psix-20210331
POWER SOLUTIONS INTERNATIONAL, INC.0001137091--12-31Non-accelerated 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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
https://cdn.kscope.io/5269724e3adaf73ad08641d6358465fb-psix-20210331_g1.jpg
FORM 10-Q
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021    
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)
Delaware33-0963637
(State or Other Jurisdiction of Incorporation or Organization)(I.R.S. Employer Identification No.)
201 Mittel Drive, Wood Dale, IL60191
(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 ClassTrading 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 companyx
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 May 3, 2021, there were 22,892,413 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 March 31, 2021 (Unaudited) and December 31, 2020
Consolidated Statements of Operations for the three months ended March 31, 2021 and 2020 (Unaudited)
Consolidated Statements of Stockholders’ (Deficit) Equity for the three months ended March 31, 2021 and 2020 (Unaudited)
Consolidated Statements of Cash Flows for the three months ended March 31, 2021 and 2020 (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 months ended March 31, 2021 (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, potential profitability and liquidity, 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 liquidity 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, 2020, and from time to time in the Company’s subsequent filings with the United States Securities and Exchange Commission (the “SEC”); the impact of the ongoing COVID-19 pandemic could have on the Company’s business and financial results; the Company’s ability to continue as a going concern; the Company’s ability to raise additional capital when needed and its liquidity; uncertainties around the Company’s ability to meet funding conditions under its financing arrangements and access to capital thereunder; the potential acceleration of the maturity at any time of the loans under the Company’s uncommitted senior secured revolving credit facility through the exercise by Standard Chartered Bank of its demand right; 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; risks related to complying with the terms and conditions of the settlements with the SEC and the United States Attorney's Office for the Northern District of Illinois (the “USAO”); variances in non-recurring expenses; risks relating to the substantial costs and diversion of personnel’s attention and resources deployed to address the internal control matters; the Company’s obligations to indemnify past and present directors and officers and certain current and former employees with respect to the investigations conducted by the SEC and the criminal division of the USAO, which will be funded by the Company with its existing cash resources due to the exhaustion of its historical primary directors’ and officers’ insurance coverage; the ability of the Company to accurately forecast sales, and the extent to which sales result in recorded revenues; changes in customer demand for the Company’s products; volatility in oil and gas prices; the impact of U.S. tariffs on imports from China on the Company’s supply chain; the impact of increasing warranty costs and the Company’s ability to mitigate such costs; any delays and challenges in recruiting and retaining key employees consistent with the Company’s plans; 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 March 31, 2021As of December 31, 2020
ASSETS
Current assets:
Cash and cash equivalents$23,404 $20,968 
Restricted cash3,299 3,299 
Accounts receivable, net of allowances of $3,269 and $3,701 as of March 31, 2021 and December 31, 2020, respectively
52,527 60,148 
Income tax receivable3,705 3,708 
Inventories, net109,092 108,213 
Prepaid expenses and other current assets8,115 6,351 
Total current assets200,142 202,687 
Property, plant and equipment, net19,400 20,181 
Intangible assets, net9,685 10,319 
Goodwill29,835 29,835 
Other noncurrent assets19,992 20,955 
TOTAL ASSETS$279,054 $283,977 
LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY
Current liabilities:
Accounts payable$55,150 $31,547 
Current maturities of long-term debt292 310 
Revolving line of credit130,000 130,000 
Other accrued liabilities66,465 77,619 
Total current liabilities251,907 239,476 
Deferred income taxes1,255 886 
Long-term debt, net of current maturities695 781 
Noncurrent contract liabilities3,087 3,181 
Other noncurrent liabilities34,055 33,556 
TOTAL LIABILITIES$290,999 $277,880 
STOCKHOLDERS’ (DEFICIT) 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 shares issued; 22,892 shares outstanding at both March 31, 2021 and December 31, 2020
23 23 
Additional paid-in capital157,371 157,262 
Accumulated deficit(168,044)(149,894)
Treasury stock, at cost, 225 shares at both March 31, 2021 and December 31, 2020
(1,295)(1,294)
TOTAL STOCKHOLDERS’ (DEFICIT) EQUITY(11,945)6,097 
TOTAL LIABILITIES AND STOCKHOLDERS’ (DEFICIT) EQUITY$279,054 $283,977 
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 March 31,
20212020
Net sales$100,171 $105,097 
Cost of sales93,101 87,383 
Gross profit7,070 17,714 
Operating expenses:
Research, development and engineering expenses6,224 6,752 
Selling, general and administrative expenses15,811 13,890 
Amortization of intangible assets634 763 
Total operating expenses22,669 21,405 
Operating loss(15,599)(3,691)
Other expense, net:
Interest expense2,161 1,274 
Other income, net (211)
Total other expense, net2,161 1,063 
Loss before income taxes(17,760)(4,754)
Income tax expense (benefit)390 (4,042)
Net loss$(18,150)$(712)
Weighted-average common shares outstanding:
Basic22,892 22,858 
Diluted22,892 22,858 
Loss per common share:
Basic$(0.79)$(0.03)
Diluted$(0.79)$(0.03)
See Notes to Consolidated Financial Statements
5


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT) EQUITY
(UNAUDITED)
(in thousands)For the Three Months Ended
Common StockAdditional Paid-in CapitalAccumulated DeficitTreasury StockTotal Stockholders’ (Deficit) Equity
Balance at December 31, 2020$23 $157,262 $(149,894)$(1,294)$6,097 
Net loss— — (18,150)— (18,150)
Stock-based compensation expense— 109 — — 109 
Common stock issued for stock-based awards, net— — — (1)(1)
Balance at March 31, 2021$23 $157,371 $(168,044)$(1,295)$(11,945)
Balance at December 31, 2019$23 $156,727 $(126,912)$(1,341)$28,497 
Net loss— — (712)— (712)
Stock-based compensation expense— 165 — (8)157 
Common stock issued for stock-based awards, net— (1)— — (1)
Balance at March 31, 2020$23 $156,891 $(127,624)$(1,349)$27,941 
See Notes to Consolidated Financial Statements
6


POWER SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)For the Three Months Ended March 31,
20212020
Cash provided by operating activities
Net loss$(18,150)$(712)
Adjustments to reconcile net loss to net cash provided by operating activities:
Amortization of intangible assets634 763 
Depreciation1,266 1,296 
Stock-based compensation expense109 157 
Amortization of financing fees1,158 116 
Deferred income taxes369 (390)
Other adjustments, net574 (162)
Changes in operating assets and liabilities:
Accounts receivable, net7,620 45,585 
Inventory, net(1,363)(16,811)
Prepaid expenses and other assets(84)(5,530)
Accounts payable24,287 (8,586)
Accrued expenses(11,144)9,694 
Other noncurrent liabilities405 (1,116)
Net cash provided by operating activities5,681 24,304 
Cash used in investing activities
Capital expenditures(617)(779)
Other investing activities, net10 7 
Net cash used in investing activities(607)(772)
Cash used in financing activities
Proceeds from revolving line of credit 127,560 
Repayments of revolving line of credit (150,258)
Payments of deferred financing costs(2,536) 
Other financing activities, net(102)(21)
Net cash used in financing activities(2,638)(22,719)
Net increase in cash, cash equivalents, and restricted cash2,436 813 
Cash, cash equivalents, and restricted cash at beginning of the period24,267 3 
Cash, cash equivalents, and restricted cash at end of the period$26,703 $816 
(in thousands)As of March 31,
20212020
Reconciliation of cash, cash equivalents, and restricted cash to the Consolidated Balance Sheets
Cash and cash equivalents$23,404 $816 
Restricted cash3,299  
Total cash, cash equivalents, and restricted cash$26,703 $816 
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
In March 2017, the Company executed a share purchase agreement (the “SPA”) with Weichai America Corp., a wholly-owned subsidiary of Weichai Power Co., Ltd. (HK2338, SZ000338) (herein collectively referred to as “Weichai”). Under the terms of the SPA, Weichai invested $60.0 million in the Company purchasing a combination of newly issued Common and Preferred Stock as well as a stock purchase warrant (the “Weichai Warrant”).
With the exercise of the Weichai Warrant in April 2019, Weichai owns a majority of the outstanding shares of the Company’s common stock par value $0.001 (“Common Stock”). As a result, Weichai is able to exercise control over matters requiring stockholders’ approval, including the election of the directors, amendment of the Company’s Certificate of Incorporation and approval of significant corporate transactions. This control could have the effect of delaying or preventing a change of control of the Company or changes in management and will make the approval of certain transactions impractical without the support of Weichai.
Weichai also entered into an Investor Rights Agreement (the “Rights Agreement”) with the Company upon execution of the SPA. The Rights Agreement provides Weichai with representation on the Company’s Board of Directors (the “Board”) and management representation rights. Weichai currently has four representatives on the Board, which constitutes the majority of the directors serving on 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 March 2021, the Company entered into an amended and restated uncommitted revolving credit agreement between the Company and Standard Chartered Bank (“Standard Chartered”), as administrative agent (the “Amended and Restated Uncommitted Revolving Credit Agreement”). The Amended and Restated Uncommitted Revolving Credit Agreement continues to allow the Company to borrow up to $130.0 million and matures on March 25, 2022. Under the Amended and
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Restated Uncommitted Revolving Credit Agreement, Standard Chartered has the right to demand payment of any and all outstanding borrowings and other amounts outstanding under the Amended and Restated Uncommitted Revolving Credit Agreement at any point in time at its discretion. In connection with the execution of the Amended and Restated Uncommitted Revolving Credit Agreement, the Company entered into an amendment and restatement of the shareholder’s loan agreement originally executed with Weichai in December 2020 (the “First Amended and Restated Shareholder’s Loan Agreement”). The First Amended and Restated Shareholder’s Loan Agreement provides the Company with access to $130.0 million of credit solely for purposes of repaying outstanding borrowings under the Amended and Restated Uncommitted Revolving Credit Agreement. The First Amended and Restated Shareholder’s Loan Agreement expires on April 25, 2022. The Amended and Restated Uncommitted Revolving Credit Agreement provides Standard Chartered with a power of attorney (“POA”) to submit a borrowing request to Weichai under the First Amended and Restated Shareholder’s Loan Agreement if the Company fails to submit a borrowing request within five business days of receiving a request from Standard Chartered. As of March 31, 2021, the Company had $130.0 million outstanding under the Amended and Restated Uncommitted Revolving Credit Agreement. See Note 6. Debt for further information regarding the terms and conditions of the Company’s debt agreements.
Significant uncertainties exist about the Company’s ability to refinance, extend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Amended and Restated Uncommitted Revolving Credit Agreement in the future. Without additional financing, the Company anticipates that it will not have sufficient cash and cash equivalents to repay amounts owing under the Amended and Restated Uncommitted Revolving Credit Agreement as it becomes due. In order to provide the Company with a more permanent source of liquidity, management plans to seek an extension and amendment and/or replacement of the Amended and Restated Uncommitted Revolving Credit Agreement or additional liquidity from its current or other lenders before March 25, 2022. There can be no assurance that the Company’s management will be able to successfully complete an extension and amendment of the Amended and Restated Uncommitted Revolving Credit Agreement or obtain new financing on acceptable terms, when required or if at all. These consolidated financial statements 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, the global economy continues to be impacted by the outbreak of the coronavirus (“COVID-19”) that was first declared a global pandemic (the “COVID-19 pandemic”) in March 2020. The potential for continued disruptions, economic uncertainty, and unfavorable oil and gas market dynamics may continue to 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 and amend, or repay its outstanding indebtedness, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Amended and Restated Uncommitted Revolving Credit Agreement, substantial doubt exists as to its ability to continue as a going concern within one year after the date that these financial statements are issued. The Company’s plans to alleviate the substantial doubt about its ability to continue as a going concern may not be successful, and it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
The consolidated financial statements included herein have been prepared assuming that the Company will continue as a going concern and contemplating the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company’s ability to continue as a going concern is dependent on generating profitable operating results, having sufficient liquidity, maintaining compliance with the covenants and other requirements under the Amended and Restated Uncommitted Revolving Credit Agreement in the future, and extending and amending, refinancing or repaying the indebtedness outstanding under such agreement.

COVID-19 Pandemic and Oil and Gas Market Volatility
During 2020, as a result of the COVID-19 pandemic, the global economy experienced substantial turmoil, which led to challenging market conditions across certain areas of the Company’s business. In addition, due to unprecedented decreases in demand, an oil price war, and economic uncertainty resulting from the COVID-19 pandemic, average crude oil prices were considerably lower in 2020 as compared to prices at the end of 2019. Since May 2020, crude oil prices increased considerably from their lows reached in April 2020. While U.S. rig counts at the end of April 2021 are higher as compared to the start of 2021, they remain well below the average for the full year of 2019 and the first quarter of 2020. 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. In addition,
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the Company experienced delays in its supply chain during the first quarter of 2021 due to temporary shortages of raw materials and container delays of overseas materials as bottlenecks occurred at ports in Asia and North America. This, in turn, caused delivery delays to some of the Company’s customers. The Company also experienced inflationary cost pressures for certain materials and is working to mitigate the impact through price increases and other measures, where possible. The potential for continued disruptions, economic uncertainty, and unfavorable oil and gas market dynamics may have a material adverse impact on the timing of delivery of customer orders and the levels of future customer orders. Accordingly, these challenges may have a material adverse impact on the Company’s future results of operations, financial position, and liquidity.
The Company initiated certain contingency actions during 2020 as a result of the significant negative impacts of these factors on the Company. During 2020, the Company took actions to continue to improve its manufacturing operations which included making reductions in its production facility workforce 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 research and development (“R&D”) programs, among others. As of January 1, 2021, the Company reinstated pay for salaried employees as well as the 401(k) match program. Any additional cost savings initiatives or other cash actions the Company undertakes in response to the COVID-19 pandemic may not achieve the intended results and may result in other adverse impacts, which could be material. Even after the COVID-19 pandemic has subsided, the Company may continue to experience negative impacts to its business, operations and financial condition as a result of any economic recession or depression that has occurred or may occur in the future.
Basis of Presentation and Consolidation
The Company is filing this Form 10-Q for the three months ended March 31, 2021, which contains unaudited consolidated financial statements as of March 31, 2021 and for the three months ended March 31, 2021 and 2020.
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, 2020 (“the 2020 Annual Report”). The Company’s significant accounting policies are described in the aforementioned 2020 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 March 31,
20212020
Customer A15 %15 %
Customer B20 %**
Customer C**14 %
Customer D**10 %
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The following table presents customers individually accounting for more than 10% of the Company’s accounts receivable:
As of March 31, 2021As of December 31, 2020
Customer A23 %16 %
Customer B13 %**
Customer C**22 %
The following table presents suppliers individually accounting for more than 10% of the Company’s purchases:
For the Three Months Ended March 31,
20212020
Supplier A14 %**
Supplier B10 %**
Supplier C**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, evaluation of goodwill, other intangibles, property, 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
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 $6.0 million and $6.4 million for the three months ended March 31, 2021 and 2020, respectively.
Restricted Cash
The Company is required to maintain minimum levels of cash collateral to support the letters of credit. The cash collateral is held in a separate bank account which the Company is restricted from accessing. As discussed in Note 9. Commitments and Contingencies, the Company had outstanding letters of credit of $2.3 million and restricted cash of $3.3 million at both March 31, 2021 and December 31, 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.







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Inventories consisted of the following:
(in thousands)

Inventories
As of March 31, 2021As of December 31, 2020
Raw materials$85,595 $89,684 
Work in process6,552 2,482 
Finished goods20,653 19,375 
Total inventories112,800 111,541 
Inventory allowance(3,708)(3,328)
Inventories, net$109,092 $108,213 
Activity in the Company’s inventory allowance was as follows:
(in thousands)For the Three Months Ended March 31,
Inventory Allowance20212020
Balance at beginning of period$3,328 $2,964 
Charged to expense553 526 
Write-offs(173)(273)
Balance at end of period$3,708 $3,217 
Other Accrued Liabilities
Other accrued liabilities consisted of the following:
(in thousands)

Other Accrued Liabilities
As of March 31, 2021As of December 31, 2020
Accrued product warranty$17,073 $14,928 
Litigation reserves *
4,129 3,128 
Contract liabilities32,978 47,960 
Accrued compensation and benefits3,172 3,124 
Operating lease liabilities3,809 3,793 
Accrued interest expense33 895 
Other5,271 3,791 
Total$66,465 $77,619 
*As of March 31, 2021 and December 31, 2020 litigation reserves related to various ongoing legal matters including associated legal fees as well as accrued indemnification costs related to former officers and employees of the Company. 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. 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.


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Accrued product warranty activities are presented below:
(in thousands)For the Three Months Ended March 31,
Accrued Product Warranty20212020
Balance at beginning of period$31,542 $25,501 
Current year provision *
4,630 2,325 
Changes in estimates for preexisting warranties **
4,119 661 
Payments made during the period(5,166)(3,926)
Balance at end of period35,125 24,561 
Less: Current portion17,073 14,027 
Noncurrent accrued product warranty$18,052 $10,534 
*Warranty costs, net of supplier recoveries, were $6.8 million and $1.7 million for the three months ended March 31, 2021 and 2020, respectively. Supplier recoveries were $1.9 million and $1.2 million for the three months ended March 31, 2021 and 2020, respectively.
**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 recorded charges for changes in estimates of preexisting warranties of $4.1 million, or $0.18 per diluted share, and $0.7 million, or $0.03 per diluted share, for the three months ended March 31, 2021 and 2020, respectively.
Recently Issued Accounting Pronouncements Adopted
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of Effects of Reference Rate Reform on Financial Reporting, which provided optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendment allows entities to elect not to apply certain modification accounting requirements to contracts affected by reference rate reform if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met. The guidance was effective upon issuance and expires after December 31, 2022. There was no impact on the Company’s Consolidated Balance Sheets, Statements of Operations, Statements of Cash Flows or Statement of Stockholders’ Equity as a result of this guidance. The Company continues to monitor contracts potentially impacted by reference rate reform, including the Company’s debt agreements, and will continue to assess the potential impacts of this guidance as reference rates are updated.
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 consolidated financial statements.
Note 2.    Revenue
Disaggregation of Revenue
The following table summarizes net sales by end market:
(in thousands)For the Three Months Ended March 31,
End Market20212020
Energy$25,159 $50,084 
Industrial34,320 37,131 
Transportation40,692 17,882 
Total$100,171 $105,097 
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The following table summarizes net sales by geographic area:
(in thousands)For the Three Months Ended March 31,
Geographic Area20212020
North America$91,915 $94,520 
Pacific Rim5,528 6,454 
Europe1,610 2,657 
Other1,118 1,466 
Total$100,171 $105,097 
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 Sheet. 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 March 31, 2021As of December 31, 2020
Short-term contract assets (included in Prepaid expenses and other current assets)
$250 $547 
Short-term contract liabilities (included in Other accrued liabilities)
(32,978)(47,960)
Long-term contract liabilities (included in Noncurrent contract liabilities)
(3,087)(3,181)
Net contract liabilities$(35,815)$(50,594)
During the three months ended March 31, 2021 and 2020, the Company recognized $14.9 million and $3.0 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, 2020 and 2019, respectively. The decrease in the contract asset during the three months ended March 31, 2021 is related to the Company’s right to consideration no longer being conditional at the end of the period. The decrease in the contract liabilities during the three months ended March 31, 2021 was primarily related to revenue recognized upon satisfaction of performance obligations related to 6.0L engines that were previously prepaid by a customer under a long-term supply agreement.
Remaining Performance Obligations
For performance obligations that extend beyond one year, the Company had $35.7 million of remaining performance obligations as of March 31, 2021 primarily related to a long-term manufacturing contract with a customer and extended warranties. The Company expects to recognize revenue related to these remaining performance obligations of approximately $32.5 million in the remainder of 2021, $0.7 million in 2022, $1.0 million in 2023, $1.0 million in 2024, $0.4 million in 2025 and less than $0.1 million in 2026 and beyond.
Note 3.    Weichai Transactions
Weichai Shareholder’s Loan Agreement
In December 2020, the Company entered into the Shareholder’s Loan Agreement with Weichai. The Shareholder’s Loan Agreement was amended and restated in March 2021. See additional discussion in Note 6. Debt.
Weichai Collaboration Arrangement and Related Party Transactions
The Company and Weichai executed a strategic collaboration agreement (the “Collaboration Agreement”) in March 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 is set to expire in March 2023.
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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 months ended March 31, 2021 and 2020, the Company’s sales to Weichai were immaterial in all periods. Purchases of inventory from Weichai were $3.1 million and $5.1 million for the three months ended March 31, 2021 and 2020, respectively. As of March 31, 2021 and December 31, 2020, the Company had immaterial receivables from Weichai and outstanding payables to Weichai of $5.0 million and $4.0 million, respectively.
Note 4.    Property, Plant and Equipment
Property, plant and equipment by type were as follows:
(in thousands)As of March 31, 2021As of December 31, 2020
Property, Plant and Equipment
Leasehold improvements$6,560 $6,725 
Machinery and equipment43,481 43,030 
Construction in progress1,228 1,670 
Total property, plant and equipment, at cost51,269 51,425 
Accumulated depreciation(31,869)(31,244)
Property, plant and equipment, net$19,400 $20,181 
Note 5.    Goodwill and Other Intangibles
Goodwill
The carrying amount of goodwill at both March 31, 2021 and December 31, 2020 was $29.8 million. Accumulated impairment losses at both March 31, 2021 and December 31, 2020 were $11.6 million.
Other Intangible Assets
Components of intangible assets are as follows:
(in thousands)As of March 31, 2021
Gross Carrying ValueAccumulated AmortizationNet Book Value
Customer relationships$34,940 $(25,717)$9,223 
Developed technology700 (657)43 
Trade names and trademarks1,700 (1,281)419 
Total$37,340 $(27,655)$9,685 
(in thousands)As of December 31, 2020
Gross Carrying ValueAccumulated AmortizationNet Book Value
Customer relationships$34,940 $(25,117)$9,823 
Developed technology700 (650)50 
Trade names and trademarks1,700 (1,254)446 
Total$37,340 $(27,021)$10,319 
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Note 6.    Debt
The Company’s outstanding debt consisted of the following:
(in thousands)As of March 31, 2021As of December 31, 2020
Short-term financing:
Revolving credit facility$130,000 $130,000 
Long-term debt:
Finance leases and other debt987 1,091 
Total long-term debt and finance leases987 1,091 
Less: Current maturities of long-term debt and finance leases292 310 
Long-term debt$695 $781 
*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, were $1.9 million and $1.1 million as of March 31, 2021 and December 31, 2020, respectively.
Credit Agreement and Shareholders’ Loan Agreement
On March 26, 2021, the Company entered into the Amended and Restated Uncommitted Revolving Credit Agreement with Standard Chartered. The Amended and Restated Uncommitted Revolving Credit Agreement allows the Company to borrow up to $130.0 million (all of which has been fully borrowed as of March 31, 2021), is uncommitted, and matures on March 25, 2022. Borrowings under the Amended and Restated Uncommitted Revolving Credit Agreement shall bear interest at either the alternate base rate or LIBOR plus 2.70%. In addition, the Company paid fees of $1.9 million related to the Amended and Restated Uncommitted Revolving Credit Agreement, which were deferred and will be amortized over the term of the Amended and Restated Uncommitted Revolving Credit Agreement. The Amended and Restated Uncommitted Revolving Credit Agreement is secured by substantially all of the Company’s assets and includes financial covenants related to the Company’s financial performance for the second, third, and fourth quarters of 2021. There were no financial covenants applicable to the first quarter of 2021. The Amended and Restated Uncommitted Revolving Credit Agreement gives Standard Chartered the right to demand payment of any and all of the outstanding borrowings and other amounts owed under the Amended and Restated Uncommitted Revolving Credit Agreement at any point in time prior to the maturity date at Standard Chartered’s discretion. Furthermore, the Amended and Restated Uncommitted Revolving Credit Agreement grants Standard Chartered a POA to submit a borrowing request to Weichai under the amended Shareholder’s Loan Agreement (see discussion below) if the Company does not submit a borrowing request to Weichai within five business days of receiving a request from Standard Chartered to submit said borrowing request.
In connection with the Amended and Restated Uncommitted Revolving Credit Agreement, the Company entered into the First Amended and Restated Shareholder’s Loan Agreement with Weichai. The First Amended and Restated Shareholder’s Loan Agreement provides the Company with a $130.0 million secured subordinated loan facility that expires on April 25, 2022. Under the First Amended and Restated Shareholder’s Loan Agreement, Weichai is obligated to advance funds solely for purposes of repaying outstanding borrowings under the Amended and Restated Uncommitted Revolving Credit Agreement if the Company is unable to repay such borrowings. Any potential borrowings under the First Amended and Restated Shareholder’s Loan Agreement would bear interest at LIBOR plus 4.50% per annum.
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 May 2021 and August 2034. For the three months ended March 31, 2021, the Company recorded lease expense of $1.5 million within Cost of sales, $0.1 million within Research, development, and engineering expenses, less than $0.1 million within Selling, general and administrative expenses and less than $0.1 million within Interest expense in the Consolidated Statements of Operations, respectively. For the three months ended March 31, 2020, the Company recorded lease expense of $1.8 million within Cost of sales, $0.1 million within Research, development and engineering expenses, $0.1 million within Selling, general and administrative expenses and less than $0.1 million within Interest expense in the Consolidated Statements of Operations, respectively.
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The following table summarizes the components of lease expense:
(in thousands)Three Months Ended March 31,
20212020
Operating lease cost
$1,242 $1,379 
Finance lease cost
Amortization of right-of-use (“ROU”) asset52 52 
Interest expense10 13 
Short-term lease cost
102 110 
Variable lease cost
338 423 
Total lease cost$1,744 $1,977 
The following table presents supplemental cash flow information related to leases:
(in thousands)For the Three Months Ended March 31,
20212020
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows paid for operating leases$1,257 $1,373 
Operating cash flows paid for interest portion of finance leases10 13 
Financing cash flows paid for principal portion of finance leases51 48 
Right-of-use assets obtained in exchange for lease obligations
Operating leases
  
Finance leases  
As of March 31, 2021 and December 31, 2020, the weighted-average remaining lease term was 6.1 years and 6.2 years for operating leases and 3.7 years and 3.8 years for finance leases, respectively. The weighted-average discount rate was 7.1% for operating leases as of both March 31, 2021 and December 31, 2020 and 6.7% for finance leases as of both March 31, 2021 and December 31, 2020.
The following table presents supplemental balance sheet information related to leases:
(in thousands)March 31, 2021December 31, 2020
Operating lease ROU assets, net 1
$16,177 $17,104
Operating lease liabilities, current 2
3,809 3,793 
Operating lease liabilities, non-current 3
13,197 14,156 
Total operating lease liabilities
$17,006 $17,949
Finance lease ROU assets, net 1
$508$568
Finance lease liabilities, current 2
198 200
Finance lease liabilities, non-current 3
357 413
Total finance lease liabilities
$555 $613 
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.
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The following table presents maturity analysis of lease liabilities as of March 31, 2021:
(in thousands)Operating LeasesFinance Leases
Nine months ending December 31, 2021$3,691 $184 
Year ending December 31, 20224,788 177 
Year ending December 31, 20233,283 103 
Year ending December 31, 20241,813 84 
Year ending December 31, 20251,851 62 
Thereafter5,546 16 
Total undiscounted lease payments
20,972 626 
Less: imputed interest
3,966 71 
Total lease liabilities
$17,006 $555 
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
Current Assets
Cash and cash equivalents are measured at carrying value, which approximates fair value because of the short-term maturities of these instruments.
Debt
The Company measured its revolving credit facility at original carrying value. Unamortized financing costs and deferred fees on the revolving credit facility are classified in Prepaid expenses and other current assets on the Consolidated Balance Sheet. The fair value of the revolving credit facility approximated carrying value, as it consisted of short-term variable rate loans.
(in thousands)As of March 31, 2021
Carrying ValueFair Value
Level 1Level 2Level 3
Revolving credit facility$130,000 $ $130,000 $ 
(in thousands)As of December 31, 2020
Carrying ValueFair Value
Level 1Level 2Level 3
Revolving credit facility$130,000 $ $130,000 $ 
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
18


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 September 2020, the Company entered into agreements with the SEC and United States Attorney’s Office for the Northern District of Illinois (the “USAO”) to resolve the investigations into the Company’s past revenue recognition practices. As further discussed in Part II. Item 8. Financial Statements and Supplementary Data., Note 10. Commitments and Contingencies of the Company’s 2020 Form 10-K, under the settled administrative order with the SEC, the Company committed to remediate the deficiencies in its internal control over financial reporting that constituted material weaknesses identified in its 2017 Form 10-K filed in May 2019 by April 30, 2021 unless an extension was provided by the SEC. On April 12, 2021, the SEC granted the Company’s request for an extension of time until March 31, 2022 in which to comply with the requirements of the administrative order to remediate the remaining outstanding material weaknesses.
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 (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. In October 2020, after the McDonald ruling, the court granted the parties’ joint request to continue the stay of the case for 60 days. The court also ordered the parties to schedule a settlement conference with the Magistrate Judge which has been scheduled for late May 2021. The stay remains in place through the scheduled settlement conference. The parties have engaged in preliminary settlement discussions in advance of the settlement conference. As of March 31, 2021 and December 31, 2020, the Company recorded an estimated liability of $0.3 million related to the potential settlement of this matter.
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 in November 2011 (the “Development Agreement”). Mast claimed that it is owed more than $9.0 million in past royalties and other damages 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. Mast has subsequently clarified its claim for past royalties owed to be approximately $4.5 million. Arbitration is anticipated to occur in the Fall of 2021; however, the Company has engaged in preliminary settlement negotiations with Mast. As of March 31, 2021 and December 31, 2020, the Company had recognized an estimated liability of $1.5 million within Other accrued liabilities related to the potential settlement of this matter.
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
19


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. For the three months ended March 31, 2021 and 2020, the Company incurred $3.2 million and $1.3 million, respectively, of costs related to these indemnification obligations. Included in the total indemnification obligations incurred for the three months ended March 31, 2021 and 2020 are costs of $1.9 million and $1.2 million, respectively, that the Company incurred on behalf of Gary Winemaster, former Chairman of the Board and former Chief Executive Officer and President, who is also a related party. 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.
In 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 March 31, 2021, the Company had six outstanding letters of credit totaling $2.3 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 Accounting Policies and Other Information, the Company had restricted cash of $3.3 million as of March 31, 2021 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 discussed in Note 1. Summary of Significant Accounting Policies and Other Information, oil prices have increased from their lows reached in April 2020. However, rig counts in the U.S. remain below the average for the full year of 2019 and the first quarter of 2020. This has impacted the demand for the Company’s products sold into the oil and gas market. Based on current and forecasted demand of the Company’s products, current and forecasted oil prices for 2021 and the significant lead time for the Company to order and acquire certain materials, the Company does not expect to meet the minimum purchase commitment for 2021 related to one of its supply agreements and recorded an expense of $1.0 million within Cost of sales in the Consolidated Statement of Operations for the three months ended March 31, 2021.
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.
The effective tax rate for the three months ended March 31, 2021 was -2.2%, compared to an effective tax rate for the three months ended March 31, 2020 of 85.0%. The effective tax rates for all periods were significantly different than the applicable U.S. statutory tax rate. For the three months ended March 31, 2021, the difference between the effective and statutory tax rates was primarily due to the Company’s full valuation allowance. For the three months ended March 31, 2020, the difference between the effective and statutory tax rates was primarily due to the impact of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act”), a change in the deferred tax liability related to an indefinite-lived intangible asset and the Company’s full valuation allowance.




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Note 11.    Stockholders’ Equity
Common and Treasury Stock
The changes in shares of Common and Treasury Stock are as follows:
(in thousands)Common Shares IssuedTreasury Stock SharesCommon Shares Outstanding
Balance at December 31, 202023,117 225 22,892 
Net shares issued for Stock awards—   
Balance as of March 31, 202123,117 225 22,892 
Note 12.    Loss Per Share
The Company computes basic earnings (loss) per share by dividing net income (loss) by the weighted-average common shares outstanding during the year. Diluted earnings (loss) per share is calculated to give effect to all potentially dilutive common shares that were outstanding during the year. 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 months ended March 31, 2021 and 2020.
The Company issued 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 13. Stock-Based Compensation in the Company’s 2020 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 March 31,
20212020
Numerator:
Net loss$(18,150)$(712)
Denominator:
Shares used in computing net loss per share:
Weighted-average common shares outstanding – basic
22,892 22,858 
Effect of dilutive securities
  
Weighted-average common shares outstanding diluted
22,892 22,858 
Loss per common share:
Loss per share of common stock – basic$(0.79)$(0.03)
Loss per share of common stock – diluted$(0.79)$(0.03)
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 months ended March 31, 2021 and 2020. For the three months ended March 31, 2021 and 2020, 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 the Amended and Restated Shareholder’s Loan Agreement and the Collaboration Agreement with Weichai.
21


Transactions with Joint Ventures
MAT-PSI Holdings, LLC
In December 2012, the Company and MAT Holdings, Inc. (“MAT”) entered into an agreement to create MAT-PSI Holdings, LLC (“MAT-PSI”), which was intended to be a holding company of its 100% Chinese wholly-owned foreign entity, referred to as Green Power. The Company invested $0.9 million for its 50% share of MAT-PSI, which was formed to manufacture, assemble and supply natural gas, gas and alternative-fueled power systems to Chinese and Asian forklift customers. The venture established a production facility in Dalian and also sourced base engines from a local Chinese factory. As MAT-PSI was not profitable, the venture was closed in 2017; however, the Company had previously been in dispute with Green Power related to the wind up of the joint venture and outstanding receivables. On March 29, 2021, the Company executed a settlement agreement with MAT and Green Power which resolved the dispute. The final settlement agreement did not have a material impact on the Company’s consolidated financial statements.
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 2021.
Joint Venture Operating Results
The Company’s investments in joint ventures are accounted for under the equity method of accounting. The Company’s Consolidated Statements of Operations included no equity earnings from this investment for the three months ended March 31, 2021. Income from this investment was $0.2 million for the three months ended March 31, 2020. The joint venture operating results are presented in Other income, net in the Company’s Consolidated Statements of Operations.
Other Related Party Transactions
See Note 9. Commitments and Contingencies for information regarding the Company’s indemnification obligations related to certain former directors and officers of the Company.
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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 months ended March 31, 2021 and 2020, 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 are made in light of recent events and trends 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 clean, alternative fuels, including natural gas, propane, and biofuels, as well as gasoline and diesel options, 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. Environment Protection Agency (“EPA”), the California Air Resource Board (“CARB”) and the People’s Republic of China’s Ministry of Ecology and Environment (“MEE”).
The Company’s products are primarily used by global original equipment manufacturers (“OEM”) and end-user customers across a wide range of applications and equipment that includes standby and prime power generation, demand response, microgrid, combined heat and power, arbor care, material handling (including forklifts), agricultural and turf, construction, pumps and irrigation, compressors, utility vehicles, light- and medium-duty vocational trucks, school and transit buses, and utility power. The Company manages the business as a single reporting segment.
For the three months ended March 31, 2021, the Company’s net sales decreased $4.9 million, or 5%, from the three months ended March 31, 2020 to $100.2 million, as a result of decreased sales of $24.9 million and $2.8 million in the energy and industrial end markets, respectively, partly offset by a $22.8 million increase in the transportation end market. Gross margin for the three months ended March 31, 2021 was 7.1%, a decrease versus 16.9% in the comparable 2020 period. Gross profit decreased $10.6 million for the three months ended March 31, 2021, while operating expenses increased by $1.3 million, as compared to the comparable period in 2020. Interest expense increased by $0.9 million for the three months ended March 31, 2021 versus the comparable period in 2020. Also, the Company recorded income tax expense of $0.4 million for the three months ended March 31, 2021 versus a $4.0 million benefit from the same period last year. Collectively, these factors contributed to a $17.4 million increase in the net loss, which totaled $18.2 million in the 2021 period compared to a net loss of $0.7 million in the same period of 2020. Diluted loss per share was $0.79 in the 2021 period compared to a diluted loss per share of $0.03 in the comparable 2020 period. Adjusted net loss, which excludes certain items described below that the Company believes are not indicative of its ongoing operating performance, was $13.0 million in the 2021 period, an increase of $12.3 million, compared to an Adjusted net loss of $0.7 million in 2020. Adjusted loss per share was $0.56 in 2021 compared to an Adjusted loss per share of $0.03 in 2020. Adjusted earnings before interest expense, income taxes, depreciation and amortization (“EBITDA”) was a negative $8.5 million in 2021 compared to positive Adjusted EBITDA of $2.6 million in 2020. Adjusted net loss, Adjusted loss per share and Adjusted EBITDA are non-GAAP financial measures. For a reconciliation of each of these measures to the nearest applicable GAAP financial measure, as well as additional information about these non-GAAP measures, see the section entitled Non-GAAP Financial Measures in this Item 2.
Net sales by geographic area and by end market for the three months ended March 31, 2021 and 2020 are presented below:
(in thousands)For the Three Months Ended March 31,
20212020
Geographic Area% of Total% of Total
North America$91,915 92 %$94,520 90 %
Pacific Rim5,528 %6,454 %
Europe1,610 %2,657 %
Other1,118 %1,466 %
Total$100,171 100 %$105,097 100 %
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(in thousands)For the Three Months Ended March 31,
20212020
End Market% of Total% of Total
Energy$25,159 25 %$50,084 48 %
Industrial34,320 34 %37,131 35 %
Transportation40,692 41 %17,882 17 %
Total$100,171 100 %$105,097 100 %
Recent Trends and Business Outlook
COVID-19 Update and Oil and Gas Market Volatility
During 2020, as a result of the COVID-19 pandemic, the global economy experienced substantial turmoil, which led to challenging market conditions across certain areas of the Company’s business. In addition, due to unprecedented decreases in demand, an oil price war, and economic uncertainty resulting from the COVID-19 pandemic, average crude oil prices were considerably lower in 2020 as compared to prices at the end of 2019. Since May 2020, crude oil prices increased considerably from their lows reached in April 2020. While U.S. rig counts at the end of April 2021 are higher as compared to the start of 2021, they remain well below the average for the full year of 2019 and the first quarter of 2020. 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. In addition, the Company experienced delays in its supply chain during the first quarter of 2021 due to temporary shortages of raw materials and container delays of overseas materials as bottlenecks occurred at ports in Asia and North America. This, in turn, caused delivery delays to some of the Company’s customers. The Company also experienced inflationary cost pressures for certain materials and is working to mitigate the impact through price increases and other measures, where possible. The potential for continued disruptions, economic uncertainty, and unfavorable oil and gas market dynamics may have a material adverse impact on the timing of delivery of customer orders and the levels of future customer orders. Accordingly, these challenges may have a material adverse impact on the Company’s future results of operations, financial position, and liquidity.
The Company initiated certain contingency actions during 2020 as a result of the significant negative impacts of these factors. During 2020, the Company took actions to continue to improve its manufacturing operations which included making reductions in its production facility workforce 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. As of January 1, 2021, the Company reinstated pay for salaried employees as well as the 401(k) match program. Any additional cost savings initiatives or other cash actions the Company undertakes in response to the COVID-19 pandemic may not achieve the intended results and may result in other adverse impacts, which could be material. Even after the COVID-19 pandemic has subsided, the Company may continue to experience negative impacts to its business, operations and financial condition as a result of any economic recession or depression that has occurred or may occur in the future.

24


Results of Operations
Results of operations for the three months ended March 31, 2021 compared with the three months ended March 31, 2020:
(in thousands, except per share amounts)For the Three Months Ended March 31,
 20212020Change% Change
Net sales $100,171 $105,097 $(4,926)(5)%
Cost of sales93,101 87,383 5,718 %
Gross profit 7,070 17,714 (10,644)(60)%
Gross margin %7.1 %16.9 %(9.8)%
Operating expenses: 
Research, development and engineering expenses6,224 6,752 (528)(8)%
Research, development and engineering expenses as a % of sales6.2 %6.4 %(0.2)%
Selling, general and administrative expenses15,811 13,890 1,921 14 %
Selling, general and administrative expenses as a % of sales15.8 %13.2 %2.6 %
Amortization of intangible assets634 763 (129)(17)%
Total operating expenses22,669 21,405 1,264 %
Operating loss (15,599)(3,691)(11,908)NM
Other expense, net: 
Interest expense 2,161 1,274 887 70 %
Other income, net— (211)211 (100)%
Total other expense, net2,161 1,063 1,098 103 %
Loss before income taxes (17,760)(4,754)(13,006)NM
Income tax expense (benefit) 390 (4,042)4,432 (110)
Net loss $(18,150)$(712)$(17,438)NM
Loss per common share:    
Basic $(0.79)$(0.03)$(0.76)NM
Diluted $(0.79)$(0.03)$(0.76)NM
Non-GAAP Financial Measures:
Adjusted net loss *
$(12,956)$(671)$(12,285)NM
Adjusted loss per share *
$(0.56)$(0.03)(0.53)NM
EBITDA *
$(13,699)$(1,421)$(12,278)NM
Adjusted EBITDA *
$(8,505)$2,626 $(11,131)NM
NM    Not meaningful
*    See reconciliation of non-GAAP financial measures to GAAP results below
25


Net Sales
Net sales decreased $4.9 million, or 5%, during the three months ended March 31, 2021 compared to the three months ended March 31, 2020, as a result of sales declines of $24.9 million and $2.8 million in the energy and industrial end markets, respectively, partly offset by a $22.8 million increase in the transportation end market. The decreased sales within the energy end market were primarily attributable to lower demand for the Company’s power generation products, including demand response products, and those used in the oil and gas industry. Lower industrial end market sales were primarily due to reduced demand within the material handling/forklift industry. Significantly higher transportation end market sales are primarily due to increased sales of products used in the medium duty truck market, due in part to lower volume levels in the same period last year due to the acceleration of the shipment of certain engines during the fourth quarter of 2019, as discussed in the Company’s Form 10-K for the year-ended December 31, 2020, which negatively impacted sales in the first quarter of 2020. The higher transportation end market sales were partly mitigated by lower demand for products used in the school bus market.
Gross Profit
Gross profit decreased by $10.6 million during the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. Gross margin was 7.1% during the three months ended March 31, 2021, a decrease compared to 16.9% for the three months ended March 31, 2020, primarily due to higher warranty expenses largely within the transportation end market, material cost increases, unfavorable product mix and the impact of lower volume, partly mitigated by cost savings driven by reductions in the production facility workforce and other actions to improve manufacturing operations. For the three months ended March 31, 2021, warranty costs were $6.8 million (net of supplier recoveries of $1.9 million), an increase of $5.1 million, including $4.1 million of charges for adjustments to preexisting warranties, as compared to warranty costs of $1.7 million (net of supplier and insurance recoveries of $1.2 million), including $0.7 million of charges for adjustments to preexisting warranties for the three months ended March 31, 2020.
Research, Development and Engineering Expenses
Research, development and engineering expenses during the three months ended March 31, 2021 were $6.2 million, a decrease of $0.5 million, or 8%, from the three months ended March 31, 2020, due to lower wages and benefits driven by reduced headcount, among other items.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses increased during the three months ended March 31, 2021 by $1.9 million, or 14%, compared to the three months ended March 31, 2020, primarily due to higher legal costs related to the Company’s indemnification obligations of former officers and employees as a result of the exhaustion of its director’s and officer’s insurance during the early part of 2020 (see additional discussion in Note 9. Commitments and Contingencies in Part I. Item 1. Financial Statements for further discussion). The Company also experienced higher wages and benefits expense, including higher incentive compensation expense, in addition to higher severance costs. These increases were partly offset by lower financial reporting costs during the three months ended March 31, 2021, among other items.
Interest Expense
Interest expense increased $0.9 million to $2.2 million for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020, due in part to higher outstanding debt levels and the amortization of deferred financing costs related to the December 2020 amendment of the senior secured revolving credit agreement with Standard Chartered Bank, partly offset by a lower interest rate for the three months ended March 31, 2021. See Note 6. Debt, included in Part 1, Item 1. Financial Statements, for additional information.
Other Income, Net
Other income, net was zero for the three months ended March 31, 2021 compared to $0.2 million for the three months ended March 31, 2020. Other income, net in 2020 was primarily comprised of the Company’s equity earnings from its joint venture. Refer to Note 13.