Document

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

https://cdn.kscope.io/2d0dd1cf5d5711b4e7eaf1b0ba9db16a-psilogo.jpg
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020    
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 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  x     NO   ¨
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 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
As of August 3, 2020, there were 22,885,855 outstanding shares of the Common Stock of the registrant.


1


TABLE OF CONTENTS
 
 
Page
PART I – FINANCIAL INFORMATION
 
Forward-Looking Statements
Item 1.
Financial Statements
 
Consolidated Balance Sheets as of June 30, 2020 (Unaudited) and December 31, 2019
 
Consolidated Statements of Operations for the three and six months ended June 30, 2020 and 2019 (Unaudited)
 
Consolidated Statements of Stockholders’ Equity for the three and six months ended June 30, 2020 and 2019 (Unaudited)
 
Consolidated Statements of Cash Flows for the three and six months ended June 30, 2020 and 2019 (Unaudited)
 
Notes to Consolidated Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II – OTHER INFORMATION
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
 
Signatures




FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10-Q for the three and six months ended June 30, 2020 (the “Quarterly Report”) 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 Power Solutions International, Inc.’s, a Delaware corporation (“Power Solutions,” “PSI” or the “Company”), 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, and from time to time in the Company’s subsequent filings with the United States Securities and Exchange Commission (the “SEC”); 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 forecast sales, and the extent to which sales result in recorded revenue; changes in customer demand for the Company’s products; volatility in oil and gas prices; the impact of U.S. tariffs on imports from China on the Company’s supply chain; 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 Quarterly Report on Form 10-Q. 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.


3


PART I FINANCIAL INFORMATION
Item 1.    Financial Statements.
POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

(in thousands, except par values)
 
As of June 30, 2020
 
As of December 31, 2019
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
32,533

 
$
3

Restricted cash
 
3,449

 

Accounts receivable, net of allowances of $3,834 and $3,561 as of June 30, 2020 and December 31, 2019, respectively
 
62,038

 
104,515

Income tax receivable
 
3,419

 
1,055

Inventories, net
 
140,321

 
108,839

Prepaid expenses and other current assets
 
9,500

 
8,110

Total current assets
 
251,260

 
222,522

Property, plant and equipment, net
 
22,137

 
23,194

Intangible assets, net
 
11,845

 
13,372

Goodwill
 
29,835

 
29,835

Other noncurrent assets
 
22,787

 
24,749

TOTAL ASSETS
 
$
337,864

 
$
313,672

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
67,367

 
$
75,835

Current maturities of long-term debt
 
282

 
195

Revolving line of credit
 
130,000

 
39,527

Other accrued liabilities
 
91,004

 
66,030

Total current liabilities
 
288,653

 
181,587

Deferred income taxes
 
781

 
1,105

Long-term debt, net of current maturities
 
816

 
55,657

Noncurrent contract liabilities
 
3,062

 
17,998

Other noncurrent liabilities
 
34,197

 
28,828

TOTAL LIABILITIES
 
$
327,509

 
$
285,175

 
 
 
 
 
STOCKHOLDERS’ EQUITY
 
 
 
 
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 23,117 shares issued; 22,860 and 22,857 shares outstanding at June 30, 2020 and December 31, 2019, respectively
 
23

 
23

Additional paid-in capital
 
165,852

 
165,527

Accumulated deficit
 
(145,366
)
 
(126,912
)
Treasury stock, at cost, 257 and 260 shares at June 30, 2020 and December 31, 2019, respectively
 
(10,154
)
 
(10,141
)
TOTAL STOCKHOLDERS’ EQUITY
 
10,355

 
28,497

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
 
$
337,864

 
$
313,672

See Notes to Consolidated Financial Statements

4


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

(in thousands, except per share amounts)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Net sales
 
$
93,056

 
$
138,684

 
$
198,153

 
$
254,471

Cost of sales
 
89,279

 
113,070

 
176,662

 
211,153

Gross profit
 
3,777

 
25,614

 
21,491

 
43,318

Operating expenses:
 
 
 
 
 
 
 
 
Research, development and engineering expenses
 
5,814

 
6,030

 
12,566

 
12,329

Selling, general and administrative expenses
 
12,580

 
13,955

 
26,470

 
30,015

Amortization of intangible assets
 
764

 
909

 
1,527

 
1,819

Total operating expenses
 
19,158

 
20,894

 
40,563

 
44,163

Operating (loss) income
 
(15,381
)
 
4,720

 
(19,072
)
 
(845
)
Other expense:
 
 
 
 
 
 
 
 
Interest expense
 
1,427

 
2,122

 
2,701

 
4,235

Loss from change in value of warrants
 

 
5,752

 

 
1,352

Loss on extinguishment of debt
 
497

 

 
497

 

Other income, net
 
(44
)
 
(395
)
 
(255
)
 
(501
)
Total other expense
 
1,880

 
7,479

 
2,943

 
5,086

Loss before income taxes
 
(17,261
)
 
(2,759
)
 
(22,015
)
 
(5,931
)
Income tax expense (benefit)
 
481

 
239

 
(3,561
)
 
(347
)
Net loss
 
$
(17,742
)
 
$
(2,998
)
 
$
(18,454
)
 
$
(5,584
)
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
22,858

 
21,702

 
22,858

 
20,171

Diluted
 
22,858

 
21,702

 
22,858

 
20,171

Loss per common share:
 
 
 
 
 
 
 
 
Basic
 
$
(0.78
)
 
$
(0.14
)
 
$
(0.81
)
 
$
(0.28
)
Diluted
 
$
(0.78
)
 
$
(0.14
)
 
$
(0.81
)
 
$
(0.28
)
See Notes to Consolidated Financial Statements

5


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
(in thousands)
 
For the Three Months Ended
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Deficit
 
Treasury Stock
 
Total Stockholders’ Equity
Balance at March 31, 2020
 
$
23

 
$
165,691

 
$
(127,624
)
 
$
(10,149
)
 
$
27,941

Net loss
 

 

 
(17,742
)
 

 
(17,742
)
Stock-based compensation expense
 

 
165

 

 
(5
)
 
160

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

 
(4
)
 

 

 
(4
)
Balance at June 30, 2020
 
$
23

 
$
165,852

 
$
(145,366
)
 
$
(10,154
)
 
$
10,355

 
 
 
 
 
 
 
 
 
 
 
Balance at March 31, 2019
 
$
19

 
$
126,977

 
$
(137,746
)
 
$
(10,225
)
 
$
(20,975
)
Net loss
 

 

 
(2,998
)
 

 
(2,998
)
Stock-based compensation expense
 

 
493

 

 
(100
)
 
393

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

 
(97
)
 

 

 
(97
)
Exercise of Weichai Warrant
 
4

 
38,064

 

 

 
38,068

Balance at June 30, 2019
 
$
23

 
$
165,437

 
$
(140,744
)
 
$
(10,325
)
 
$
14,391


(in thousands)
 
For the Six Months Ended
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Deficit
 
Treasury Stock
 
Total Stockholders’ Equity
Balance at December 31, 2019
 
$
23

 
$
165,527

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

Net loss
 

 

 
(18,454
)
 

 
(18,454
)
Stock-based compensation expense
 

 
330

 

 
(13
)
 
317

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

 
(5
)
 

 

 
(5
)
Balance at June 30, 2020
 
$
23

 
$
165,852

 
$
(145,366
)
 
$
(10,154
)
 
$
10,355

 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
 
$
19

 
$
126,412

 
$
(135,160
)
 
$
(9,849
)
 
$
(18,578
)
Net loss
 

 

 
(5,584
)
 

 
(5,584
)
Stock-based compensation expense
 

 
1,404

 

 
(476
)
 
928

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

 
(443
)
 

 

 
(443
)
Exercise of Weichai Warrant
 
4

 
38,064

 

 

 
38,068

Balance at June 30, 2019
 
$
23

 
$
165,437

 
$
(140,744
)
 
$
(10,325
)
 
$
14,391


6


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(in thousands)
 
For the Six Months Ended June 30,
 
 
2020
 
2019
Cash provided by operating activities
 
 
 
 
Net loss
 
$
(18,454
)
 
$
(5,584
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Amortization of intangible assets
 
1,527

 
1,819

Depreciation
 
2,608

 
2,605

Change in value of warrants
 

 
1,352

Stock-based compensation expense
 
317

 
928

Amortization of financing fees
 
609

 
361

Deferred income taxes
 
(323
)
 
(458
)
Loss on extinguishment of debt
 
497

 

Other non-cash adjustments, net
 
253

 
(68
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
42,492

 
10,292

Inventory, net
 
(31,980
)
 
(4,393
)
Prepaid expenses and other assets
 
22

 
4,902

Accounts payable
 
(8,634
)
 
(1,201
)
Accrued expenses
 
24,692

 
(5,354
)
Other noncurrent liabilities
 
(9,616
)
 
(3,230
)
Net cash provided by operating activities
 
4,010

 
1,971

Cash used in investing activities
 
 
 
 
Capital expenditures
 
(1,416
)
 
(1,536
)
Other investing activities, net
 
7

 

Net cash used in investing activities
 
(1,409
)
 
(1,536
)
Cash provided by (used in) financing activities
 
 
 
 
Repayments of long-term debt and lease liabilities
 
(55,200
)
 
(78
)
Proceeds from revolving line of credit
 
180,298

 
267,584

Repayments of revolving line of credit
 
(89,826
)
 
(268,743
)
Payments of deferred financing costs
 
(1,970
)
 
(375
)
Proceeds from Weichai Warrant exercise

 

 
1,616

Other financing activities, net
 
76

 
(443
)
Net cash provided by (used in) financing activities
 
33,378

 
(439
)
Net increase (decrease) in cash, cash equivalents, and restricted cash
 
35,979

 
(4
)
Cash, cash equivalents, and restricted cash at beginning of the period
 
3

 
54

Cash, cash equivalents, and restricted cash at end of the period
 
$
35,982

 
$
50

(in thousands)
 
As of June 30,
 
 
2020
 
2019
Reconciliation of cash, cash equivalents, and restricted cash to the Consolidated Balance Sheets
 
 
 
 
Cash and cash equivalents
 
$
32,533

 
$
50

Restricted cash
 
3,449

 

Total cash, cash equivalents, and restricted cash
 
$
35,982

 
$
50


See Notes to Consolidated Financial Statements

7


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
Weichai America Corp., a wholly-owned subsidiary of Weichai Power Co., Ltd. (HK2338, SZ000338) (herein collectively referred to as “Weichai”), currently owns a majority of the outstanding shares of the Company’s Common Stock. As a result, Weichai is able to exercise control over Company matters including those requiring stockholders’ approval, including the election of the directors, amendments to 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 and could deter or prevent actions that may be favored by other shareholders.
Weichai currently has three representatives on the Company’s Board of Directors (the “Board”). Under the Investor Rights Agreement (the “Rights Agreement”) between Weichai and the Company, since Weichai became the majority owner of the Company’s outstanding shares of Common Stock, 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 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
In April 2020, the Company closed on its new senior secured revolving credit facility pursuant 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 $130.0 million, matures on March 26, 2021 with an optional 60-day extension, subject to certain conditions and payment of a 0.25% extension fee. See Note 6. Debt for further information regarding the terms and conditions of the Credit Agreement.
The Credit Agreement includes financial covenants which were effective for the Company beginning with the six months ended June 30, 2020. The financial covenants include an interest coverage ratio and a minimum threshold for earnings before interest,

8


taxes, depreciation and amortization (“EBITDA”) as further defined in the Credit Agreement. For the six months ended June 30, 2020, the Company did not meet the defined minimum EBITDA requirement. A breach of the financial covenants under the Credit Agreement constitutes an event of default and, if not cured or waived, could result in the obligations under the Credit Agreement being accelerated. The Company is currently in discussion with Standard Chartered in connection with the financial covenant breach.
Significant uncertainties exist about the Company’s ability to refinance, extend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, obtain a cure or waiver in connection with the financial covenant breach, and maintain compliance with the covenants and other requirements under the Credit Agreement in the future. 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 obtain a cure or waiver of its financial covenant violation or 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 Quarterly Report 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;
continue to fund and expand operations both organically and through acquisitions; and
respond to competitive pressures or unanticipated working capital requirements.
Additionally, as discussed further below, 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 to the Company, 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, obtain a cure or waiver of its financial covenant breach, and maintain compliance with the covenants and other requirements under the Credit Agreement in the future, 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, obtaining a cure or waiver in connection with the financial covenant breach, maintaining compliance with the covenants and other requirements under the Credit Agreement in the future, and refinancing or repaying the indebtedness outstanding under the Credit Agreement.
Recent COVID-19 Outbreak and Oil and Gas Market Price Volatility
As a result of the COVID-19 pandemic, 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, due to unprecedented decreases in demand, an oil price war, and economic uncertainty resulting from the COVID-19 pandemic, crude oil prices have declined considerably as compared to prices at the end of 2019. 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 Company has seen a decline in orders and lower volumes compared to the prior year. The potential impact of future disruptions, continued economic uncertainty, and continued depressed crude oil prices and low rig count levels may have a significant adverse impact on the timing of delivery of customer orders and the levels of future customer orders. Accordingly, these adverse impacts may significantly impact the Company’s results of future operations, financial position, and liquidity.
The Company performs its annual goodwill impairment test as of October 1, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company considered the significant changes in the market due to the COVID-19 pandemic and the oil and gas market price volatility in performing its assessment of whether an interim impairment review was required for any reporting units and determined that a triggering event had occurred for both reporting units as of March 31, 2020. The Company considered both qualitative and quantitative factors in its assessment including the significant amount of headroom resulting from the prior fiscal year’s impairment test and potential

9


changes in key assumptions, including discount rates, expected profitability and long-term growth rates, used in the last fiscal year’s impairment analysis that may have been impacted by the recent market conditions and economic events. Based on this interim assessment, the Company concluded that goodwill was not impaired as of March 31, 2020. It is reasonably possible that potential adverse impacts of the factors noted above could result in the recognition of material impairments of goodwill and other long-lived assets or other related charges in future periods as the extent and duration of the impact of the COVID-19 pandemic and resulting effect on the Company’s operations continues to evolve and remains uncertain.
The Company has initiated certain contingency actions as a result of the significant negative impacts of these factors. As of the date of this Quarterly Report, the Company’s production facility workforce has been reduced to align with current volume trends. In addition, the Company implemented various temporary cost reduction measures, including reduced pay for salaried employees, suspension of the 401(k) match program, and deferred spending on certain R&D programs, among others. The measures with regard to pay for employees and the Company’s 401(k) plan match will run through September 30, 2020, at which time the Company will assess market conditions. The Company continues to review operating expenses as part of the contingency planning process.
Basis of Presentation and Consolidation
The Company is filing this Form 10-Q for the three and six months ended June 30, 2020, which contains unaudited consolidated financial statements as of and for the three and six months ended June 30, 2020 and 2019.
The consolidated financial statements include the accounts of Power Solutions International, Inc. and its wholly-owned subsidiaries and majority-owned subsidiaries in which the Company exercises control. The foregoing financial information was prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim financial reporting. All intercompany balances and transactions have been eliminated in consolidation.
Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The accompanying consolidated financial statements should be read in conjunction with, and have been prepared in accordance with accounting policies reflected in, the consolidated financial statements and related notes, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (“the 2019 Annual Report”). The Company’s significant accounting policies are described in the aforementioned 2019 Annual Report. Included below are certain updates to those policies. The accompanying interim financial information is unaudited; however, the Company believes the financial information reflects all adjustments (consisting of items of a normal recurring nature) necessary for a fair presentation of financial position, results of operations and cash flows in conformity with U.S. GAAP. Operating results for interim periods are not necessarily indicative of annual operating results.
The Company operates as one business and geographic operating segment. Operating segments are defined as components of a business that can earn revenue 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.
Concentrations
The following table presents customers individually accounting for more than 10% of the Company’s net sales:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Customer A
 
15
%
 
17
%
 
15
%
 
17
%
Customer B
 
10
%
 
**

 
10
%
 
**

Customer C
 
**

 
12
%
 
**

 
**

The following table presents customers individually accounting for more than 10% of the Company’s accounts receivable:
 
 
As of June 30, 2020
 
As of December 31, 2019
Customer A
 
13
%
 
**

Customer B
 
14
%
 
**

Customer C
 
10
%
 
49
%


10


The following table presents suppliers individually accounting for more than 10% of the Company’s purchases:
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Supplier A
 
30
%
 
13
%
 
20
%
 
15
%
Supplier B
 
**

 
16
%
 
**

 
13
%
Supplier C
 
**

 
10
%
 
**

 
11
%
**    Less than 10% of the total
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.
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 $5.6 million for each of the three months ended June 30, 2020 and 2019. These costs were $12.0 million and $11.5 million for the six months ended June 30, 2020 and 2019, respectively.
Restricted Cash
In April 2020, the Company entered into the Credit Agreement with Standard Chartered and extinguished the prior credit agreement with Wells Fargo Bank, N.A. (“Wells Fargo”) as discussed further in Note 6. Debt. While the revolving credit facility with Wells Fargo was extinguished, Wells Fargo continues to perform other services for the Company including issuing letters of credit. Wells Fargo required the Company to have cash collateral to support the letters of credit and other services provided. As discussed in Note 9. Commitments and Contingencies, the Company had outstanding letters of credit of $3.0 million and restricted cash of $3.4 million at June 30, 2020.
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 consisted of the following:
(in thousands)

Inventories
 
As of June 30, 2020
 
As of December 31, 2019
Raw materials
 
$
120,237

 
$
90,677

Work in process
 
3,422

 
2,007

Finished goods
 
19,704

 
19,119

Total inventories
 
143,363

 
111,803

Inventory allowance
 
(3,042
)
 
(2,964
)
Inventories, net
 
$
140,321

 
$
108,839




11


Activity in the Company’s inventory allowance was as follows:
(in thousands)
 
For the Six Months Ended June 30,
Inventory Allowance
 
2020
 
2019
Balance at beginning of period
 
$
2,964

 
$
5,730

Charged to expense
 
897

 
41

Write-offs
 
(819
)
 
(878
)
Balance at end of period
 
$
3,042

 
$
4,893

Other Accrued Liabilities
Other accrued liabilities consisted of the following:
(in thousands)

Other Accrued Liabilities
 
As of June 30, 2020
 
As of December 31, 2019
Accrued product warranty
 
$
16,660

 
$
17,142

Litigation reserves *
 
4,429

 
5,020

Contract liabilities
 
52,412

 
26,898

Accrued compensation and benefits
 
6,443

 
6,599

Operating lease liabilities
 
3,759

 
3,789

Accrued interest expense
 
906

 
1,087

Other
 
6,395

 
5,495

Total
 
$
91,004

 
$
66,030

*
As of June 30, 2020 and December 31, 2019, litigation reserves primarily consisted of reserves related to ongoing government investigations and the settlement of the Federal Derivative Litigation. The Company concluded that insurance recovery was probable related to $2.2 million and $1.9 million of the litigation reserves as of June 30, 2020 and December 31, 2019, respectively, and recognized full recovery of the settlement amounts in Prepaid expenses and other current assets. See Note 9. 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.













12


Accrued product warranty activities are presented below:
(in thousands)
 
For the Six Months Ended June 30,
Accrued Product Warranty
 
2020
 
2019
Balance at beginning of period
 
$
25,501

 
$
23,102

Current year provision
 
7,418

 
4,585

Changes in estimates for preexisting warranties *
 
9,925

 
2,730

Payments made during the period
 
(10,373
)
 
(4,454
)
Balance at end of period
 
32,471

 
25,963

Less: Current portion
 
16,660

 
15,078

Noncurrent accrued product warranty
 
$
15,811

 
$
10,885

*
Change in estimates for preexisting warranties reflect changes in the Company’s estimate of warranty costs for products sold in prior periods. Such adjustments typically occur when claims experience deviates from historical and expected trends. The Company’s warranty liability is generally affected by failure rates, repair costs and the timing of failures. Future events and circumstances related to these factors could materially change the estimates and require adjustments to the warranty liability. In addition, new product launches require a greater use of judgment in developing estimates until historical experience becomes available. For the three and six months ended June 30, 2020, the Company recorded charges for changes in estimates of preexisting warranties of $9.3 million, or $0.41 per diluted share, and $9.9 million, or $0.43 per diluted share, respectively. For the six months ended June 30, 2019, the Company recorded charges for changes in estimates of preexisting warranties of $2.7 million, or $0.13 per diluted share.
Recently Issued Accounting Pronouncements Adopted
In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This guidance requires the use of existing accounting guidance applicable to software developed for internal use to be applied to cloud computing service contracts’ implementation costs. The costs capitalized would be amortized over the life of the agreement, including renewal option periods likely to be used. The Company adopted the standard effective January 1, 2020 on a prospective basis. There was no impact on the Company’s financial statements including the related notes as a result of adopting the guidance.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, which both reduces and expands selected disclosure requirements. The principal changes expected to impact the Company’s disclosure are requirements to disclose the range and weighted average of each of the significant unobservable items and the way the weighted average of a range is calculated for items in the “table of significant unobservable inputs.” The guidance also requires disclosure of changes in unrealized gains and losses in other comprehensive income and removes requirements regarding, among other items, disclosure of the valuation process for Level 3 measurements. The Company adopted the guidance on January 1, 2020. There was no impact on the Company’s financial statements including the related notes as a result of adopting the guidance.
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other: Simplifying the Test for Goodwill Impairment, which eliminated the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The Company adopted the guidance on January 1, 2020 on a prospective basis. There was no impact on the Company’s financial statements including the related notes as a result of adopting the guidance.
Recently Issued Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which applies primarily to the Company’s accounts receivable impairment loss allowances. The guidance provides a revised model whereby the current expected credit losses are used to compute impairment of financial instruments. The new model requires evaluation of historical experience and various current and expected factors, which may affect the estimated amount of losses and requires determination of whether the affected financial instruments should be grouped in units of account. The guidance, as originally issued, was effective for fiscal years beginning after December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) Effective Dates, which deferred the effective dates of these standards for certain entities. Based on the guidance, the effective date of ASU 2016-13 is deferred for the Company until fiscal year 2023. The Company currently plans to adopt the guidance on January 1, 2023 when it becomes effective. The Company is continuing to assess the impact of the standard on its financial statements.



13


Note 2.    Revenue
Disaggregation of Revenue
The following table summarizes net sales by end market:
(in thousands)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
End Market
 
2020
 
2019
 
2020
 
2019
Energy
 
$
29,649

 
$
52,245

 
$
79,733

 
$
97,893

Industrial
 
30,463

 
54,660

 
67,594

 
105,247

Transportation
 
32,944

 
31,779

 
50,826

 
51,331

Total
 
$
93,056

 
$
138,684

 
$
198,153

 
$
254,471

The following table summarizes net sales by geographic area:
(in thousands)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
Geographic Area
 
2020
 
2019
 
2020
 
2019
North America
 
$
81,979

 
$
119,943

 
$
176,499

 
$
217,622

Pacific Rim
 
6,295

 
10,804

 
12,749

 
23,429

Europe
 
2,578

 
5,006

 
5,235

 
8,383

Other
 
2,204

 
2,931

 
3,670

 
5,037

Total
 
$
93,056

 
$
138,684

 
$
198,153

 
$
254,471

Contract Balances
Most of the Company’s contracts are for a period of less than one year; however, certain long-term manufacturing and extended warranty contracts extend beyond one year. The timing of revenue recognition may differ from the time of invoicing to customers and these timing differences result in contract assets or contract liabilities on the Company’s Consolidated Balance Sheets. Contract assets include amounts related to the contractual right to consideration for completed performance when the right to consideration is conditional. The Company records contract liabilities when cash payments are received or due in advance of performance. Contract assets and contract liabilities are recognized at the contract level.
(in thousands)
 
As of June 30, 2020
 
As of December 31, 2019
Short-term contract assets (included in Prepaid expenses and other current assets)
 
$
2,340

 
$
694

Short-term contract liabilities (included in Other accrued liabilities)
 
(52,412
)
 
(26,898
)
Long-term contract liabilities (included in Noncurrent contract liabilities)
 
(3,062
)
 
(17,998
)
Net contract liabilities
 
$
(53,134
)
 
$
(44,202
)
During the six months ended June 30, 2020 and 2019, the Company recognized $4.8 million and $3.7 million, respectively, of revenue upon satisfaction of performance obligations related to amounts that were included in the net contract liabilities balance as of December 31, 2019 and 2018, respectively. The increase in the contract asset during the six months ended June 30, 2020 is related to performance completed and revenue recognized under certain contracts but for which the Company’s right to consideration is conditional at the end of the period. The increase in the contract liabilities during the six months ended June 30, 2020 is primarily related to prepayments for certain engines by a customer under a long-term supply agreement.
Remaining Performance Obligations
For performance obligations that extend beyond one year, the Company had $54.9 million of remaining performance obligations as of June 30, 2020 which primarily relates to prepayments for certain engines by a customer under a long-term supply agreement. The Company expects to recognize revenue related to these remaining performance obligations of approximately $27.0 million in the remainder of 2020, $25.2 million in 2021, $0.7 million in 2022, $0.8 million in 2023, $0.8 million in 2024 and $0.4 million in 2025 and beyond.



14


Note 3.    Weichai Transactions
Weichai Warrant
In September 2018, Weichai’s stock purchase warrant (the “Weichai Warrant”) was amended under the terms of a second amended and restated warrant (“Amended and Restated Warrant”) to defer its exercise date to a 90-day period commencing April 1, 2019, to adjust the exercise price to a price per share of the Company’s Common Stock equal to the lesser of (i) 50% of the Volume-Weighted Average Price (“VWAP”) during the 20 consecutive trading day period preceding October 1, 2018 and (ii) 50% of the VWAP during the 20 consecutive trading day period preceding the date of exercise, subject to an adjustment that could reduce the exercise price by up to $15.0 million. In the event that the adjustment exceeded the exercise price, the excess would be due to the warrant holder.
The Weichai Warrant was a freestanding derivative financial instrument that was not indexed solely to the Company’s Common Stock due to the Weichai Warrant exercise terms. On April 23, 2019, Weichai exercised the Weichai Warrant resulting in the Company issuing 4,049,759 shares of the Company’s Common Stock and Weichai becoming the owner of 51.5% of the outstanding shares of the Company’s Common Stock, as of such date. The exercise proceeds for the warrants of $1.6 million were based on 50% of the VWAP during the 20 consecutive trading day period preceding April 23, 2019 and the $15.0 million reduction in the exercise price described above. Changes in value of the Weichai Warrant, including the impact of the exercise, resulted in a loss of $5.8 million and $1.4 million reported in Loss from change in value of warrants in the Company’s Consolidated Statements of Operations for the three and six months ended June 30, 2019, respectively.
Weichai Collaboration Arrangement and Related Party Transactions
The Company and Weichai executed a strategic collaboration agreement (the “Collaboration Agreement”) on March 20, 2017, in order to achieve their respective strategic objectives and enhance the strategic cooperation alliance to share experiences, expertise and resources. Among other things, the Collaboration Agreement established a joint steering committee, permitted Weichai to second a limited number of certain 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 provided for the steering committee to create various sub-committees 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.
The Company evaluates whether an arrangement is a collaborative arrangement at its inception based on the facts and circumstances specific to the arrangement. The Company also reevaluates whether an arrangement qualifies or continues to qualify as a collaborative arrangement whenever there is a change in either the roles of the participants or the participants’ exposure to significant risks and rewards dependent on the ultimate commercial success of the endeavor. For those collaborative arrangements where it is determined that the Company is the principal participant, costs incurred, and revenue generated from third parties are recorded on a gross basis in the financial statements. For the three and six months ended June 30, 2020 and 2019, the Company’s sales to Weichai were immaterial in all periods. Purchases of inventory from Weichai were $7.1 million and $12.2 million for the three and six months ended June 30, 2020, respectively. Purchases of inventory from Weichai were $0.1 million and $0.9 million for the three and six months ended June 30, 2019, respectively. As of June 30, 2020 and December 31, 2019, the Company had immaterial receivables from Weichai and outstanding payables to Weichai of $10.3 million and $5.9 million, respectively.
Note 4.    Property, Plant and Equipment
Property, plant and equipment by type were as follows:
(in thousands)
 
As of June 30, 2020
 
As of December 31, 2019
Property, Plant and Equipment
 
 
 
 
Leasehold improvements
 
$
6,760

 
$
6,745

Machinery and equipment
 
42,664

 
41,243

Construction in progress
 
1,679

 
1,679

Total property, plant and equipment, at cost
 
51,103

 
49,667

Accumulated depreciation
 
(28,966
)
 
(26,473
)
Property, plant and equipment, net
 
$
22,137

 
$
23,194


15


Note 5.    Goodwill and Other Intangibles
Goodwill
The carrying amount of goodwill at both June 30, 2020 and December 31, 2019 was $29.8 million. Accumulated impairment losses at both June 30, 2020 and December 31, 2019 were $11.6 million.
See Note 1. Summary of Significant Accounting Policies and Other Information for additional discussion of the Company’s impairment considerations related to the impacts of the COVID-19 pandemic and the oil and gas market price volatility.
Other Intangible Assets
Components of intangible assets are as follows:
(in thousands)
 
As of June 30, 2020
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Book Value
Customer relationships
 
$
34,940

 
$
(23,676
)
 
$
11,264

Developed technology
 
700

 
(628
)
 
72

Trade names and trademarks
 
1,700

 
(1,191
)
 
509

Total
 
$
37,340

 
$
(25,495
)
 
$
11,845

(in thousands)
 
As of December 31, 2019
 
 
Gross Carrying Value
 
Accumulated Amortization
 
Net Book Value
Customer relationships
 
$
34,940

 
$
(22,236
)
 
$
12,704

Developed technology
 
700

 
(605
)
 
95

Trade names and trademarks
 
1,700

 
(1,127
)
 
573

Total
 
$
37,340

 
$
(23,968
)
 
$
13,372

Note 6.    Debt
The Company’s outstanding debt consisted of the following:
(in thousands)
 
As of June 30, 2020
 
As of December 31, 2019
Short-term financing:
 
 
 
 
Revolving credit facility
 
$
130,000

 
$
39,527

 
 
 
 
 
Long-term debt:
 
 
 
 
   Unsecured senior notes
 
$

 
$
55,000

Finance leases and other debt
 
1,098

 
1,087

Unamortized debt issuance costs
 

 
(235
)
Total long-term debt and finance leases
 
1,098

 
55,852

Less: Current maturities of long-term debt and finance leases
 
282

 
195

Long-term debt
 
$
816

 
$
55,657

*
Unamortized financing costs and deferred fees on the revolving credit facility are not presented in the above table as they are classified in Prepaid expenses and other current assets on the Consolidated Balance Sheet. Unamortized debt issuance costs related to the revolving credit facility were $1.5 million as of June 30, 2020.
Credit Agreement
On April 2, 2020, the Company closed on its new senior secured revolving credit facility pursuant to that certain credit agreement, dated as of March 27, 2020, by and between the Company and Standard Chartered as administrative agent. The Credit Agreement 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 payment of a 0.25% extension fee. Borrowings under the Credit Agreement bear interest at either the base rate as defined in the Credit Agreement or the London Interbank Offered Rate (“LIBOR”) plus 2.00% per annum, 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

16


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 (i) to repay the outstanding balance of $16.8 million on the revolving credit agreement between the Company and Wells Fargo Bank, N.A. (the “Wells Fargo Credit Agreement”), (ii) to fully redeem and discharge $55.0 million in aggregate outstanding principal amount of its unsecured notes due June 2020 (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. The Company recognized a loss on the extinguishment of the Wells Fargo Credit Agreement and the Unsecured Senior Notes of $0.5 million related to premiums to early retire the Unsecured Senior Notes and unamortized debt issuance costs. The Company deferred debt issuance costs related to the closing of the Credit Agreement of $2.0 million. 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 discussed above, the Credit Agreement includes financial covenants which were effective for the Company beginning with the six months ended June 30, 2020. The financial covenants include an interest coverage ratio and a minimum EBITDA threshold as further defined in the Credit Agreement. For the six months ended June 30, 2020, the Company did not meet the defined minimum EBITDA requirement. A breach of the financial covenants under the Credit Agreement constitutes an event of default and, if not cured or waived, could result in the obligations under the Credit Agreement being accelerated. The Company is currently in discussion with Standard Chartered in connection with the financial covenant breach. See Note 1. Summary of Significant Accounting Policies and Other Information for further discussion of the Company’s going concern considerations.
Note 7.    Leases
Leases
The Company has obligations under lease arrangements primarily for facilities, equipment and vehicles. These leases have original lease periods expiring between July 2020 and August 2034. For the three and six months ended June 30, 2020, the Company recorded lease expense of $1.6 million and $3.4 million within Cost of sales, $0.1 million and $0.2 million within Research, development, and engineering, $0.1 million and $0.2 million within Selling, general and administrative and less than $0.1 million within Interest expense in the Consolidated Statements of Operations, respectively. For the three and six months ended June 30, 2019, the Company recorded lease expense of $1.8 million and $3.6 million within Cost of sales, less than $0.1 million and $0.2 million within Research, development and engineering expenses, $0.1 million within Selling, general and administrative and less than $0.1 million within Interest expense in the Consolidated Statements of Operations, respectively.
The following table summarizes the components of lease expense:
(in thousands)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Operating lease cost
 
$
1,368

 
$
1,406

 
$
2,747

 
$
2,807

Finance lease cost
 
 
 
 
 
 
 
 
Amortization of right-of-use (“ROU”) asset
 
52

 
45

 
104

 
69

Interest expense
 
12

 
14

 
25

 
21

Short-term lease cost
 
108

 
133

 
217

 
276

Variable lease cost
 
374

 
311

 
797

 
766

Total lease cost
 
$
1,914

 
$
1,909

 
$
3,890

 
$
3,939

The following table presents supplemental cash flow information related to leases:
(in thousands)
 
For the Six Months Ended June 30,
 
 
2020
 
2019
Cash paid for amounts included in the measurement of lease liabilities
 
 
 
 
Operating cash flows paid for operating leases
 
$
2,734

 
$
2,444

Operating cash flows paid for interest portion of finance leases
 
25

 
21

Financing cash flows paid for principal portion of finance leases
 
96

 
61

Right-of-use assets obtained in exchange for lease obligations
 
 
 
 
Operating leases
 
299

 
280

Finance leases
 

 
517


17


As of June 30, 2020 and December 31, 2019, the weighted-average remaining lease term was 6.4 years and 6.7 years for operating leases and 4.1 years and 4.5 years for finance leases, respectively. The weighted-average discount rate was 7.2% for operating leases and 6.8% for finance leases as of both June 30, 2020 and December 31, 2019.
The following table presents supplemental balance sheet information related to leases:
(in thousands)
 
June 30, 2020
 
December 31, 2019
Operating lease ROU assets, net 1
 
$
19,014

 
$
20,677

 
 
 
 
 
Operating lease liabilities, current 2
 
3,759

 
3,789

Operating lease liabilities, non-current 3
 
16,063

 
17,679

Total operating lease liabilities
 
$
19,822

 
$
21,468

 
 
 
 
 
Finance lease ROU assets, net 1
 
$
656

 
$
777

 
 
 
 
 
Finance lease liabilities, current 2
 
192

 
195

Finance lease liabilities, non-current 3
 
524

 
617

Total finance lease liabilities
 
$
716

 
$
812

1.
Included in Other noncurrent assets for operating leases and Property, plant and equipment, net for finance leases on the Consolidated Balance Sheets.
2.
Included in Other accrued liabilities for operating leases and Current maturities of long-term debt for finance leases on the Consolidated Balance Sheets.
3.
Included in Other noncurrent liabilities for operating leases and Long-term debt, net of current maturities for finance leases on the Consolidated Balance Sheets.
The following table presents maturity analysis of lease liabilities as of June 30, 2020:
(in thousands)
 
Operating Leases
 
Finance Leases
Six months ending December 31, 2020
 
$
2,555

 
$
121

Year ending December 31, 2021
 
4,948

 
243

Year ending December 31, 2022
 
4,788

 
175

Year ending December 31, 2023
 
3,283

 
101

Year ending December 31, 2024
 
1,813

 
82

Thereafter
 
7,399

 
96

Total undiscounted lease payments
 
24,786

 
818

Less: imputed interest
 
4,964

 
102

Total lease liabilities
 
$
19,822

 
$
716

Note 8.    Fair Value of Financial Instruments
For assets and liabilities measured at fair value on a recurring and nonrecurring basis, a three-level hierarchy of measurements based upon observable and unobservable inputs is used to arrive at fair value. Observable inputs are developed based on market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions about valuation based on the best information available in the circumstances. Depending on the inputs, the Company classifies each fair-value measurement as follows:
Level 1 – based on quoted prices in active markets for identical assets or liabilities;
Level 2 – based on other significant observable inputs for the assets or liabilities through corroborations with market data at the measurement date; and
Level 3 – based on significant unobservable inputs that reflect management’s best estimate of what market participants would use to price the assets or liabilities at the measurement date.
Financial Instruments Measured at Carrying Value
Debt
The Company measured its revolving credit facilities and the Unsecured Senior Notes at original carrying value including accrued interest, net of unamortized deferred financing costs and fees. The fair value of the revolving credit facility approximated carrying value, as it consisted of short-term variable rate loans.

18


The fair value measurement of the Unsecured Senior Notes was defined as Level 3 at December 31, 2019 in the three-level fair value hierarchy, as the inputs to their valuation were not all market observable.
(in thousands)
 
As of June 30, 2020
 
 
Carrying Value
 
Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
Revolving credit facility
 
$
130,000

 
$

 
$
130,000

 
$

(in thousands)
 
As of December 31, 2019
 
 
Carrying Value
 
Fair Value
 
 
 
Level 1
 
Level 2
 
Level 3
Revolving credit facility
 
$
39,527

 
$

 
$
39,527

 
$

Unsecured Senior Notes
 
54,765

 

 

 
54,600

Financial Instruments Measured at Fair Value
Warrants
The following table summarizes changes in the estimated fair value of the Company’s warrant liability:
(in thousands)
 
 
 
For the Six Months Ended June 30, 2019
Balance at beginning of period
 
 
 
$
35,100

Change in value of warrants *
 
 
 
1,352

Settlement of warrants
 
 
 
(36,452
)
Balance at end of period
 
 
 
$

*
The change in value of the warrant liability is presented as Loss from change in value of warrants in the Company’s Consolidated Statements of Operations.
Note 9.    Commitments and Contingencies
Legal Contingencies
The legal matters discussed below and others could result in losses, including damages, fines, civil penalties and criminal charges, which could be substantial. The Company records accruals for these contingencies to the extent the Company concludes that a loss is both probable and reasonably estimable. Regarding the matters disclosed below, unless otherwise disclosed, the Company has determined that liabilities associated with these legal matters are reasonably possible; however, unless otherwise stated, the possible loss or range of possible loss cannot be reasonably estimated. Given the nature of the litigation and investigations and the complexities involved, the Company is unable to reasonably estimate a possible loss for all such matters until the Company knows, among other factors, the following:
what claims, if any, will survive dispositive motion practice;
the extent of the claims, particularly when damages are not specified or are indeterminate;
how the discovery process will affect the litigation;
the settlement posture of the other parties to the litigation; and
any other factors that may have a material effect on the litigation or investigation.
However, the Company could incur judgments, enter into settlements or revise its expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on the Company’s results of operations in the period in which the amounts are accrued and/or liquidity in the period in which the amounts are paid.
Securities and Exchange Commission and United States Attorney’s Office for the Northern District of Illinois Investigations
In August 2016, the Chicago Regional Office of the SEC commenced an investigation focused on, among other things, the Company’s financial reporting, misapplication of U.S. GAAP, revenue recognition practices and related conduct, which resulted in the accounting errors giving rise to the financial restatements reported in prior SEC filings. In 2016, the United States Attorney's Office for the Northern District of Illinois (the “USAO”) began conducting a parallel investigation regarding these matters. The Company is fully cooperating with the SEC and the USAO in their investigations. The Company is engaged in ongoing discussions with the SEC and the USAO regarding resolutions of these matters. 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, criminal or civil charges, fines, other monetary penalties, injunctive relief and

19


compliance conditions imposed by a court or agreement, which may have a material adverse effect on the financial condition, results of operations or cash flows of the Company.
Federal Derivative Litigation
In February 2017, Travis Dorvit filed a putative stockholder derivative action in the U.S. District Court for the Northern District of Illinois, captioned Dorvit v. Winemaster, et al., No. 1:17-cv-01097 (N.D. Ill.) (the “Dorvit Action”), against certain of the Company’s current and former officers and directors. The complaint asserted claims for breach of fiduciary duty and unjust enrichment arising from the same matters at issue in the consolidated case captioned Guinta v. Power Solutions International, Inc., No. 1:16-cv-09599 (N.D.Ill.), which had alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), arising from public filings, press releases and conference calls between February 2014 and February 2017, and which was settled in May 2019 (hereinafter, the “Giunta Action”). In April 2018, Michael Martin filed a second putative stockholder derivative action, captioned Martin v. Winemaster, et al., No. 18-CV-2386 (N.D. Ill.) (the “Martin Action”), in the same court against certain of the Company’s current and former officers and directors. In July 2018, the court consolidated the Martin Action and the Dorvit Action.
In July 2018, the plaintiffs in the consolidated Dorvit and Martin Actions filed an amended consolidated complaint (the “Second Amended Complaint”) against certain of the Company’s current and former officers and directors, who are indemnified by the Company as to their legal fees and defense costs. The Second Amended Complaint asserts claims for breach of fiduciary duty, unjust enrichment, corporate waste and failure to hold an annual stockholders’ meeting, and it seeks an unspecified amount of damages, an order compelling the Company to hold an annual stockholders’ meeting and an award of costs, including reasonable attorneys’ fees and expenses. In April 2019, the parties reached an agreement in principle to settle the litigation for approximately $1.9 million (“Settlement Amount”), half of which will be used to pay certain defense costs on behalf of the Company, and the remaining half of which the plaintiffs sought as an award of their attorneys’ fees and expenses in connection with the benefit conferred by the settlement. The settlement was approved by the court in August 2019 over two objections, including from the plaintiffs in the McClenney Action (defined below). Plaintiffs in the McClenney Action appealed the court’s order approving the settlement. On February 28, 2020, the U.S. Court of Appeals for the Seventh Circuit affirmed the district court’s approval of the settlement. The deadline for the plaintiffs in the McClenney Action to seek further review in the U.S. Supreme Court elapsed on July 27, 2020 and the settlement is now final. The Company’s insurers made a payment of half of the Settlement Amount in September 2019 toward the fulfillment of the plaintiff’s award of attorneys’ fees and expenses, and the insurers have allocated the remaining half of the Settlement Amount toward the payment of certain defense costs consistent with the terms of the settlement. The Company had accrued for the settlement in Other accrued liabilities and for the full insurance recovery of the Settlement Amount in Prepaid expenses and other current assets as of December 31, 2019.
State Derivative Litigation
In May 2017, Lewis McClenney filed a putative stockholder derivative action in the Chancery Division of the Circuit Court of Cook County, Illinois, captioned McClenney v. Winemaster, et al., No. 2017-CH-06481 (the “McClenney Action”), against certain of the Company’s current and former officers and directors. The McClenney Action asserted claims for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement and corporate waste arising from the same matters at issue in the Giunta Action. On the same day that the McClenney Action was filed, Sara Rebscher also filed a putative stockholder derivative action in the same court, captioned Rebscher v. Winemaster, et al., No. 2017-CH-06517 (the “Rebscher Action”). The Rebscher Action asserts claims for breach of fiduciary duty and unjust enrichment against certain of the Company’s current and former officers and directors, arising from the same matters at issue in the Giunta Action. Additionally, the complaint in the Rebscher Action asserts a claim for professional negligence and accounting malpractice against the Company’s former auditor, RSM U.S. LLP (“RSM”). In July 2017, the court consolidated the McClenney Action and the Rebscher Action. Subsequently, the court appointed Rebscher as lead plaintiff and designated the Rebscher Action as the operative complaint. In November 2018, the court granted the Company’s motion to dismiss the consolidated case with prejudice on the grounds that it is duplicative of the Dorvit and Martin Actions. Plaintiffs moved for reconsideration of the court’s decision, which the court denied in January 2019. In February 2019, plaintiffs filed a notice of appeal from the court’s order dismissing the case. In December 2019, the Illinois Appellate Court affirmed the dismissal of the McClenney Action. Plaintiffs did not seek rehearing in the Illinois Appellate Court and did not petition for leave to appeal to the Illinois Supreme Court.
Jerome Treadwell v. the Company                     
In October 2018, a putative class-action complaint was filed against the Company and NOVAtime Technology, Inc. (“NOVAtime”) in the Circuit Court of Cook County, Illinois. In December 2018, NOVAtime removed the case to the U.S. District Court for the Northern District of Illinois, Eastern Division under the Class Action Fairness Act. Plaintiff has since voluntarily dismissed NOVAtime from the lawsuit without prejudice and filed an amended complaint in April 2019. The operative, amended complaint asserts violations of the Illinois Biometric Information Privacy Act (“BIPA”) in connection with employees’ use of the time clock to clock in and clock out using a finger scan and seeks statutory damages, attorneys’ fees, and injunctive and equitable relief. An aggrieved party under BIPA may recover (i) $1,000 per violation if the Company is found to have negligently violated BIPA or

20


(ii) $5,000 per violation if the Company is found to have intentionally or recklessly violated BIPA plus reasonable attorneys’ fees. In May 2019, the Company filed its motion to dismiss the plaintiff’s amended complaint. In December 2019, the court denied the Company’s motion to dismiss. In January 2020, the Company moved for reconsideration of the court’s order denying the motion to dismiss, or in the alternative, to stay the case pending the Illinois Appellate Court’s ruling in McDonald v. Symphony Healthcare on a legal question that would be potentially dispositive in this matter. In February 2020, the court denied the Company’s motion for reconsideration, but required the parties to submit additional briefing on the Company’s motion to stay. In April 2020, the Court granted the Company’s motion to stay and stayed the case pending the Illinois Appellate Court’s ruling in McDonald v. Symphony Healthcare. The Company intends to vigorously defend against this action. At this time, the Company is unable to predict the outcome of this matter or meaningfully quantify how the final resolution of this matter may impact its results of operations, financial condition or cash flows.
Don Wilkins v. the Company
In April 2017, Don Wilkins, former VP of Advanced Product Development for the Company, filed a two-count complaint alleging breach of contract by the Company and violation of the Illinois Wage Payment and Collections Act (“IWPCA”) by the Company and its former CEO, Gary Winemaster (the “Wilkins Complaint”). The Wilkins Complaint claims the Company did not have cause to terminate Mr. Wilkins’ Employment and Confidentiality Agreement (the “Wilkins Agreement”), executed January 6, 2012, and that the Company and Mr. Winemaster violated the IWPCA by failing to pay him accrued but unpaid vacation and earned commissions. The Wilkins Complaint seeks damages including a $2.0 million bonus entitlement in the Wilkins Agreement, guaranteed annual salary to increase at 1.5 times the Consumer Price Index per year from the termination date to the end-date of the Wilkins Agreement, December 31, 2020, and 20,000 shares of restricted stock granted to him in 2013 with a vesting schedule through 2020. In June 2017, the Company and Mr. Winemaster answered the complaint and asserted numerous defenses. The Company also asserted counterclaims against Mr. Wilkins including violation of the Illinois Trade Secrets Act, breach of the Wilkins Agreement, breach of fiduciary duty, and spoliation. In January 2019, Wilkins voluntarily dismissed with prejudice his claims for unpaid commissions and vacation against the Company and Mr. Winemaster, subject to the parties’ confidential settlement agreement of those claims. In February 2020, the Company filed a motion for protective order or to stay the litigation, which the Court denied in April 2020. In May 2020, the parties reached an agreement to settle all remaining claims for a $1.1 million payment (“Wilkins Settlement Amount”) to Mr. Wilkins. The Company paid $0.9 million of the Wilkins Settlement Amount which was reserved as of the first quarter of 2019. The Company’s insurance provider contributed the remainder of the Wilkins Settlement Amount. On June 1, 2020, the Court dismissed the Wilkins Complaint with prejudice and with each party to bear their own costs and attorneys’ fees.
Mast Powertrain v. the Company
In February 2020, the Company received a demand for arbitration from Mast Powertrain, LLC (“Mast”) pursuant to a development agreement entered into on December 20, 2011 (the “Development Agreement”). Mast claimed that it is owed more than $9.0 million in royalties for products sold by the Company pursuant to the Development Agreement. The Company has disputed Mast’s damages, denied that any royalties are owed to Mast, denied any liability, and counterclaimed for overpayment on invoices paid to Mast. The parties are in the beginning stages of arbitration and discussions for resolution. At this time, the Company is unable to predict the outcome of this matter or meaningfully quantify how the final resolution of this matter may impact its results of operations, financial condition or cash flows.
Indemnification Agreements
Under the Company’s bylaws and certain indemnification agreements, the Company has obligations to indemnify current and former officers and directors and certain current and former employees. As a result of cumulative legal fees and settlements previously paid, the Company fully exhausted its primary directors’ and officers’ insurance coverage of $30 million during the first quarter of 2020. Additional expenses currently expected to be incurred and that will 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. The Company accrues for such costs as incurred within Selling, general and administrative expenses in the Company’s Consolidated Statements of Operations. At this time, the Company is not able to estimate the impact of these obligations due to the actions ongoing; however, the impact may be material to the Company’s results of operations, financial condition, and cash flows.
At the end of June 2020, the Company entered into a new directors’ and officers’ liability insurance policy. The insurance policy includes standard exclusions including for any ongoing or pending litigation such as the previously disclosed investigations by the SEC and USAO.
Other Commitments
At June 30, 2020, the Company had seven outstanding letters of credit totaling $3.0 million. The letters of credit primarily serve as collateral for the Company for certain facility leases and insurance policies. As discussed in Note 1. Summary of Significant

21


Accounting Policies and Other Information, the Company had restricted cash of $3.4 million at June 30, 2020 related to these letters of credit.
The Company has arrangements with certain suppliers that require it to purchase minimum volumes or be subject to monetary penalties. As of June 30, 2020, if the Company were to stop purchasing from each of these suppliers, the aggregate amount of the penalty would be approximately $4.7 million. Most of these arrangements enable the Company to secure supplies of critical components. The Company does not currently anticipate any material penalties under these contracts; however, given the significant declines in oil prices in early 2020 and the impacts of the COVID-19 pandemic, the Company continues to monitor and evaluate the impact of potential future purchase volume reductions.
Note 10.    Income Taxes
On a quarterly basis, the Company computes an estimated annual effective tax rate considering ordinary income and related income tax expense. Ordinary income refers to income (loss) before income tax expense excluding significant, unusual or infrequently occurring items. The tax effect of an unusual or infrequently occurring item is recorded in the interim period in which it occurs.
The Company has assessed the need to maintain a valuation allowance for deferred tax assets based on an assessment of whether it is more likely than not that deferred tax benefits will be realized through the generation of future taxable income. Appropriate consideration is given to all available evidence, both positive and negative, in assessing the need for a valuation allowance. In assessing the realizability of the Company’s deferred tax assets, the Company considered whether it is more likely than not that some or all of the deferred tax assets will be realized through the generation of future taxable income. In making this determination, the Company assessed all of the evidence available at the time, including recent earnings, forecasted income projections and historical performance. The Company determined that the negative evidence outweighed the objectively verifiable positive evidence and continues to maintain a full valuation allowance against deferred tax assets.
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Among the changes to the U.S. federal income tax rules, the CARES Act modified net operating loss carryback rules that were eliminated by the 2017 Tax Cuts and Jobs Act, restored 100% bonus depreciation for qualified improvement property, increased the limit on the deduction for net interest expense and accelerated the time frame for refunds of alternative minimum tax (“AMT”) credits. The Company’s ability to elect bonus depreciation for the 2018 and 2019 tax years, carryback net operating losses to earlier years, and immediately refund AMT credits due to the enactment of the CARES Act resulted in a tax benefit of $1.9 million for the six months ended June 30, 2020. There is no material impact to the Company’s deferred tax assets due to the full valuation allowance.
The effective tax rate for the three and six months ended June 30, 2020 was (2.8)% and 16.2%, respectively, compared to an effective tax rate for the three and six months ended June 30, 2019 of (8.7)% and 5.9%. The effective tax rates for all periods were significantly different than the applicable U.S. statutory tax rate. For the three months ended June 30, 2020, the difference between the effective and statutory tax rates was primarily due to an adjustment in the impact of the CARES Act. For the six months ended June 30, 2020, the difference between the effective and statutory tax rates was primarily due to the impact of the enactment of the CARES Act in the first quarter of 2020, a change in the deferred tax liability related to an indefinite-lived intangible asset and the Company’s full valuation allowance. For the three and six months ended June 30, 2019, the difference between the effective and statutory tax rates is primarily due to the Company’s full valuation allowance, the impact of the losses related to the Weichai Warrant and an increase in the deferred tax liability related to indefinite-lived assets which cannot serve as a source of income for the realization of deferred tax assets and states that base tax on gross margin.
Note 11.    Stockholders’ Equity
Common and Treasury Stock
The changes in shares of Common and Treasury Stock are as follows:
(in thousands)
 
Common Shares Issued
 
Treasury Stock Shares
 
Common Shares Outstanding
Balance as of January 1, 2020
 
23,117

 
260

 
22,857

Net shares issued for Stock awards
 

 
(3
)
 
3

Balance as of June 30, 2020
 
23,117

 
257

 
22,860


22


Note 12.    Loss Per Share
The Company computes basic loss per share by dividing net loss distributable to common shares by the weighted-average common shares outstanding during the period. Diluted loss per share is calculated to give effect to all potentially dilutive common shares that were outstanding during the period. Weighted-average diluted common shares outstanding primarily reflect the additional shares that would be issued upon the assumed exercise of stock options and the assumed vesting of unvested share awards. The treasury stock method has been used to compute diluted loss per share for the three and six months ended June 30, 2020 and 2019.
The Company issued warrants that represent the right to purchase shares of Common Stock, Stock Appreciation Rights (“SARs”) and Restricted Stock Awards (“RSAs”), all of which have been evaluated for their potentially dilutive effect under the treasury stock method. See Note 3. Weichai Transactions herein for additional information on the Weichai Warrant and Note 12. Stock-Based Compensation in the Company’s 2019 Annual Report for additional information on the SARs and the RSAs.
The computations of basic and diluted loss per share are as follows:
(in thousands, except per share basis)
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2020
 
2019
 
2020
 
2019
Numerator:
 
 
 
 
 
 
 
Net loss
$
(17,742
)
 
$
(2,998
)
 
$
(18,454
)
 
$
(5,584
)
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Shares used in computing net loss per share:
 
 
 
 
 
 
 
Weighted-average common shares outstanding – basic
22,858

 
21,702

 
22,858

 
20,171

Effect of dilutive securities

 

 

 

Weighted-average common shares outstanding  diluted
22,858

 
21,702

 
22,858

 
20,171

 
 
 
 
 
 
 
 
Loss per common share:
 
 
 
 
 
 
 
Loss per share of common stock – basic
$
(0.78
)
 
$
(0.14
)
 
$
(0.81
)
 
$
(0.28
)
Loss per share of common stock – diluted
$
(0.78
)
 
$
(0.14
)
 
$
(0.81
)
 
$
(0.28
)
The aggregate number of shares excluded from the diluted loss per share calculations, because they would have been anti-dilutive, were 0.2 million shares for both the three and six months ended June 30, 2020, respectively, and 1.1 million and 2.7 million shares during the three and six months ended June 30, 2019, respectively. For the three and six months ended June 30, 2020 and 2019, SARs and RSAs were not included in the diluted loss per share calculations as they would have been anti-dilutive (1) due to the losses reported in the Consolidated Statements of Operations or (2) the Company’s average stock price was less than the exercise price of the SARs or the grant price of the RSAs.
Note 13.    Related Party Transactions
Weichai Transactions
See Note 3. Weichai Transactions for information regarding transactions with Weichai.
Transactions with Joint Ventures
Doosan-PSI, LLC
In 2015, the Company and Doosan Infracore Co., Ltd. (“Doosan”), a subsidiary of Doosan Group, entered into an agreement to form Doosan-PSI, LLC. The Company invested $1.0 million to acquire 50% of the venture, which was formed to operate in the field of developing, designing, testing, manufacturing, assembling, branding, marketing, selling, distributing and providing support for industrial gas engines and all components and materials required for assembly of the gas engines to the global power generation market outside of North America and South Korea. In the fourth quarter of 2019, Doosan and the Company agreed to wind down and dissolve the joint venture. This is expected to be completed in the third quarter of 2020.
Joint Venture Operating Results
The Company’s Consolidated Statements of Operations included income from this investment of less than $0.1 million and $0.3 million for the three and six months ended June 30, 2020, respectively. Income from this investment was $0.4 million and $0.5 million for the three and six months ended June 30, 2019, respectively. The joint venture operating results are presented in Other income, net in the Company’s Consolidated Statements of Operations.

23


Item 2.    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 three and six months ended June 30, 2020 and 2019, 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. See “Forward-Looking Statements.” The following discussion should also be read in conjunction with the Company’s unaudited consolidated financial statements and the related Notes included in this Quarterly Report.
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, research and development (“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 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).
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, and the related recent historic decline in oil demand. The Company has experienced a significant overall reduction in demand for its products which is, in large part, attributable to the impact of the COVID-19 pandemic. This reduction in demand has adversely impacted the Company’s financial results for the three and six months ended June 30, 2020.
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 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 the three months ended June 30, 2020, the Company’s net sales decreased $45.6 million from the three months ended June 30, 2019 to $93.1 million, the result of decreased sales volumes across the industrial and energy end markets of $24.2 million and $22.6 million, respectively, partly offset by a $1.2 million increase in the transportation end market. Gross margin for the three months ended June 30, 2020 was 4.1%, a decrease versus 18.5% in the comparable 2019 period. Gross profit declined by $21.8 million for the three months ended June 30, 2020, while operating expenses decreased by $1.7 million, as compared to the comparable period in 2019. For the three months ended June 30, 2019, the Company recognized a loss of $5.8 million as a result of the change in the value of the Weichai Warrant including the impact of it being exercised in April 2019. Because the Weichai Warrant was exercised in April 2019, it had no impact on the three months ended June 30, 2020. See Note 3. Weichai Transactions, included in Part 1, Item 1. Financial Statements, for additional information. Also, the Company recognized a loss on the extinguishment of debt for the three months ended June 30, 2020 of $0.5 million, compared to no loss on the extinguishment of debt for the three months ended June 30, 2019. Collectively, these factors contributed to a $14.7 million increase in the net loss, which totaled $17.7 million in the 2020 period compared to a net loss of $3.0 million in the same period of 2019. Diluted loss per share was $0.78 in the 2020 period compared to a diluted loss per share of $0.14 in the comparable 2019 period. Adjusted net loss, which excludes certain items described below that the Company believes are not indicative of its ongoing operating performance, was $12.2 million in the 2020 period, a decrease of $20.7 million, compared to Adjusted net income of $8.5 million in 2019. Adjusted loss per share was $0.53 in 2020 compared to Adjusted earnings per share of $0.39 in 2019. Adjusted earnings before interest expense, income taxes, depreciation and amortization (“EBITDA”) was a loss of $8.6 million in 2020 compared to Adjusted EBITDA of $13.0 million in 2019. Adjusted net loss (income), Adjusted loss (income) 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 2.
For the six months ended June 30, 2020, the Company’s net sales decreased $56.3 million, or 22.1%, compared to the six months ended June 30, 2019, as a result of sales declines of $37.7 million, $18.2 million and $0.5 million in the industrial, energy and transportation end markets, respectively. Gross margin was 10.8% and 17.0% during the six months ended June 30, 2020 and 2019, respectively. Gross profit decreased during the six months ended June 30, 2020 by $21.8 million compared to the six months ended June 30, 2019, while operating expenses decreased by $3.6 million as compared to the comparable period in 2019. Interest expense decreased by $1.5 million for the six months ended June 30, 2020 versus the comparable period in

24


2019. There was no impact from a change in value of warrants for the six months ended June 30, 2020 due to the Weichai Warrant being exercised in April 2019. The Company recognized a loss of $1.4 million for the six months ended June 30, 2019 as a result of the change in the value of the Weichai Warrant including the impact of the exercise. See Note 3. Weichai Transactions, included in Part 1, Item 1. Financial Statements, for additional information. The Company recognized a loss on the extinguishment of debt for the six months ended June 30, 2020 of $0.5 million, compared to no loss on the extinguishment of debt for the six months ended June 30, 2019. Also, the Company recorded an income tax benefit of $3.6 million for the six months ended June 30, 2020 versus a $0.3 million benefit for the same period last year. Collectively, these factors contributed to a $12.9 million increase in the net loss, which totaled $18.5 million in the 2020 period compared to a net loss of $5.6 million in the same period of 2019. Diluted loss per share was $0.81 in the 2020 period compared to a diluted loss per share of $0.28 in the comparable 2019 period. Adjusted net loss, which excludes certain items described below that the Company believes are not indicative of its ongoing operating performance, was $12.8 million in the 2020 period, a decrease of $21.2 million, compared to Adjusted net income of $8.4 million in 2019. Adjusted loss per share was $0.56 in 2020 compared to Adjusted earnings per share of $0.41 in 2019. Adjusted EBITDA was a loss of $6.0 million in 2020 compared to Adjusted EBITDA of $16.7 million in 2019. Adjusted net loss (income), Adjusted loss (earnings) 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 2.

Net sales by geographic area and by end market for the three and six months ended June 30, 2020 and 2019 are presented below:

 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Geographic Area
 
 
% of Total
 
 
% of Total
 
 
% of Total
 
 
% of Total
North America
 
$
81,979

88
%
 
$
119,943

86
%
 
$
176,499

89
%
 
$
217,622

86
%
Pacific Rim
 
6,295

7
%
 
10,804

8
%
 
12,749

6
%
 
23,429

9
%
Europe
 
2,578

3
%
 
5,006

4
%
 
5,235

3
%
 
8,383

3
%
Others
 
2,204

2
%
 
2,931

2
%
 
3,670

2
%
 
5,037

2
%
Total
 
$
93,056

100
%
 
$
138,684

100
%
 
$
198,153

100
%
 
$
254,471

100
%

 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
End Market
 
 
% of Total
 
 
% of Total
 
 
 
 
 
 
Energy
 
$
29,649

32
%
 
$
52,245

38
%
 
$
79,733

40
%
 
$
97,893

39
%
Industrial
 
30,463

33
%
 
54,660

39
%
 
67,594

34
%
 
105,247

41
%
Transportation
 
32,944

35
%
 
31,779

23
%
 
50,826

26
%
 
51,331

20
%
Totals
 
$
93,056

100
%
 
$
138,684

100
%
 
$
198,153

100
%
 
$
254,471

100
%

25


Results of Operations
Results of operations for the three and six months ended June 30, 2020 compared with the three and six months ended June 30, 2019:
(in thousands, except per share amounts)
 
For the Three Months Ended June 30,
 
 
 
 
 
For the Six Months Ended June 30,
 
 
 
 
 
 
2020
 
2019
 
Change
 
% Change
 
2020
 
2019
 
Change
 
% Change
Net sales
 
$
93,056

 
$
138,684

 
$
(45,628
)
 
(33
)%
 
$
198,153

 
$
254,471

 
$
(56,318
)
 
(22
)%
Cost of sales
 
89,279

 
113,070

 
(23,791
)
 
(21
)%
 
176,662

 
211,153

 
(34,491
)
 
(16
)%
Gross profit
 
3,777

 
25,614

 
(21,837
)
 
(85
)%
 
21,491

 
43,318

 
(21,827
)
 
(50
)%
Gross margin %
 
4.1
%
 
18.5
%
 
(14.4
)%
 
 
 
10.8
%
 
17.0
%
 
(6.2
)%
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research, development and engineering expenses
 
5,814

 
6,030

 
(216
)
 
(4
)%
 
12,566

 
12,329

 
237

 
2
 %
Research, development and engineering expenses as a % of sales
 
6.2
%
 
4.3
%
 
1.9
 %
 
 
 
6.3
%
 
4.8
%
 
1.5
 %
 
 
Selling, general and administrative expenses
 
12,580

 
13,955

 
(1,375
)
 
(10
)%
 
26,470

 
30,015

 
(3,545
)
 
(12
)%
Selling, general and administrative expenses as a % of sales
 
13.5
%
 
10.1
%
 
3.4
 %
 
 
 
13.4
%
 
11.8
%
 
1.6
 %
 
 
Amortization of intangible assets
 
764

 
909

 
(145
)
 
(16
)%
 
1,527

 
1,819

 
(292
)
 
(16
)%
Total operating expenses
 
19,158

 
20,894

 
(1,736
)
 
(8
)%
 
40,563

 
44,163

 
(3,600
)
 
(8
)%
Operating (loss) income
 
(15,381
)
 
4,720

 
(20,101
)
 
NM

 
(19,072
)
 
(845
)