gasoline and diesel and products that use these fuels. Natural gas, propane, diesel and gasoline are flammable and are potentially dangerous products. Any accidents involving the Company’s power systems could materially impede widespread market acceptance and demand for its power systems. In addition, the Company may be subject to a claim by end-users of its OEM customers’ products or others alleging that they have suffered property damage, personal injury or death because its power systems or the products of its customers into which its power systems are integrated did not perform adequately. Such a claim could be made whether or not the Company’s power systems perform adequately under the circumstances. From time to time, the Company may be subject to product liability claims in the ordinary course of business, and it carries a limited amount of product liability insurance for this purpose. However, current insurance policies may not provide sufficient or any coverage for such claims, and the Company cannot predict whether it will be able to maintain insurance coverage on commercially acceptable terms.
The Company’s OEM customers may not continue to outsource their power system needs.
The purchasers of the Company’s power systems are OEMs that manufacture a wide range of applications and equipment that include standby and prime power generation, demand response, microgrid, combined heat and power, utility power, arbor equipment, material handling (including forklifts), agricultural and turf, construction, pumps and irrigation, compressors, utility vehicles, light- and medium-duty vocational trucks, and school and transit buses. As a result of the significant resources and expertise required to develop and manufacture emission-certified power systems, certain of these customers have historically chosen to outsource production of power systems to the Company. To a significant extent, the Company depends on OEMs continuing to outsource design and production of power systems, power system components and subsystems. OEM customers may not continue to outsource as much or any of their power system production in the future. Increased levels of OEM vertical integration could result from a number of factors, such as shifts in the Company’s customers’ business strategies, acquisition by a customer of a power system manufacturer or the emergence of low-cost production opportunities in foreign countries. Any number of these factors could have an adverse impact on the Company’s business.
The Company could fail to adequately protect its intellectual property rights or could face claims of intellectual property infringement by third parties.
The Company believes that the success of its business depends, in substantial part, upon its proprietary technology, information, processes and know-how. The Company does not own any material patents and relies on a combination of trademark and trade secret laws, along with confidentiality agreements, contractual provisions and licensing arrangements, to establish and protect its intellectual property rights. Despite the Company’s efforts to protect its intellectual property rights, existing laws afford only limited protection, and the Company’s actions may be inadequate to protect its rights or to prevent others from claiming violations of their proprietary rights. In addition, the laws of some foreign countries may not protect the Company’s proprietary rights as fully or in the same manner as the laws of the United States. The unauthorized use of the Company’s intellectual property rights and proprietary technology by others could materially harm its business.
In addition, the Company cannot be certain that its products, services and power system technologies, including any intellectual property licensed from third parties for use therein or incorporated into components that it sources from its suppliers, do not, or in the future will not, infringe or otherwise violate the intellectual property rights of third parties. The Company may in the future be subject to infringement claims that may result in litigation. Successful infringement claims against the Company could result in substantial monetary liability, require it to enter into royalty or licensing arrangements, or otherwise materially disrupt the conduct of its business. In addition, even if the Company prevails in the defense of any such claims, any such litigation could be time-consuming and expensive to defend or settle and could materially adversely affect its business.
The Company is exposed to, and may be adversely affected by, potential security breaches or other disruptions to its information technology systems and data security.
The Company relies on its information technology systems and networks in connection with many of its business activities. The Company’s operations routinely involve receiving, storing, processing and transmitting sensitive information pertaining to its business, customers, dealers, suppliers, employees and other sensitive matters. Cyber incidents could materially disrupt operational systems, result in loss of trade secrets or other proprietary or competitively sensitive information, compromise personally identifiable information regarding customers or employees, and jeopardize the security of the Company’s facilities. A cyber incident could be caused by malicious outsiders using sophisticated methods to circumvent firewalls, encryption and other security defenses.

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Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until they are launched against a target, the Company may be unable to anticipate these techniques or to implement adequate preventive measures. Information technology security threats, including security breaches, computer malware and other cyber-attacks, are increasing in both frequency and sophistication and could create financial liability, subject the Company to legal or regulatory sanctions, or damage its reputation with customers, dealers, suppliers and other stakeholders. The Company continuously seeks to maintain a robust program of information security and controls, but the impact of a material information technology event could have a material adverse effect on its reputation and results of operations.
Failure to attract and retain qualified personnel could affect the Company’s business results.
The Company’s success depends on its ability to attract, retain and motivate a highly skilled and diverse management team and workforce. Failure to ensure that the Company has the depth and breadth of personnel with the necessary skill set and experience could impede its ability to deliver growth objectives and execute its strategy. Competition for qualified employees among companies that rely heavily upon engineering and technology is at times intense, and the loss of qualified employees could hinder the Company’s ability to conduct research activities successfully and develop marketable products. As the Company continues to expand, it will need to promote or hire additional staff, and it may be difficult to attract or retain such individuals as a result of increased compensation and benefit mandates without incurring significant additional costs.

Risks Related to Ownership of the Company’s Stock

Ownership of the Company’s stock is concentrated among certain current and former employees and Weichai, therefore limiting other stockholders’ ability to influence corporate matters.
As of April 22, 2020, Weichai beneficially owned 51.4% of the Company’s outstanding shares of Common Stock. Additionally, Gary S. Winemaster, the Company’s founder, former Chairman of the Board, Chief Executive Officer, and President and nonexecutive Chief Strategy Officer, beneficially owned approximately 16.0% of the Company’s outstanding shares of Common Stock, and Kenneth J. Winemaster, the Company’s co-founder and Executive Vice President, beneficially owned approximately 9.7% of the Company’s outstanding shares of Common Stock. Each of these stockholders, by virtue of their significant equity ownership in the Company, may be able to significantly influence, and, in the case of Weichai, control the outcome of, all matters requiring stockholder approval, including the election and removal of directors and any merger or other significant corporate transactions. The interests of these stockholders may not coincide with the interests of other stockholders. The concentration of ownership might also have the effect of delaying or preventing a change of control of the Company that other stockholders may view as beneficial. With the exercise of the Weichai Warrant, Weichai alone owns a majority of the outstanding shares of Common Stock and, therefore, it possesses voting control over the Company sufficient to prevent any change of control from occurring.
Weichai also maintains certain rights through its Investor Rights Agreement with the Company.
Weichai entered into an Investor Rights Agreement (the “Rights Agreement”) with the Company upon execution of the SPA. The Rights Agreement provides Weichai with representation on the Company’s Board and management representation rights. Weichai currently has three representatives on the Board. According to the Rights Agreement, once Weichai exercised the Weichai Warrant and became the majority owner of the Company’s outstanding shares of Common Stock calculated on a fully diluted as-converted basis (excluding certain excepted issuances), the Company became required to appoint to the Board, an additional individual designated by Weichai, or such additional number of individuals so that Weichai designees shall constitute the majority of the directors serving on the Board. As of the date of this filing, Weichai has not designated an additional representative to the Board. According to the Rights Agreement, during any period when the Company is a “controlled company” within the meaning of the NASDAQ Listing Rules, it will take such measures as to avail itself of the “controlled company” exemptions available under Rule 5615 of the NASDAQ Listing Rules of Rules 5605(b), (d) and (e). With Weichai becoming a majority owner of the Company’s outstanding shares of its Common Stock, Weichai will be able to exercise control over matters requiring stockholders’ approval, including the election of the Directors, amendment of the Company’s Charter and approval of significant corporate transactions. This control could have the effect of delaying or preventing a change of control of the Company or changes in management and will make the approval of certain transactions impractical without the support of Weichai.
A change in ownership or a failure to generate sufficient taxable income may limit the Company’s ability to use net operating loss (“NOL”) carryforwards to reduce future tax payments.
The Company has NOL carryforwards with which to offset its future taxable income for U.S. federal income tax reporting purposes. However, the Company may be subject to substantial annual limitations provided by the Internal Revenue Code (the “IRC”) if an “ownership change,” as defined in Section 382 of the IRC, occurs with respect to the Company’s capital stock. Generally, an ownership change occurs if certain persons or groups increase their aggregate ownership of the Company’s total capital stock by more than 50 percentage points in a three-year period. If an ownership change occurs, the Company’s ability to use domestic pre-

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change in ownership NOLs to reduce taxable income is generally limited to an annual amount based on (i) the fair market value of its stock immediately prior to the ownership change multiplied by the long-term tax-exempt interest rate plus (ii) under certain circumstances, realized built-in gains on certain assets held prior to the ownership change for the first five years after the ownership change. Although pre-change in ownership NOLs that exceed the Section 382 limitation in any year continue to be allowed as carryforwards for the remainder of the 20-year carryforward period (indefinite carryforward period for NOLs generated in taxable years ended after December 31, 2017) and can be used to offset taxable income for years within the carryforward period subject to the limitation in each year, the use of the remaining pre-change in ownership NOLs for the loss year will be prohibited if the carryforward period for any loss year expires. If the Company should fail to generate a sufficient level of taxable income prior to the expiration of the NOL carryforward periods, then it will lose the ability to apply the NOLs as offsets to future taxable income. Similar limitations also apply to certain U.S. federal tax credits. In April 2019, Weichai exercised the Weichai Warrant resulting in Weichai becoming the majority owner of the outstanding shares of the Company’s Common Stock. The Company believes that this will constitute an “ownership change” as defined in Section 382. Based on the current Section 382 annual limitation, the Company believes all tax attributes subject to Section 382 will be utilized prior to the expiration dates.
Item 1B.    Unresolved Staff Comments.
None.
Item 2.    Properties.
The Company’s operations are located in 11 leased facilities in the United States, totaling approximately 1.0 million square feet of floor space. The Company’s corporate headquarters is located in Wood Dale, Illinois, a suburb of Chicago.
The Company’s primary manufacturing, assembly, engineering, research and development, sales and distribution facilities are located in suburban Chicago, Illinois and Darien, Wisconsin.
The Company believes that all of its facilities have been adequately maintained, are in good operating condition and are suitable for its current needs. These facilities are expected to meet the Company’s needs in the foreseeable future.
Item 3.    Legal Proceedings.
See Note 10. Commitments and Contingencies, included in Part II, Item 8. Financial Statements and Supplementary Data, for a discussion of legal proceedings, which are incorporated herein by reference.
Item 4.    Mine Safety Disclosures.
Not applicable.

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PART II
Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities.
The Company’s Common Stock traded on the NASDAQ under the symbol “PSIX” from May 28, 2013 through April 18, 2017. The Company’s Common Stock was suspended from trading on NASDAQ effective at the open of business on April 19, 2017 (and subsequently delisted) and began trading on the OTC Pink marketplace (“OTCPink”), operated by OTC Markets Group, Inc. (“OTC Market”) on that date under “PSIX.”
The OTCPink is a quotation system and not a national securities exchange, and many companies have experienced limited liquidity when traded through this quotation system. The quotations represent inter-dealer prices without adjustment for retail markups, markdowns or commissions, and may not necessarily represent actual transactions.
Quarterly Period *
 
High
 
Low
Fiscal year ended December 31, 2019
 
 
 
 
First quarter
 

$9.20

 

$6.69

Second quarter
 
11.49

 
7.03

Third quarter
 
10.75

 
6.70

Fourth quarter
 
7.49

 
3.55

 
 
 
 
 
Fiscal year ended December 31, 2018
 
 
 
 
First quarter
 
8.35

 
6.25

Second quarter
 
9.80

 
7.00

Third quarter
 
12.97

 
9.50

Fourth quarter
 
12.20

 
7.01

As of April 22, 2020, the sale price for the Company’s Common Stock, as reported by the OTC Market, was $3.80 per share.
Holders
As of April 22, 2020, there were approximately 1,700 holders of record of the Company’s Common Stock.
Dividend Policy
The Company has not paid any cash dividends on its Common Stock to date. The payment of dividends is currently restricted by the Credit Agreement and was restricted by the Wells Fargo Credit Agreement and the indenture governing the Unsecured Senior Notes. The Company intends to retain its future earnings to support operations and to finance expansion.
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance under Compensation Plans
See Note 13. Stock-Based Compensation, included in Item 8. Financial Statements and Supplementary Data.
Issuer Purchases of Equity Securities
During 2019 and 2018, the Company did not repurchase any equity securities.
Item 6.    Selected Financial Data.
The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act, and it is not required to provide the information under this item.
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis includes forward-looking statements about the Company’s business and consolidated results of operations for the fiscal years ended December 31, 2019 and 2018, including discussions about management’s expectations for the Company’s business. These statements represent projections, beliefs and expectations based on current circumstances and conditions and in light of recent events and trends, and these statements should not be construed either as assurances of performance or as promises of a given course of action. Instead, various known and unknown factors are likely to cause the Company’s actual performance and management’s actions to vary, and the results of these variances may be both material and adverse. A description

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of material factors known to the Company that may cause its results to vary, or may cause management to deviate from its current plans and expectations, is set forth under “Risk Factors” in this report. See also “Forward-Looking Statements.” The following discussion should also be read in conjunction with the Company’s consolidated financial statements and the related Notes included in this report. As discussed further herein, the Company adopted Accounting Standards Update 2016-02, Leases (Topic 842), effective January 1, 2019 using a modified retrospective approach. The 2018 results were not restated and are not comparative to 2019; however, the Company does not believe the impact is material. See Item 8. Financial Statements and Supplementary Data, Note 7. Leases, for further discussion.
Executive Overview
The Company designs, engineers, manufactures, markets and sells a broad range of advanced, emission-certified engines and power systems that run on a wide variety of fuels, including natural gas, propane, gasoline, diesel and biofuels, within the energy, industrial and transportation end markets with primary manufacturing, assembly, engineering, R&D, sales and distribution facilities located in suburban Chicago, Illinois and Darien, Wisconsin. The Company provides highly engineered, comprehensive solutions designed to meet specific customer application requirements and technical specifications, including those imposed by environmental regulatory bodies, such as the EPA, the CARB and the MEE.
The Company’s products are primarily used by global OEM and end-user customers across a wide range of applications and equipment that includes standby and prime power generation, demand response, microgrid, combined heat and power, arbor care, material handling (including forklifts), agricultural and turf, construction, pumps and irrigation, compressors, utility vehicles, light- and medium-duty vocational trucks, school and transit buses, and utility power. The Company manages the business as a single reporting segment.
For 2019, the Company’s net sales increased by 10% to $546.1 million from $496.0 million in 2018, the result of sales increases of $37.1 million and $34.0 million in the energy and transportation end markets, respectively, partially offset by a sales decline of $21.1 million in the industrial end market. Full year 2019 results included sales of approximately $30 million associated with the shipment of certain engines at the request of one of the Company’s customers in the fourth quarter of 2019 that were originally scheduled for the first half of 2020. Gross margin for 2019 was 18.3%, a strong improvement of 650 basis points versus 11.8% in 2018, primarily the result of increased sales, favorable mix, strategic pricing actions, lower warranty costs and operational productivity improvements. Gross profit improved by $41.1 million in 2019, while operating expenses decreased by $12.8 million, as compared to the same period in 2018. Additionally, in 2019, the loss from the change in value and exercise of the Weichai Warrant declined to $1.4 million from $10.4 million in 2018. Collectively, these factors contributed to a $63.0 million increase in net income, which totaled $8.2 million in 2019 compared to a loss of $54.7 million in 2018. Earnings per share was $0.38 in 2019 compared to a loss per share of $2.94 in 2018. Adjusted net income, which excludes certain items described below that the Company believes are not indicative of its ongoing operating performance, increased by $41.9 million to $28.1 million in 2019, compared to an Adjusted net loss of $13.8 million in 2018. Adjusted earnings per share was $1.30 in 2019 compared to Adjusted loss per share of $0.74 in 2018. Adjusted earnings before interest expense, income taxes, depreciation and amortization (“EBITDA”) was $45.2 million in 2019 compared to Adjusted EBITDA of $4.2 million in 2018. Adjusted net income (loss), Adjusted earnings (loss) per share and Adjusted EBITDA are non-GAAP financial measures. For a reconciliation of each of these measures to the nearest applicable GAAP financial measure, as well as additional information about these non-GAAP measures, see the section entitled Non-GAAP Financial Measures in this Item 7. The Company’s 2019 results included sales of approximately $30 million associated with the shipment of certain engines within the transportation end market at the request of one of the Company’s customers (Freightliner) during the fourth quarter of 2019 that were originally scheduled for the first half of 2020.
 

26


Net sales by geographic area and by end market for 2019 and 2018 are presented below:
(in thousands)
 
For the Year Ended December 31, 2019
 
For the Year Ended December 31, 2018
Geographic Area
 
 
% of Total
 
 
% of Total
North America
 
$
483,302

89
%
 
$
436,068

88
%
Pacific Rim
 
39,180

7
%
 
42,071

8
%
Europe
 
16,562

3
%
 
13,743

3
%
Others
 
7,032

1
%
 
4,156

1
%
Total
 
$
546,076

100
%
 
$
496,038

100
%

(in thousands)
 
For the Year Ended December 31, 2019
 
For the Year Ended December 31, 2018
End Market
 
 
% of Total
 
 
% of Total
Energy
 
$
222,779

41
%
 
$
185,685

37
%
Industrial
 
180,111

33
%
 
201,196

41
%
Transportation
 
143,186

26
%
 
109,157

22
%
Total
 
$
546,076

100
%
 
$
496,038

100
%
Weichai Transactions
In March 2017, the Company and Weichai entered into a number of transactions (see Note 3. Weichai Transactions, included in Item 8. Financial Statements and Supplementary Data, for additional information), including the issuance of Common and Preferred Stock and a stock purchase warrant to Weichai for aggregate proceeds of $60.0 million. The stock purchase warrant issued to Weichai was exercisable for any number of additional shares of Common Stock such that Weichai, upon exercise, would hold 51% of the Common Stock then outstanding on a fully dilutive basis, on terms and subject to adjustments as provided in the SPA. On April 23, 2019, Weichai exercised the Weichai Warrant and increased its ownership to 51.5% of the Company’s outstanding Common Stock, as of such date.
Through the Weichai Transactions, the Company sought to expand its range of products and its presence in the Pacific Rim.
The Company and Weichai executed the Collaboration Agreement in order to achieve their respective objectives, enhance the cooperation alliance and share experiences, expertise and resources. Among other things, the Collaboration Arrangement established a joint steering committee, permitted Weichai to second a limited number of technical, marketing, sales, procurement and finance personnel to work at the Company and established several collaborations related to stationary natural-gas applications and Weichai diesel engines. The Collaboration Agreement also provides for the steering committee to create various subcommittees with operating roles and otherwise governs the treatment of intellectual property of parties prior to the collaboration and the intellectual property developed during the collaboration. The Collaboration Agreement had a term of three years that was set to expire in March 2020. On March 26, 2020, the Collaboration Agreement was extended for an additional term of three years. For the years ended December 31, 2019 and 2018, sales to Weichai were not material. The Company purchased $4.4 million and $3.5 million of inventory from Weichai during 2019 and 2018, respectively.
Incremental Financial Reporting and Government Investigation Expenses
Incremental financial reporting and government investigation expenses consist of professional services fees related to the Company’s efforts to restate prior period financial statements, prepare, audit and file delinquent financial statements, and remediate internal control material weaknesses as well as fees and reserves related to Company, SEC, and USAO investigations. Since August 2016, the Company has experienced a substantial and disruptive diversion of management resources to address various accounting, financial reporting and financial issues. During that time, the Company determined that it was necessary to restate financial results for 2014 and 2015 as well as the first quarter of 2016 and, since then, has also focused on becoming timely on all of its SEC financial reporting requirements, which is achieved with the filing of this Annual Report on Form 10-K for the year ended December 31, 2019. Additionally, the SEC and the USAO are conducting investigations into the Company’s financial reporting, revenue recognition practices and related conduct (see Note 10. Commitments and Contingencies, included in Part II. Item 8. Financial Statements and Supplementary Data, for additional information). Incremental financial reporting and government investigation expenses, strategic and financing options, and key employee retention and severance-related expenses included in 2019 and 2018 operating results, were $17.5 million and $27.0 million, respectively.

27


Recent Trends and Business Outlook
Recent COVID-19 Outbreak and Oil and Gas Market Price Volatility
The COVID-19 pandemic has resulted in the implementation of significant governmental measures to control the spread of the virus, including quarantines, travel restrictions, business shutdowns, and restrictions on the movement of people in the United States and abroad. These factors, in turn, may not only impact the Company’s operations, financial condition, and demand for its goods and services, but its overall ability to react timely to mitigate the impact of the COVID-19 pandemic. The Company is aggressively beginning the execution of contingency actions as a result of the expected significant negative impacts of these factors. The Company is reviewing operating expenses as part of the contingency planning process, including prioritizing certain R&D investments in support of the Company’s long-term growth objectives. As of the date of this 2019 Annual Report, the Company has implemented the following temporary cost reduction measures designed to mitigate the operating and financial impacts of the COVID-19 pandemic on its business:
reduced the hours of operations of the Company’s production facilities;
reduced the work week for all office employees;
reduced pay for salaried employees by between 10% and 30%, depending on the employee’s position;
suspended the Company’s 401(k) plan match;
deferred spending on certain R&D programs;
implemented a hiring freeze;
restricted all non-essential travel; and
minimized discretionary expenses and consulting services.
The full impact of the COVID-19 pandemic continues to evolve as of the date of this 2019 Annual Report.
The global economy has experienced substantial turmoil including impacts from the world financial markets, which have experienced a period of significant volatility and overall declines. In addition, as of the date of this 2019 Annual Report, due to unprecedented decreases in demand, an oil price war, and economic uncertainty resulting from the COVID-19 pandemic, crude oil prices have declined precipitously. A significant portion of the Company’s sales and profitability is derived from the sale of products that are used within the oil and gas industry. While the Company has yet to experience significant supply chain interruptions or material cancellations of orders, the potential impact of future disruptions, continued economic uncertainty, and continued depressed crude oil prices, and declining rig count levels may have a significant adverse impact that may result in the recognition of material impairments or other related charges.
GM 6.0L Engine Offering: The Company has an exclusive agreement with Freightliner through December 31, 2020 to distribute 6.0L engines to on-highway customers. With the GM announcement that it will discontinue its production of the 6.0L engine, the Company has been conducting last-time buys of this engine to ensure adequate supply to Freightliner and other customers. In relation to these last-time buys, the Company had a net positive cash impact from customer prepayments of approximately $6 million as of December 31, 2019. The Company expects a net positive cash impact from customer prepayments to continue in 2020. The Company does not have a supply agreement with GM for its successor product to the 6.0L engine. However, it is actively exploring opportunities to identify engine alternatives for this product. The Company’s 2019 results included sales of approximately $30 million associated with the shipment of certain engines at the request of one of the Company’s customers (Freightliner) during the fourth quarter of 2019 that were originally scheduled for the first half of 2020.
Hyster-Yale Supply Arrangement: The Company had a multi-year supply agreement with Hyster-Yale, which ended December 31, 2018, for the supply of a range of engines at certain specified volume levels. Since the beginning of 2019, the Company has continued to supply products to Hyster-Yale while the two parties continued to negotiate a new agreement. The Company is nearing the completion of a renewed supply agreement; however, Hyster-Yale has indicated that it will be obtaining alternative supply beginning in 2021 for several high-volume engines that the Company currently provides, including the 2.0L and 2.4L engines sourced from the Company’s supplier SAME. As a result of this, coupled with the discontinuation of a certain engine that the Company provides this customer during 2020, the Company anticipates that its sales volumes to Hyster-Yale may begin to decline in 2020, with further declines expected in 2021 and 2022. The Company believes it is positioned to continue its relationship in a moderated capacity with this customer in 2022 and beyond.
Strategic Initiatives/Growth Strategies: The Company has initiated a set of business objectives aimed at improving profitability, streamlining processes, strengthening the business and focusing on achieving growth in higher-return product lines. Central to this plan is the Company’s increased emphasis on energy product offerings through new product development and investments, in addition to leveraging the Company’s relationship with Weichai. With the introduction of numerous natural gas and diesel engines in 2018 and 2019, coupled with its existing strong product lineup, despite economic disruptions related to the recent COVID-19 pandemic, the Company believes that it has a solid foundation to achieve long-term growth within the energy market.

28


Results of Operations
Results of operations for the year ended December 31, 2019 compared with the year ended December 31, 2018:
(in thousands, except per share amounts)
 
For the Year Ended December 31,
 
 
 
 
 
 
2019
 
2018
 
Change
 
% Change
Net sales
 
$
546,076

 
$
496,038

 
$
50,038

 
10
 %
Cost of sales
 
446,188

 
437,269

 
8,919

 
2
 %
Gross profit
 
99,888

 
58,769

 
41,119

 
70
 %
Gross margin %
 
18.3
%
 
11.8
%
 
6.5
 %
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Research, development and engineering expenses
 
24,932

 
28,601

 
(3,669
)
 
(13
)%
Research, development and engineering expenses as a % of sales
 
4.6
%
 
5.8
%
 
(1.2
)%
 
 
Selling, general and administrative expenses
 
54,114

 
59,631

 
(5,517
)
 
(9
)%
Selling, general and administrative expenses as a % of sales
 
9.9
%
 
12.0
%
 
(2.1
)%
 
 
Asset impairment charges
 
1

 
2,234

 
(2,233
)
 
(100
)%
Amortization of intangible assets
 
3,638

 
5,008

 
(1,370
)
 
(27
)%
Total operating expenses
 
82,685

 
95,474

 
(12,789
)
 
(13
)%
Operating income (loss)
 
17,203

 
(36,705
)
 
53,908

 
(147
)%
Other expense:
 
 
 
 
 
 
 
 
Interest expense
 
7,871

 
7,628

 
243

 
3
 %
Loss from change in value and exercise of warrants
 
1,352

 
10,400

 
(9,048
)
 
(87
)%
Other income, net
 
(677
)
 
(176
)
 
(501
)
 
NM

Total other expense
 
8,546

 
17,852

 
(9,306
)
 
(52
)%
Income (loss) before income taxes
 
8,657

 
(54,557
)
 
63,214

 
(116
)%
Income tax expense
 
409

 
169

 
240

 
142
 %
Net income (loss)
 
$
8,248

 
$
(54,726
)
 
$
62,974

 
(115
)%
 
 
 
 
 
 
 
 
 
Earnings (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
$
0.38

 
$
(2.94
)
 
$
3.32

 
(113
)%
Diluted
 
$
0.38

 
$
(2.94
)
 
$
3.32

 
(113
)%
 
 
 
 
 
 
 
 
 
Non-GAAP Financial Measures:
 
 
 
 
 
 
 
 
Adjusted net income (loss) *
 
$
28,112

 
$
(13,820
)
 
$
41,932

 
NM

Adjusted earnings (loss) per share *
 
$
1.30

 
$
(0.74
)
 
$
2.04

 
NM

EBITDA *
 
$
25,327

 
$
(36,725
)
 
$
62,052

 
(169
)%
Adjusted EBITDA *
 
$
45,191

 
$
4,181

 
$
41,010

 
NM

NM
Not meaningful
*
See reconciliation of non-GAAP financial measures to GAAP results below
Net Sales
Net sales increased $50.0 million, or 10%, in 2019 compared to 2018, as a result of sales increases of $37.1 million and $34.0 million in the energy and transportation end markets, respectively, partially offset by a sales decline of $21.1 million in the industrial end market. The increased sales within the energy end market were primarily attributable to stronger demand for power generation products, including those used within the oil and gas market, and increased demand for demand response products. The increased sales within the transportation end market were primarily attributable to higher demand for products used in the medium-duty truck market and included approximately $30 million of sales associated with the aforementioned shipment of certain engines at the request of one of the Company’s customers, Freightliner, during the fourth quarter of 2019 that were originally scheduled for the first half of 2020. Also, to a lesser degree, the increased sales were a result of higher demand for products used in the school bus market. The sales decline within the industrial end market was primarily attributable to lower demand for products used in the material handling/forklift and arbor care markets.



29


Gross Profit
Gross margin was 18.3% and 11.8% in 2019 and 2018, respectively. Gross profit increased in 2019 by $41.1 million, or 70%, compared to 2018 primarily due to the sales growth noted above, coupled with favorable product mix, strategic pricing actions, lower warranty costs and operational productivity improvements. For 2019, warranty costs of $10.1 million (net of supplier and insurance recoveries of $3.0 million), including $2.7 million of charges for adjustments to preexisting warranties, declined by $8.5 million as compared to 2018 warranty costs of $18.6 million (net of supplier recoveries of $1.1 million), including $3.8 million of charges for adjustments to preexisting warranties. The 2019 warranty costs included $0.6 million of charges related to specific engine supplier quality issues, for which the Company is actively seeking cost reimbursement.
Research, Development and Engineering Expenses
Research, development and engineering expenses in 2019 were $24.9 million, a decrease of $3.7 million, or 13%, from 2018 levels, primarily as a result of decreased spending on project activity during the year.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) decreased in 2019 by $5.5 million, or 9%, compared to 2018. The decrease in SG&A expenses is largely attributable to lower incremental financial reporting and government investigation expenses, which were $15.1 million in 2019, a decrease of $9.1 million, as compared to $24.2 million in 2018. Lower incremental financial reporting and government investigation expenses were primarily due to a decrease in professional services expenses related to the restatement and audit of the 2017 and prior year restated financial statements filed in May 2019. In addition, key employee retention program expenses, strategic alternatives and strategic review expenses and stock-based compensation were lower by $2.1 million, $0.2 million, and $0.2 million, respectively, in 2019. These decreases were partially offset by higher wages, benefits, and incentive compensation expense in 2019 as compared to 2018. The Company also incurred severance and post-employment costs of $2.0 million in 2019 as compared to an absence of these costs in 2018. As a percentage of net sales, SG&A expenses were 9.9% and 12.0% in 2019 and 2018, respectively.
Asset Impairment Charges
Asset impairment charges decreased in 2019 as immaterial impairment charges were recorded during the year related to certain long-lived assets that were no longer in service. In the fourth quarter of 2018, based on uncertainty of the market for the conversion of certain gasoline engines to alternative fuel engines, the Company concluded that the projected future cash flows were not sufficient to recover the carrying value of certain developed technology intangible assets acquired from AGA Systems, LLC (“AGA”). As a result, the Company recorded an impairment charge of $2.2 million to write off the remaining book value of the intangible assets.
Interest Expense
Interest expense increased $0.3 million to $7.9 million in 2019 from $7.6 million in 2018.
The Wells Fargo Base and London Interbank Offered Rate - “LIBOR” interest rates were 6.3% and 5.0% per annum, respectively, at December 31, 2019, and the Base and LIBOR interest rates were 7.3% and 6.0% at December 31, 2018, respectively. The interest rate on the Unsecured Senior Notes was 6.5% at January 1, 2018, and increased to 8.5% in October 2018. The interest rate on the Unsecured Senior Notes declined to 7.5% in May 2019 upon the filing of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
Loss from Change in Value and Exercise of Warrants
The Company recognized a loss of $1.4 million and $10.4 million in 2019 and 2018, respectively, from the change in the value of the Weichai Warrant. The Weichai Warrant was exercised in April 2019 and the impact of the exercise is reflected in the 2019 loss of $1.4 million. See Note 3. Weichai Transactions and Note 8. Fair Value of Financial Instruments, included in Item 8. Financial Statements and Supplementary Data, for additional information.
Other Income, Net
Other income, net increased by $0.5 million in 2019 principally as a result of improved performance in the Company’s joint venture with Doosan which is accounted for as an equity method investment. See Note 15. Related Party Transactions included in Item 8. Financial Statements and Supplementary Data, for additional information.
Income Tax Expense
The Company recorded income tax expense of $0.4 million in 2019, as compared to $0.2 million for 2018. The Company’s pretax income was $8.7 million in 2019 compared to a pretax loss of $54.6 million in 2018. There was no significant change in the Company’s tax provision as the Company continues to record a full valuation allowance against deferred tax assets. See Note 11. Income Taxes, included in Item 8. Financial Statements and Supplementary Data, for additional information related to the Company’s income tax provision.

30


Non-GAAP Financial Measures
In addition to the results provided in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) above, this report also includes non-GAAP (adjusted) financial measures. Non-GAAP financial measures provide insight into selected financial information and should be evaluated in the context in which they are presented. These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation from, or as a substitute for, financial information presented in compliance with U.S. GAAP, and non-GAAP financial measures as reported by the Company may not be comparable to similarly titled amounts reported by other companies. The non-GAAP financial measures should be considered in conjunction with the consolidated financial statements, including the related notes, and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report. Management does not use these non-GAAP financial measures for any purpose other than the reasons stated below.
Non-GAAP Financial Measure
Comparable GAAP Financial Measure
Adjusted net income (loss)
Net income (loss)
Adjusted earnings (loss) per share
Earnings (loss) per common share – diluted
EBITDA
Net income (loss)
Adjusted EBITDA
Net income (loss)
The Company believes that Adjusted net income (loss), Adjusted earnings (loss) per share, EBITDA, and Adjusted EBITDA provide relevant and useful information, which is widely used by analysts, investors and competitors in its industry as well as by the Company’s management in assessing the performance of the Company. Adjusted net income (loss) is defined as net income as adjusted for certain items that the Company believes are not indicative of its ongoing operating performance. Adjusted earnings (loss) per share is a measure of the Company’s diluted net earnings (loss) per share adjusted for the impact of special items. EBITDA provides the Company with an understanding of earnings before the impact of investing and financing charges and income taxes. Adjusted EBITDA further excludes the effects of other non-cash and certain other items that do not reflect the ordinary earnings of the Company’s operations.
Adjusted net income (loss), Adjusted earnings (loss) per share, EBITDA, and Adjusted EBITDA are used by management for various purposes, including as a measure of performance of the Company’s operations and as a basis for strategic planning and forecasting. Adjusted net income (loss), Adjusted earnings (loss) per share, and Adjusted EBITDA may be useful to an investor because these measures are widely used to evaluate companies’ operating performance without regard to items excluded from the calculation of such measures, which can vary substantially from company to company depending on the accounting methods, the book value of assets, the capital structure and the method by which the assets were acquired, among other factors. They are not, however, intended as an alternative measure of operating results or cash flow from operations as determined in accordance with U.S. GAAP.
The following table presents a reconciliation from Net income (loss) to Adjusted net income (loss):
(in thousands)
 
For the Year Ended December 31,
 
 
2019
 
2018
Net income (loss)
 
$
8,248

 
$
(54,726
)
Changes in value of warrants 1
 
1,352

 
10,400

Stock-based compensation 2
 
988

 
1,229

Asset impairment charges 3
 
1

 
2,234

Key employee retention program 4
 
422

 
2,567

Strategic alternatives and strategic review expenses 5
 

 
247

Severance 6
 
1,995

 

Incremental financial reporting and government investigation expenses 7
 
15,106

 
24,229

Adjusted net income (loss)
 
$
28,112

 
$
(13,820
)

31


The following table presents a reconciliation from Earnings (loss) per common share – diluted to Adjusted earnings (loss) per share:
 
 
For the Year Ended December 31,
 
 
2019
 
2018
Earnings (loss) per common share – diluted
 
$
0.38

 
$
(2.94
)
Changes in value of warrants 1
 
0.06

 
0.56

Stock-based compensation 2
 
0.05

 
0.07

Asset impairment charges 3
 

 
0.12

Key employee retention program 4
 
0.02

 
0.14

Strategic alternatives and strategic review expenses 5
 

 
0.01

Severance 6
 
0.09

 

Incremental financial reporting and government investigation expenses 7
 
0.70

 
1.30

Adjusted earnings (loss) per share – diluted
 
$
1.30

 
$
(0.74
)
 
 
 
 
 
Diluted shares (in thousands)
 
21,530

 
18,585

The following table presents a reconciliation from Net income (loss) to EBITDA and Adjusted EBITDA:
(in thousands)
 
For the Year Ended December 31,
 
 
2019
 
2018
Net income (loss)
 
$
8,248

 
$
(54,726
)
Interest expense
 
7,871

 
7,628

Income tax expense
 
409

 
169

Depreciation
 
5,161

 
5,196

Amortization of intangible assets
 
3,638

 
5,008

EBITDA
 
25,327

 
(36,725
)
Changes in value of warrants 1
 
1,352

 
10,400

Stock-based compensation 2
 
988

 
1,229

Asset impairment charges 3
 
1

 
2,234

Key employee retention program 4
 
422

 
2,567

Strategic alternatives and strategic review expenses 5
 

 
247

Severance 6
 
1,995

 

Incremental financial reporting and government investigation expenses 7
 
15,106

 
24,229

Adjusted EBITDA
 
$
45,191

 
$
4,181

1.
Amounts consist of changes in the value, including the impact of the exercise in April 2019, of the Weichai Warrant.
2.
Amounts reflect non-cash stock-based compensation expense (2019 and 2018 amounts excludes $0.3 million and $1.4 million, respectively, associated with the retention programs, see note 4 below).
3.
Amount in 2018 primarily reflects impairment of developed technology assets acquired from AGA as discussed further in Item 8. Financial Statements and Supplementary Data, Note 5. Goodwill and Other Intangibles.
4.
Amount represents incremental compensation costs (including $0.3 million and $1.4 million in 2019 and 2018, respectively, of stock-based compensation) incurred to provide retention benefits to certain employees.
5.
Represents professional services expenses incurred in connection with the evaluation of strategic alternatives and financing options.
6.
Amounts represent severance and other post-employment costs for certain former employees of the Company.
7.
Amounts represent professional services fees related to the Company’s efforts to restate prior period financial statements, prepare, audit and file delinquent financial statements, and remediate internal control material weaknesses as well as fees and reserves related to the SEC and USAO investigations. The amounts exclude $1.2 million and $1.6 million of professional services fees related to the audit of the Company’s financial statements and ongoing internal control remediation in 2019 and 2018, respectively.

32


Cash Flows
Cash was impacted as follows:
(in thousands)
 
For the Year Ended December 31,
 
 
 
 
 
 
2019
 
2018
 
Change
 
% Change
Net cash provided by (used in) operating activities
 
$
18,157

 
$
(6,168
)
 
$
24,325

 
NM

Net cash used in investing activities
 
(3,658
)
 
(10,239
)
 
6,581

 
(64
)%
Net cash (used in) provided by financing activities
 
(14,550
)
 
16,461

 
(31,011
)
 
NM

Net (decrease) increase in cash and restricted cash
 
$
(51
)
 
$
54

 
$
(105
)
 
NM

Capital expenditures
 
$
(3,681
)
 
$
(3,645
)
 
$
(36
)
 
1
 %
2019 Cash Flows
Cash Flow from Operating Activities
Net cash provided by operations was $18.2 million in 2019 compared to net cash used in operations of $6.2 million in 2018 resulting in an increase of $24.3 million in cash provided by operating activities year-over-year. This was primarily due to improvement in net income of $63.0 million, partially offset by a decline in non-cash adjustments of $16.2 million and cash generated from working capital of $22.5 million. During 2019, working capital requirements resulted in a cash outflow of $2.9 million compared to a cash inflow of $19.5 million in 2018. The net cash outflow from working capital in 2019 was primarily due to higher inventory related to the GM 6.0L engines purchased for Freightliner and lower accounts payable partially offset by higher accrued expenses and other liabilities.
Cash Flow from Investing Activities
Net cash used in investing activities was $3.7 million in 2019 compared to net cash used in investing activities of $10.2 million in 2018 resulting in a decrease of $6.6 million of net cash used in investing activities year-over-year. Cash flows from investing activities in 2019 primarily consisted of capital expenditures of $3.7 million which was consistent with capital expenditures in 2018. There was no cash used for asset acquisitions in 2019 compared to $6.6 million used in 2018.
Cash Flow from Financing Activities
The Company used $14.6 million in cash for financing activities in 2019 compared to $16.5 million in cash generated by financing activities in 2018, resulting in an increase of $31.0 million used by financing activities year over year. Primary cash outflows in 2019 were $15.1 million in net repayments of the revolving line of credit.
Liquidity and Capital Resources
On April 2, 2020, the Company closed on its new senior secured revolving credit facility pursuant to the Credit Agreement with Standard Chartered, which allows the Company to borrow up to $130.0 million, and matures on March 26, 2021 with an optional 60-day extension subject to certain conditions and the payment of a 0.25% extension fee. Borrowings under the Credit Agreement shall bear interest at either the alternate base rate or LIBOR plus 2.00%, and the Company is required to pay a 0.25% commitment fee on the average daily unused portion of the revolving credit facility under the Credit Agreement. The Credit Agreement is secured by substantially all of the Company’s assets and includes certain financial covenants as well as a change of control provision. On April 2, 2020, the Company borrowed $95.0 million under the Credit Agreement and utilized the funds to (i) repay the outstanding balance of $16.8 million under the Wells Fargo Credit Agreement, (ii) fully redeem and discharge $55.0 million in aggregate principal amount of the Unsecured Senior Notes and pay related interest, and (iii) for general corporate purposes. The Wells Fargo Credit Agreement was terminated in connection with the repayment of the outstanding balance. On April 29, 2020, the Company borrowed an additional $35.0 million under the Credit Agreement, which is the remaining portion of availability, providing the Company with greater financial flexibility. As of April 29, 2020, the Company had borrowings outstanding of $130.0 million under the Credit Agreement and a cash balance in excess of $45 million. These amounts reflect a net positive cash impact from customer prepayments of $11.8 million.
Significant uncertainties exist about the Company’s ability to refinance, extend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Credit Agreement. Based on the Company’s current forecasts, without additional financing, the Company anticipates that it will not have sufficient cash and cash equivalents to repay the Credit Agreement by the March 26, 2021 maturity date. Management currently plans to seek additional liquidity from its current or other lenders before March 26, 2021. There can be no assurance that the Company will be able to successfully complete a refinancing on or before March 26, 2021 on acceptable terms or repay this outstanding indebtedness when required or if at all.

33


Additionally, in early 2020, the global economy has experienced substantial turmoil including impacts from the world financial markets which have experienced a period of significant volatility and overall declines. In addition, in early March 2020, due to unprecedented decreases in demand, an oil price war, and economic uncertainty resulting from the COVID-19 pandemic, crude oil prices have declined precipitously. A significant portion of the Company’s sales and profitability is derived from the sale of products that are used within the oil and gas industry. While the Company has yet to experience supply chain interruptions or material cancellations of orders, the potential impact of future disruptions, continued economic uncertainty, and continued depressed crude oil prices and declining rig count levels may have a significant adverse impact that may result in the recognition of material impairments or other related charges. Moreover, the full impact of the COVID-19 pandemic on the Company’s operations and liquidity continues to evolve.
Due to uncertainties surrounding the Company’s future ability to refinance, extend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Credit Agreement, substantial doubt exists as to its ability to continue as a going concern within one year after the date that these financial statements are issued. If the Company does not have sufficient liquidity to fund its business activities, it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
As of December 31, 2019, the Company’s total debt obligations under the Wells Fargo Credit Agreement and the Unsecured Senior Notes were $94.3 million in the aggregate, with available borrowing capacity of $14.9 million under the Wells Fargo Credit Agreement. In relation to last-time buys of GM 6.0L engines, the Company had a net positive impact from customer prepayments of approximately $5.6 million as of December 31, 2019.
The Wells Fargo Credit Agreement contained certain covenants for which a failure to satisfy could have resulted in a default under the Credit Agreement. See Item 8. Financial Statements and Supplementary Data Note 6. Debt for additional information related to a waiver obtained from Wells Fargo on May 16, 2019 that waived the failure to satisfy financial information covenants through December 31, 2019.
Off-Balance Sheet Arrangements
At December 31, 2019, the Company had seven outstanding letters of credit totaling $3.0 million. See Item 8. Financial Statements and Supplementary Data, Note 10. Commitments and Contingencies for additional information related to the Company’s off-balance sheet arrangements and the outstanding letters of credit.
Commitments and Contingencies
Legal matters are further discussed in Note 10. Commitments and Contingencies, included in Item 8. Financial Statements and Supplementary Data. See Part I. Item 1A. Risk Factors for further discussion of legal risks to the Company.
Critical Accounting Policies and Estimates
The Company’s consolidated financial statements are prepared in accordance with U.S. GAAP. Preparation of these financial statements requires the Company to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company’s most critical accounting policies and estimates are those most important to the portrayal of its financial condition and results of operations and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. The Company has identified the following as its most critical accounting policies and judgments. Although management believes that its estimates and assumptions are reasonable, they are based on information available when they are made and, therefore, may differ from estimates made under different assumptions or conditions.
The Company’s significant accounting policies are discussed in Note 1. Summary of Significant Accounting Policies and Other Information, included in Item 8. Financial Statements and Supplementary Data, and should be reviewed in connection with the following discussion of accounting policies that require difficult, subjective and complex judgments.
Revenue Recognition
The Company determines the amount of revenue to be recognized through the following steps:
identification of the contract, or contracts with a customer;
identification of the performance obligations in the contract;
determination of the transaction price;
allocation of the transaction price to the performance obligations in the contract; and
recognition of revenue when, or as, the Company satisfies the performance obligations.
Revenue for the Company is generated from contracts that may include a single performance obligation or multiple performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account for revenue recognition. Revenue is measured at the transaction price which is based on the amount of consideration

34


that the Company expects to receive in exchange for transferring the promised goods or services to the customer. The transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company is required to estimate the total consideration expected to be received from contracts with customers. The consideration expected to be received may be variable based on the specific terms of the contract and the Company’s past practices.
For contracts with multiple performance obligations, the Company allocates the total transaction price to distinct performance obligations based on directly observable data, if available, or the Company’s best estimate of the stand-alone selling price of each distinct performance obligation. The primary method used to estimate the stand-alone selling price is the cost plus a margin approach.
The Company applies significant judgment in order to identify and determine the number of performance obligations, determine the total transaction price, allocate the transaction price to each performance obligation, and determine the appropriate timing of revenue recognition.
The Company’s payment terms are less than one year, and its sales arrangements do not contain any significant financing components.
Timing of revenue recognition. The Company recognizes revenue related to performance obligations in its contracts with customers when control passes to the customer. Control passes to the customer when the customer has the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. For the majority of the Company’s products, revenue is recognized at a point in time when the products are shipped or delivered to the customer based on the shipping terms as that is the point in time when control passes to the customer.
The Company also recognizes revenue over time primarily when the Company’s performance obligations include: enhancing a customer-controlled asset (generally when an engine is provided by the customer), constructing an asset with no alternative future use and the Company has an enforceable right to payment throughout the period as the services are performed or providing an extended warranty beyond the Company’s standard warranty. The Company recognizes revenue throughout the manufacturing process when constructing an asset based on labor hours incurred because the customer receives the benefit of the asset as the product is constructed. The Company believes labor hours incurred relative to total estimated labor hours at completion faithfully depicts the transfer of control to the customer. The Company recognizes revenue related to extended warranty programs based on the passage of time over the extended warranty period.
Variable consideration. Variable consideration primarily includes rebates and discounts. The Company estimates the projected amount of rebates and discounts based on current assumptions, customer-specific information and historical experience. Variable consideration is recorded as a reduction of revenue to the extent that it is probable that there will not be significant changes to the Company’s estimate of variable consideration when any uncertainties are settled.
Inventories
The Company’s inventories consist primarily of engines and parts. Engines are valued at the lower of cost plus estimated freight-in or net realizable value. Parts are valued at the lower of cost (first-in, first out) or net realizable value. Net realizable value approximates replacement cost.
It is the Company’s policy to review inventories on a continuous basis for obsolete, excess and slow-moving items and to record valuation adjustments for such items in order to eliminate non-recoverable costs from inventory. The Company writes down inventory for an estimated amount equal to the difference between the cost of the inventory and the estimated realizable value. Additionally, an inventory reserve is provided based upon the Company’s estimate of future demand for the quantity of inventory on hand. In determining an estimate of future demand, multiple factors are taken into consideration, including (i) customer purchase orders and customer projected demand, (ii) historical sales/usage for each inventory item and (iii) utilization within a current or anticipated future power system. These factors are primarily based upon quantifiable information, and therefore the Company has not experienced significant differences in inventory valuation due to variances in the Company’s estimation of future demand.
Goodwill Impairment
Goodwill represents the excess of purchase price and related costs over the values assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is not amortized, but instead it is tested for impairment annually, or more frequently if circumstances indicate that a possible impairment may exist.

35


The Company performs its annual impairment test using the discounted cash flow method which involves the Company’s management making estimates with respect to a variety of factors that will significantly impact the future performance of the business, including the following:
future volume projections;
estimated margins on sales;
estimated growth rate for SG&A costs;
future effective tax rate; and
weighted-average cost of capital (“WACC”) used to discount future performance of the Company.
Because these estimates form a basis for the determination of whether or not the impairment charge should be recorded, these estimates are considered to be critical accounting estimates.
As of December 31, 2019, the Company has $29.8 million of goodwill. Future goodwill impairment charges may be required for certain reporting units if the reporting units suffer declines in profitability due to changes in volume, market pricing, cost or the business environment. Significant adverse changes to the Company’s business environment and future cash flows could cause the recognition of impairment charges, which could be material, in future periods.
As a result of the recent COVID-19 pandemic and its impacts on the global economy, it is reasonably possible that the Company will be adversely impacted in future periods which may result in the recognition of material goodwill impairment charges.
Impairment of Long-Lived Assets
Long-lived assets, other than goodwill which is separately tested for impairment, are evaluated for impairment whenever events indicate that the carrying amount of such assets may not be recoverable. Potential indicators of impairment may include a deteriorating business climate, an asset remaining idle for more than a short period of time, advances in technology, or plans to discontinue use of, or change, in the business model for the operation in which a long-lived asset is used. The Company evaluates long-lived assets for impairment by comparing the carrying value of the long-lived assets with the estimated future net undiscounted cash flows expected to result from the use of the assets, including cash flows from disposition. If the future net undiscounted cash flows are less than the carrying value, the Company then calculates an impairment loss. The impairment loss is calculated by comparing the long-lived asset’s carrying value with its estimated fair value, which may be based on estimated future discounted cash flows. The Company also periodically reevaluates the useful lives of its long-lived assets due to advances and changes in its technologies.
The Company’s impairment loss calculations contain critical estimates because they require the Company’s management to make assumptions and to apply judgment to estimate future cash flows and long-lived asset fair values, including forecasting useful lives of the long-lived assets and selecting discount rates.
If actual results are not consistent with the assumptions used, the Company could experience an impairment triggering event and be exposed to losses that could be material. As a result of the recent COVID-19 pandemic and its impacts on the global economy, it is reasonably possible that the Company will be adversely impacted in future periods which may result in the recognition of material impairment charges related to its long-lived assets.
During 2019, the Company incurred immaterial impairment charges related to certain assets no longer in service. During 2018, the Company recognized an impairment charge of $2.2 million which primarily related to developed technology acquired in the AGA acquisition. See Note 5. Goodwill and Other Intangibles, included in Item 8. Financial Statements and Supplementary Data.
Warranty
The Company offers a standard limited warranty on the workmanship of its products that in most cases covers defects for a defined period. Warranties for certified emission products are mandated by the EPA and/or the CARB and are generally longer than the Company’s standard warranty on certain emission-related products. The Company’s products may also carry limited warranties from suppliers. The Company’s warranties generally apply to engines fully manufactured by the Company and to the modifications the Company makes to supplier base products. Costs related to supplier warranty claims are often times borne by the supplier and passed through to the end customer. The Company estimates and records a liability and related charges to income for its warranty program at the time products are sold to customers. Estimates are based on historical experience and reflect management’s best estimates of expected costs at the time products are sold. As of December 31, 2019, the Company had warranty reserves of $25.5 million.
The Company records adjustments to preexisting warranties for changes in its estimate of warranty costs for products sold in prior fiscal years in the period in which it is determined that actual costs may differ from the Company’s initial or previous estimates. Such adjustments typically occur when new information received by the Company indicates claims experience deviates from historical and expected trends. During 2019, the Company recognized a charge for adjustments to preexisting warranties of $2.7 million compared to a charge of $3.8 million in 2018.

36


When the Company identifies cost effective opportunities to address issues in products sold or corrective actions for safety issues, it initiates product recalls or field campaigns. As a result of the uncertainty surrounding the nature and frequency of product recalls and field campaigns, the liability for such actions is generally recorded when the Company commits to a product recall or field campaign. In each subsequent quarter after a recall or field campaign is initiated, the recorded warranty liability balance is analyzed, reviewed and adjusted, if necessary, to reflect any changes in the anticipated average cost of repair or number of repairs to be completed prospectively.
When collection is reasonably assured, the Company also estimates the amount of warranty claim recoveries to be received from its suppliers. Warranty costs and recoveries are included in Cost of sales in the Consolidated Statements of Operations.
Weichai Warrants
The Weichai Warrants were measured at fair value based on unobservable inputs and, therefore, were classified as Level 3 in the fair-value hierarchy.
The Weichai Warrant was issued in March 2017 and is further discussed in Note 3. Weichai Transactions, included in Item 8. Financial Statements and Supplementary Data. The monetary value of the Weichai Warrant was dependent both on variations in the fair value of the Company’s Common Stock and on the estimated number of shares required to settle its terms. The fair value of the Weichai Warrant liability was estimated using the Black-Scholes option pricing model and Monte Carlo simulations. Significant inputs into the valuation includes the market value of the Company’s Common Stock, the estimated exercise price of the warrant (including a price adjustment) and the estimated price volatility. Given the unobservable nature of certain inputs to the valuation of the Weichai Warrant, the Weichai Warrant was classified as Level 3 in the fair-value hierarchy. Significant changes in the estimates of these inputs could result in material changes to the liability, with the changes in value recorded in the Consolidated Statements of Operations. The Weichai Warrant was exercised in April 2019.
Deferred Tax Asset Valuation Allowance
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to be settled or realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company records net deferred tax assets to the extent that the Company believes the assets will more likely than not be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies and results of recent operations. Valuation allowances are established when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. The ultimate recovery of deferred tax assets is dependent upon the amount and timing of future taxable income and other factors such as the taxing jurisdiction in which the asset is to be recovered. A high degree of judgment is required to determine if, and the extent to which, valuation allowances should be recorded against deferred tax assets.
As of December 31, 2019 and 2018, the Company recorded a deferred tax asset valuation allowance of $41.7 million and $44.4 million, respectively. Although the Company believes that its approach to estimates and judgments as described herein is reasonable, actual results could differ, and the Company may be exposed to increases or decreases in income taxes that could be material. See Note 11. Income Taxes, included in Item 8. Financial Statements and Supplementary Data, for additional information regarding the deferred tax valuation allowance.
Uncertain Tax Positions
The Company records uncertain tax positions on the basis of a two-step process whereby (i) the Company determines whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is greater than 50% likely to be realized upon ultimate settlement with the related tax authority. The Company recognizes interest and penalties related to uncertain tax positions as part of income tax expense. As of December 31, 2019 and 2018, the Company had unrecognized tax benefits of $1.4 million and $1.4 million, respectively, for uncertain tax positions. See Note 11. Income Taxes, included in Item 8. Financial Statements and Supplementary Data, for additional information regarding uncertain tax provisions.
Impact of New Accounting Standards
For information about recently issued accounting pronouncements, see Note 1. Summary of Significant Accounting Policies and Other Information, included in Item 8. Financial Statements and Supplementary Data.

37


Item 7A.    Quantitative and Qualitative Disclosures about Market Risk.
The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this item.

38


Item 8.    Financial Statements and Supplementary Data.
The following consolidated financial statements are included in Item 8 of this Form 10-K.
Index to Consolidated Financial Statements
 
Page
Consolidated Financial Statements of Power Solutions International, Inc.
 
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2019 and 2018
Consolidated Statements of Operations for 2019 and 2018
Consolidated Statements of Stockholders’ Equity (Deficit) for 2019 and 2018
Consolidated Statements of Cash Flows for 2019 and 2018
Notes to Consolidated Financial Statements

39


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Power Solutions International, Inc.
Wood Dale, Illinois 
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Power Solutions International, Inc. (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Going Concern Uncertainty
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, significant uncertainties exist about the Company’s ability to refinance, extend, or repay outstanding indebtedness and maintain sufficient liquidity to fund its business activities. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Change in Accounting Method Related to Leases
As discussed in Note 1 to the consolidated financial statements, the Company has changed its method for accounting for leases in 2019 due to the adoption of Accounting Standards Codification Topic 842 Leases.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ BDO USA, LLP
We have served as the Company’s auditor since 2018.
Chicago, Illinois
May 4, 2020

40


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS

(in thousands, except par values)
 
As of December 31,
 
 
2019
 
2018
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
3

 
$
54

Accounts receivable, net of allowances of $3,561 and $2,596 as of December 31, 2019 and December 31, 2018, respectively
 
104,515

 
86,471

Income tax receivable
 
1,055

 
973

Inventories, net
 
108,839

 
105,614

Prepaid expenses and other current assets
 
8,110

 
22,917

Total current assets
 
222,522

 
216,029

Property, plant and equipment, net
 
23,194

 
24,266

Intangible assets, net
 
13,372

 
17,010

Goodwill
 
29,835

 
29,835

Other noncurrent assets
 
24,749

 
2,742

TOTAL ASSETS
 
$
313,672

 
$
289,882

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
75,835

 
$
85,218

Current maturities of long-term debt
 
195

 
80

Revolving line of credit
 
39,527

 
54,613

Warrant liability
 

 
35,100

Other accrued liabilities
 
66,030

 
45,700

Total current liabilities
 
181,587

 
220,711

Deferred income taxes
 
1,105

 
647

Long-term debt, net of current maturities
 
55,657

 
55,088

Noncurrent contract liabilities
 
17,998

 
14,611

Other noncurrent liabilities
 
28,828

 
17,403

TOTAL LIABILITIES
 
$
285,175

 
$
308,460

 
 
 
 
 
STOCKHOLDERS’ EQUITY (DEFICIT)
 
 
 
 
Preferred stock – $0.001 par value. Shares authorized: 5,000. No shares issued and outstanding at all dates.
 
$

 
$

Common stock – $0.001 par value; 50,000 shares authorized; 23,117 and 19,067 shares issued; 22,857 and 18,638 shares outstanding at December 31, 2019 and December 31, 2018, respectively
 
23

 
19

Additional paid-in capital
 
165,527

 
126,412

Accumulated deficit
 
(126,912
)
 
(135,160
)
Treasury stock, at cost, 260 and 429 shares at December 31, 2019 and December 31, 2018, respectively
 
(10,141
)
 
(9,849
)
TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)
 
28,497

 
(18,578
)
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
$
313,672

 
$
289,882

See Notes to Consolidated Financial Statements

41


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)
 
For the Year Ended December 31,
 
 
2019
 
2018
Net sales
 
$
546,076

 
$
496,038

Cost of sales
 
446,188

 
437,269

Gross profit
 
99,888

 
58,769

Operating expenses:
 
 
 
 
Research, development and engineering expenses
 
24,932

 
28,601

Selling, general and administrative expenses
 
54,114

 
59,631

Asset impairment charges
 
1

 
2,234

Amortization of intangible assets
 
3,638

 
5,008

Total operating expenses
 
82,685

 
95,474

Operating income (loss)
 
17,203

 
(36,705
)
Other expense:
 
 
 
 
Interest expense
 
7,871

 
7,628

Loss from change in value and exercise of warrants
 
1,352

 
10,400

Other income, net
 
(677
)
 
(176
)
Total other expense
 
8,546

 
17,852

Income (loss) before income taxes
 
8,657

 
(54,557
)
Income tax expense
 
409

 
169

Net income (loss)
 
$
8,248

 
$
(54,726
)
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
Basic
 
21,512

 
18,585

Diluted
 
21,530

 
18,585

Earnings (loss) per common share:
 
 
 
 
Basic
 
$
0.38

 
$
(2.94
)
Diluted
 
$
0.38

 
$
(2.94
)
See Notes to Consolidated Financial Statements

42


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(in thousands)
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Deficit
 
Treasury Stock
 
Total Stockholders’ Equity (Deficit)
Balance at December 31, 2017
 
$
19

 
$
123,838

 
$
(82,147
)
 
$
(9,538
)
 
$
32,172

Net loss
 

 

 
(54,726
)
 

 
(54,726
)
Stock-based compensation expense
 

 
2,974

 

 
(311
)
 
2,663

Payment of withholding taxes for net settlement of stock-based awards
 

 
(400
)
 

 

 
(400
)
Cumulative effect of adoption of ASC 606
 

 

 
1,713

 

 
1,713

Balance at December 31, 2018
 
19

 
126,412

 
(135,160
)
 
(9,849
)
 
(18,578
)
Net income
 

 

 
8,248

 

 
8,248

Stock-based compensation expense
 

 
1,540

 

 
(292
)
 
1,248

Payment of withholding taxes for net settlement of stock-based awards
 

 
(489
)
 

 

 
(489
)
Issuance of common stock to Weichai
 
4

 
38,064

 

 

 
38,068

Balance at December 31, 2019
 
$
23

 
$
165,527

 
$
(126,912
)
 
$
(10,141
)
 
$
28,497

See Notes to Consolidated Financial Statements

43


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
 
For the Year Ended December 31,
 
 
2019
 
2018
Cash provided by (used in) operating activities
 
 
 
 
Net income (loss)
 
$
8,248

 
$
(54,726
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
Amortization of intangible assets
 
3,638

 
5,008

Depreciation
 
5,161

 
5,196

Change in value and exercise of warrants
 
1,352

 
10,400

Stock-based compensation expense
 
1,248

 
2,663

Amortization of financing fees
 
698

 
1,497

Deferred income taxes
 
457

 
(56
)
Asset impairment charges
 
1

 
2,234

Other non-cash adjustments, net
 
276

 
2,085

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
(18,095
)
 
(17,890
)
Inventory, net
 
(3,977
)
 
(26,202
)
Prepaid expenses and other assets
 
17,125

 
(761
)
Accounts payable
 
(9,494
)
 
33,968

Accrued expenses
 
13,948

 
11,630

Other noncurrent liabilities
 
(2,429
)
 
18,786

Net cash provided by (used in) operating activities
 
18,157

 
(6,168
)
Cash used in investing activities
 
 
 
 
Capital expenditures
 
(3,681
)
 
(3,645
)
Asset acquisitions
 

 
(6,595
)
Other investing activities, net
 
23

 
1

Net cash used in investing activities
 
(3,658
)
 
(10,239
)
Cash (used in) provided by financing activities
 
 
 
 
Proceeds from revolving line of credit
 
544,146

 
516,440

Repayments of revolving line of credit
 
(559,232
)
 
(498,881
)
Proceeds from Weichai Warrant exercise
 
1,616

 

Other financing activities, net
 
(1,080
)
 
(1,098
)
Net cash (used in) provided by financing activities
 
(14,550
)
 
16,461

Net (decrease) increase in cash and restricted cash
 
(51
)
 
54

Cash and restricted cash at beginning of the year
 
54

 

Cash and restricted cash at end of the year
 
$
3

 
$
54

See Notes to Consolidated Financial Statements

44


POWER SOLUTIONS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1.    Summary of Significant Accounting Policies and Other Information
Nature of Business Operations
Power Solutions International, Inc. (“Power Solutions,” “PSI” or the “Company”), a Delaware corporation, is a global producer and distributor of a broad range of high-performance, certified, low-emission power systems, including alternative-fueled power systems for original equipment manufacturers (“OEMs”) of off-highway industrial equipment and certain on-road vehicles and large custom-engineered integrated electrical power generation systems.
The Company’s customers include large, industry-leading and multinational organizations. The Company’s products and services are sold predominantly to customers throughout North America as well as to customers located throughout the Pacific Rim and Europe. The Company’s power systems are highly engineered, comprehensive systems which, through the Company’s technologically sophisticated development and manufacturing processes, including its in-house design, prototyping, testing and engineering capabilities and its analysis and determination of the specific components to be integrated into a given power system (driven in large part by emission standards and cost considerations), allow the Company to provide its customers with power systems customized to meet specific OEM application requirements, other technical customers’ specifications and requirements imposed by environmental regulatory bodies.
The Company’s power system configurations range from a basic engine integrated with appropriate fuel system components to completely packaged power systems that include any combination of cooling systems, electronic systems, air intake systems, fuel systems, housings, power takeoff systems, exhaust systems, hydraulic systems, enclosures, brackets, hoses, tubes and other assembled componentry. The Company also designs and manufactures large, custom-engineered integrated electrical power generation systems for both standby and prime power applications. The Company purchases engines from third-party suppliers and produces internally designed engines, all of which are then integrated into its power systems.
Of the other components that the Company integrates into its power systems, a substantial portion consist of internally designed components and components for which it coordinates significant design efforts with third-party suppliers, with the remainder consisting largely of parts that are sourced off-the-shelf from third-party suppliers. Some of the key components (including purchased engines) embody proprietary intellectual property of the Company’s suppliers. As a result of its design and manufacturing capabilities, the Company is able to provide its customers with a power system that can be incorporated into a customer’s specified application. In addition to the certified products described above, the Company sells diesel, gasoline and non-certified power systems and aftermarket components.
Stock Ownership and Control
In March 2017, the Company executed a share purchase agreement (the “SPA”) with Weichai America Corp., a wholly owned subsidiary of Weichai Power Co., Ltd. (HK2338, SZ000338) (herein collectively referred to as “Weichai”). Under the terms of the SPA, Weichai invested $60.0 million in the Company purchasing a combination of newly issued Common and Preferred Stock as well as a stock purchase warrant (the “Weichai Warrant”).
With the exercise of the Weichai Warrant in April 2019, Weichai owns a majority of the outstanding shares of the Company’s Common Stock. As a result, Weichai is able to exercise control over matters requiring stockholders’ approval, including the election of the directors, amendment of the Company’s Charter and approval of significant corporate transactions. This control could have the effect of delaying or preventing a change of control of the Company or changes in management and will make the approval of certain transactions impractical without the support of Weichai.
Weichai also entered into an Investor Rights Agreement (the “Rights Agreement”) with the Company upon execution of the SPA. The Rights Agreement provides Weichai with representation on the Company’s Board of Directors (the “Board”) and management representation rights. Weichai currently has three representatives on the Board. According to the Rights Agreement, once Weichai exercised the Weichai Warrant and became the majority owner of the Company’s outstanding shares of Common Stock calculated on a fully diluted as-converted basis (excluding certain excepted issuances), the Company became required to appoint to the Board an additional individual designated by Weichai or such additional numbers of individuals so that Weichai designees constitute the majority of the directors serving on the Board. As of the date of this filing, Weichai has not designated an additional representative to the Board. According to the Rights Agreement, during any period when the Company is a “controlled company” within the meaning of the NASDAQ Stock Market (“NASDAQ”) Listing Rules, it will take such measures as to avail itself of the “controlled company” exemptions available under Rule 5615 of the NASDAQ Listing Rules of Rules 5605(b), (d) and (e).
Going Concern Considerations
On April 2, 2020, the Company closed on its new senior secured revolving credit facility pursuant to that credit agreement dated March 27, 2020 between the Company and Standard Chartered Bank ("Standard Chartered"), as administrative agent (the "Credit Agreement"). The Credit Agreement, which allows the Company to borrow up to $130.0 million, matures on March 26, 2021 with

45


an optional 60-day extension subject to certain conditions and payment of a 0.25% extension fee. See Note 6. Debt for further discussion of the Credit Agreement.
Significant uncertainties exist about the Company’s ability to refinance, extend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Credit Agreement. Based on the Company’s current forecasts, without additional financing, the Company anticipates that it will not have sufficient cash and cash equivalents to repay the Credit Agreement by March 26, 2021. Management plans to seek additional liquidity from its current or other lenders before March 26, 2021. There can be no assurance that the Company’s management will be able to successfully complete a financing on acceptable terms or repay this outstanding indebtedness, when required or if at all. The consolidated financial statements included in this Form 10-K do not include any adjustments that might result from the outcome of the Company’s efforts to address these issues.
Furthermore, if the Company cannot raise capital on acceptable terms, it may not, among other things, be able to do the following:
continue to expand the Company’s research and product investments and sales and marketing organization;
expand operations both organically and through acquisitions; and
respond to competitive pressures or unanticipated working capital requirements.
Additionally, as discussed in Note 16. Subsequent Events, in January 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally. In March 2020, the WHO classified the COVID-19 outbreak as a global pandemic (the “COVID-19 pandemic”), based on the rapid increase in exposure globally. The potential impact of future disruptions, continued economic uncertainty, and continued depressed crude oil prices and declining rig count levels may have a material adverse impact on the results of operations, financial position, and liquidity of the Company.
The Company’s management has concluded that, due to uncertainties surrounding the Company’s future ability to refinance, extend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Credit Agreement, substantial doubt exists as to its ability to continue as a going concern within one year after the date that these financial statements are issued. The Company’s plans to alleviate the substantial doubt about its ability to continue as a going concern may not be successful, and it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
The consolidated financial statements included herein have been prepared assuming that the Company will continue as a going concern and contemplating the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company’s ability to continue as a going concern is dependent on generating profitable operating results, having sufficient liquidity, maintaining compliance with the covenants and other requirements under the Credit Agreement and refinancing or repaying the indebtedness outstanding under this agreement.
Basis of Presentation and Consolidation
The consolidated financial statements include the accounts of Power Solutions International, Inc. and its wholly owned subsidiaries. The Company’s consolidated financial statements were prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and include the assets, liabilities, sales and expenses of all wholly owned subsidiaries and majority-owned subsidiaries in which the Company exercises control. All intercompany balances and transactions have been eliminated in consolidation.
The Company operates as one business and geographic operating segment. Operating segments are defined as components of a business that can earn revenues and incur expenses for which discrete financial information is available that is evaluated on a regular basis by the chief operating decision maker (“CODM”). The Company’s CODM is its principal executive officer, who decides how to allocate resources and assess performance. A single management team reports to the CODM, who manages the entire business. The Company’s CODM reviews consolidated statements of operations to make decisions, allocate resources and assess performance, and the CODM does not evaluate the profit or loss from any separate geography or product line.
Reclassifications
Certain amounts recorded in the prior-period consolidated financial statements presented have been reclassified to conform to the current-period financial statement presentation. These reclassifications had no effect on previously reported results of operations.

46


Concentrations
The following table presents customers individually accounting for more than 10% of the Company’s net sales:
 
 
For the Year Ended December 31,
 
 
2019
 
2018
Customer A
 
17
%
 
11
%
Customer B
 
13
%
 
15
%
The following table presents customers individually accounting for more than 10% of the Company’s accounts receivable:
 
 
As of December 31,
 
 
2019
 
2018
Customer A
 
49
%
 
25
%
Customer B
 
**

 
15
%
**
Less than 10% of the total
The following table presents suppliers individually accounting for more than 10% of the Company’s purchases:
 
 
For the Year Ended December 31,
 
 
2019
 
2018
Supplier A
 
25
%
 
19
%
Supplier B
 
13
%
 
13
%
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates and assumptions include the valuation of allowances for uncollectible receivables, inventory reserves, warranty reserves, stock-based compensation, evaluation of goodwill, other intangibles, plant and equipment for impairment, and determination of useful lives of long-lived assets. Actual results could materially differ from those estimates.
Cash and Cash Equivalents
Cash equivalents consist of short-term, highly liquid investments that mature within three months or less. Such investments are stated at cost, which approximates fair value. The Company’s revolving credit agreement with Wells Fargo Bank, N.A. (“Wells Fargo”) included a “lockbox” arrangement that received all receipts and from which the Company could request increases in the revolver borrowings. On April 2, 2020, the Company entered into the Credit Agreement with Standard Chartered. The Credit Agreement does not include a “lockbox” arrangement. See Note 6. Debt for additional information regarding the Wells Fargo Credit Agreement (the “Wells Fargo Credit Agreement”) and the Credit Agreement.
Research and Development
Research and development (“R&D”) expenses are expensed when incurred. R&D expenses consist primarily of wages, materials, testing and consulting related to the development of new engines, parts and applications. These costs were $23.3 million and $26.8 million for 2019 and 2018, respectively.
Income Taxes
The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to be settled or realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company records net deferred tax assets to the extent that it believes these assets will more likely than not be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies and results of recent operations.

47


The Company records uncertain tax positions in accordance with accounting guidance, on the basis of a two-step process whereby (i) it determines whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is greater than 50% likely to be realized upon ultimate settlement with the related tax authority. Tax benefits related to uncertain tax positions taken or expected to be taken on a tax return are recorded when such benefits meet a more-likely-than-not threshold. Otherwise, these tax benefits are recorded when a tax position has been effectively settled, which means that the appropriate taxing authority has completed its examination even though the statute of limitations remains open, or the statute of limitation has expired. Interest and penalties related to uncertain tax positions are recognized as part of income tax expense and are accrued beginning in the period that such interest and penalties would be applicable under relevant tax law until such time that the related tax benefits are recognized.
Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable represent amounts billed to customers and not yet collected. Trade accounts receivable are recorded at the invoiced amount, which approximates net recoverable value, and generally do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the existing accounts receivable and is established through a charge to selling, general and administrative expenses. The allowance is primarily determined based on historical collection experience and reviews of customer creditworthiness. Trade accounts receivable and the allowance for doubtful accounts are reviewed on a regular basis. When necessary, an allowance for the full amount of specific accounts deemed uncollectible is recorded. Accounts receivable losses are deducted from the allowance and the account balance is written off when the customer receivable is deemed uncollectible. Recoveries of previously written off balances are recognized when received. An allowance associated with anticipated future sales returns is also included in the allowance for doubtful accounts.
Insurance Recoveries
The Company records insurance recoveries related to amounts recorded as estimated losses on events covered by the Company’s insurance policies when management determines that the recovery is probable and the amount can be reasonably determined. As of December 31, 2019 and 2018, the Company had recorded assets related to insurance recoveries of $3.6 million and $16.0 million, respectively, primarily related to litigation reserves and related legal fees.
Inventories
The Company’s inventories consist primarily of engines and parts. Engines are valued at the lower of cost plus estimated freight-in or net realizable value. Parts are valued at the lower of cost or net realizable value. Net realizable value approximates replacement cost. Cost is principally determined using the first-in, first-out method and includes material, labor and manufacturing overhead. It is the Company’s policy to review inventories on a continuing basis for obsolete, excess and slow-moving items and to record valuation adjustments for such items in order to eliminate non-recoverable costs from inventory. Valuation adjustments are recorded in an inventory reserve account and reduce the cost basis of the inventory in the period in which the reduced valuation is determined. Inventory reserves are established based on quantities on hand, usage and sales history, customer orders, projected demand and utilization within a current or future power system. Specific analysis of individual items or groups of items is performed based on these same criteria, as well as on changes in market conditions or any other identified conditions.
Inventories consist of the following:
(in thousands)
 
As of December 31,
Inventories
 
2019
 
2018
Raw materials
 
$
90,677

 
$
90,877

Work in process
 
2,007

 
2,390

Finished goods
 
19,119

 
18,077

Total inventories
 
111,803

 
111,344

Inventory allowance
 
(2,964
)
 
(5,730
)
Inventories, net
 
$
108,839

 
$
105,614


48


Activity in the Company’s inventory allowance was as follows:
(in thousands)
 
For the Year Ended December 31,
Inventory Allowance
 
2019
 
2018
Balance at beginning of period
 
$
5,730

 
$
6,227

Charged to expense
 
677

 
2,153

Write-offs
 
(3,443
)
 
(2,650
)
Balance at end of period
 
$
2,964

 
$
5,730

Property, Plant and Equipment
Property, plant and equipment is carried at cost and presented net of accumulated depreciation and impairments. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Property, plant and equipment is evaluated periodically to determine if an adjustment to depreciable lives is warranted. Such evaluation is based principally on the expected utilization of the long-lived assets.
Repairs and maintenance costs are charged directly to expense as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated.
Estimated useful lives by each type of asset category are as follows:
 
 
Years
Buildings
 
Up to 39
Leasehold improvements
 
Lesser of (i) expected useful life of improvement or (ii) life of lease (including likely extension thereof)
Machinery and equipment
 
1 to 10
Intangible Assets
The Company’s intangible assets include customer relationships, developed technology, trade names and trademarks. Intangible assets are amortized on an accelerated basis over a period of time that approximates the pattern over which the Company expects to gain the estimated economic benefits, and such period generally ranges between three years and 15 years.
Impairment of Long-Lived Assets
The Company assesses potential impairments to its long-lived assets or asset groups, excluding goodwill which is separately tested for impairment, whenever events indicate that the carrying amount of such assets may not be recoverable. Long-lived assets are evaluated for impairment by comparing the carrying value of the asset or asset group with the estimated future net undiscounted cash flows expected to result from the use of the asset or asset group, including cash flows from disposition. If the future net undiscounted cash flows are less than the carrying value, an impairment loss is calculated. An impairment loss is determined by the amount that the asset’s or asset group’s carrying value exceeds its estimated fair value. Estimated fair value is generally measured by discounting estimated future cash flows. If an impairment loss is recognized, the adjusted balance becomes the new cost basis and is depreciated (amortized) over the remaining useful life. The Company also periodically reassesses the useful lives of its long-lived assets due to advances and changes in technologies.
In 2019, the Company incurred immaterial impairment charges related to certain long-lived assets removed from service during the year. In the fourth quarter of 2018, the Company recognized an impairment charge of $2.2 million related to developed technology. See Note 5. Goodwill and Other Intangibles for further discussion.
As a result of the recent COVID-19 pandemic and its impacts on the global economy, it is reasonably possible that the Company will be adversely impacted in future periods which may result in the recognition of material impairment charges related to its long-lived assets.
Goodwill
Goodwill represents the excess of the cost of an acquired business over the amounts assigned to the net acquired assets. Goodwill is not amortized but is tested for impairment at the reporting unit level, on an annual basis or more frequently, if events occur or circumstances change indicating potential impairment. The Company annually tests goodwill for impairment on October 1.
In evaluating goodwill for impairment, the Company may first assess qualitative factors to determine whether it is more likely than not (i.e., there is a likelihood of more than 50%) that the Company’s fair value is less than its carrying amount. Qualitative factors that the Company considers include, but are not limited to, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events. If the Company bypasses the qualitative assessment, or if the Company

49


concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the Company performs a two-step goodwill impairment test to identify potential goodwill impairment and measures the amount of goodwill impairment it will recognize, if any.
In the first step of the two-step goodwill impairment test, the Company compares the estimated fair value of the reporting unit with its related carrying value. The Company has two reporting units: PSI and Professional Power Products, Inc. (“3PI”). If the estimated fair value exceeds the carrying amount, no further analysis is needed. If, however, the reporting unit’s estimated fair value is less than its carrying amount, the Company proceeds to the second step and calculates the implied fair value of goodwill to determine whether any impairment is required.
The Company calculates its estimated fair value using the income and market approaches when feasible, or an asset approach when neither the income nor the market approach has sufficient data. For the income approach, a discounted cash flow method, the Company uses internally developed discounted cash flow models that include the following assumptions, among others: projections of revenues, expenses and related cash flows based on assumed long-term growth rates and demand trends, expected future investments to grow new units, and estimated discount rates. The Company based these assumptions on its historical data and experience, industry projections, and micro and macro general economic condition projections and expectations. The market approach, also called the Guideline Public Company Approach, compares the value of an entity to similar publicly traded companies. The asset approach estimates the selling price the unit could achieve under assumed market conditions.
If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
During the years ended December 31, 2019 and 2018, the Company performed a Step 1 assessment and determined that the estimated fair value of the reporting units exceeded the carrying value; as such, no impairment charges were recognized.
As a result of the recent COVID-19 pandemic and its impacts on the global economy, it is reasonably possible that the Company will be adversely impacted in future periods which may result in the recognition of material goodwill impairment charges.
Other Accrued Liabilities
Other accrued liabilities consisted of the following:
(in thousands)
 
As of December 31,
Other Accrued Liabilities
 
2019
 
2018
Accrued product warranty
 
$
17,142

 
$
9,767

Litigation reserves *
 
5,020

 
16,139

Contract liabilities
 
26,898

 
4,897

Accrued compensation and benefits
 
6,599

 
4,520

Operating lease liabilities
 
3,789

 

Accrued interest expense
 
1,087

 
1,175

Other
 
5,495

 
9,202

Total
 
$
66,030

 
$
45,700

*
As of December 31, 2019, litigation reserves primarily consisted of reserves related to ongoing government investigations and the settlement of the Federal Derivative Litigation. As of December 31, 2018, litigation reserves primarily consisted of accruals for the settlement of the Securities Litigation, Federal Derivative Litigation, and the Cohen matter. The Company concluded that insurance recovery was probable related to $1.9 million and $14.0 million of the litigation reserves as of December 31, 2019 and 2018, respectively, and recognized full recovery of the settlement amounts in Prepaid expenses and other current assets. See Note 10. Commitments and Contingencies for additional information.
Warranty Costs
The Company offers a standard limited warranty on the workmanship of its products that in most cases covers defects for a defined period. Warranties for certified emission products are mandated by the U.S. Environmental Protection Agency (the “EPA”) and / or the California Air Resources Board (the “CARB”) and are longer than the Company’s standard warranty on certain emission-related products. The Company’s products also carry limited warranties from suppliers. The Company’s warranties generally apply to engines fully manufactured by the Company and to the modifications the Company makes to supplier base products. Costs related to supplier warranty claims are generally borne by the supplier and passed through to the end customer.
Warranty estimates are based on historical experience and represent the projected cost associated with the product. A liability and related expense are recognized at the time products are sold. The Company adjusts estimates when it is determined that actual costs may differ from initial or previous estimates.

50


The Company records adjustments to preexisting warranties for changes in its estimate of warranty costs for products sold in prior fiscal years in the period in which new information is received and the information indicates that actual costs may differ from the Company’s initial or previous estimates. Such adjustments typically occur when claims experience deviates from historic and expected trends. During 2019, the Company recognized a charge for adjustments to preexisting warranties of $2.7 million compared to charges of $3.8 million in 2018.
When the Company identifies cost effective opportunities to address issues in products sold or corrective actions for safety issues, it initiates product recalls or field campaigns. As a result of the uncertainty surrounding the nature and frequency of product recalls and field campaigns, the liability for such actions is generally recorded when the Company commits to a product recall or field campaign. In each subsequent quarter after a recall or field campaign is initiated, the recorded warranty liability balance is analyzed, reviewed and adjusted, if necessary, to reflect any changes in the anticipated average cost of repair or number of repairs to be completed prospectively.
When collection is reasonably assured, the Company also estimates the amount of warranty claim recoveries to be received from its suppliers. Warranty costs and recoveries are included in Cost of sales in the Consolidated Statements of Operations.
Accrued product warranty activities are presented below:
(in thousands)
 
For the Year Ended December 31,
Accrued Product Warranty
 
2019
 
2018
Balance at beginning of year
 
$
23,102

 
$
12,628

Current year provision
 
10,349

 
15,840

Changes in estimates for preexisting warranties *
 
2,730

 
3,842

Payments made during the period
 
(10,680
)
 
(9,208
)
Balance at end of year
 
25,501

 
23,102

Less: Current portion
 
17,142