Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis includes forward-looking statements about the Company’s business and consolidated results of operations for the fiscal years ended December 31, 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 in light of recent events and trends, and these statements should not be construed either as assurances of performance or as promises of a given course of action. Instead, various known and unknown factors are likely to cause the Company’s actual performance and management’s actions to vary, and the results of these variances may be both material and adverse. A description of material factors known to the Company that may cause its results to vary, or may cause management to deviate from its current plans and expectations, is set forth under “Risk Factors” in this report. See also “Forward-Looking Statements.” The following discussion should also be read in conjunction with the Company’s consolidated financial statements and the related Notes included in this report.
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 power systems, industrial and transportation end markets with primary manufacturing, assembly, engineering, R&D, sales and distribution facilities located in suburban Chicago, Illinois and Darien, Wisconsin. The Company provides highly engineered, comprehensive solutions designed to meet specific customer application requirements and technical specifications, including those imposed by environmental regulatory bodies, such as the EPA, the CARB and the MEE.
The Company’s products are primarily used by global OEM and end-user customers across a wide range of applications and equipment that includes standby and prime power generation, demand response, microgrid, combined heat and power, arbor care, material handling (including forklifts), agricultural and turf, construction, pumps and irrigation, compressors, utility vehicles, light- and medium-duty vocational trucks, school and transit buses, and utility power. The Company manages the business as a single reporting segment.
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For 2021, net sales increased $38.6 million, or 9%, compared to 2020, as a result of sales increases of $42.5 million and $22.3 million within the transportation and industrial end markets, respectively, partly offset by a decrease of $26.2 million in the power systems end market. Gross margin was 9.0% and 14.0% during 2021 and 2020, respectively. Gross profit decreased during 2021 by $17.2 million compared to 2020, while operating expenses increased by $2.7 million as compared to 2020. Interest expense increased by $1.6 million in 2021 versus 2020. Other expense (income), net increased b y $1.2 million during 2021. Also, the Company recorded an income tax benefit of $0.4 million for 2021 versus a benefit of $3.7 million for 2020. Collectively, these factors contributed to a $25.5 million increase in the net loss, which totaled $48.5 million in 2021 compared to net loss of $23.0 million in 2020. Diluted loss per share was $2.12 in the 2021 period compared to diluted loss per share of $1.00 in 2020. Adjusted net loss, which excludes certain items described below that the Company believes are not indicative of its ongoing operating performance, was $26.7 million in 2021 compared to Adjusted net loss of $11.1 million in 2020. Adjusted loss per share was $1.16 in 2021 compared to Adjusted loss per share of $0.48 in 2020. Adjusted earnings before interest expense, income taxes, depreciation and amortization (“EBITDA”) was a loss of $12.4 million in 2021 compared to Adjusted EBITDA of $3.0 million in 2020. Adjusted net loss, 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 ab out these non-GAAP measures, see the section entitled Non-GAAP Financial Measures in this Item 7.
Net sales by geographic area and by end market for 2021 and 2020 are presented below:
(in thousands) For the year ended December 31, 2021 For the Year Ended December 31, 2020
Geographic Area % of Total % of Total
United States $ 406,077 89 % $ 366,445 88 %
North America 8,616 2 % 9,831 2 %
Pacific Rim 25,457 5 % 25,869 6 %
Europe 7,457 2 % 9,339 3 %
Others 8,648 2 % 6,155 1 %
Total $ 456,255 100 % $ 417,639 100 %
(in thousands) For the year ended December 31, 2021 For the Year Ended December 31, 2020
End Market % of Total % of Total
Power Systems $ 123,132 27 % $ 149,282 36 %
Industrial 153,289 34 % 131,026 31 %
Transportation 179,834 39 % 137,331 33 %
Total $ 456,255 100 % $ 417,639 100 %
During 2021, the Company sold over 49,000 engines of which approximately 52% utilized propane or natural gas as their fuel source and 39% utilized gasoline. The remaining 9% of engines were dual fuel gasoline/propane, diesel and service/base engines.
Weichai Transactions
In March 2017, the Company and Weichai entered into a number of transactions (see Note 3. Weichai Transactions , included in Item 8. Financial Statements and Supplementary Data , for additional information), including the issuance of Common and Preferred Stock and a stock purchase warrant to Weichai for aggregate proceeds of $60.0 million. The stock purchase warrant issued to Weichai was exercisable for any number of additional shares of Common Stock such that Weichai, upon exercise, would hold 51% of the Common Stock then outstanding on a fully dilutive basis, on terms and subject to adjustments as provided in the SPA. On April 23, 2019, Weichai exercised the Weichai Warrant and increased its ownership to 51.5% of the Company’s outstanding Common Stock, as of such date.
Through the Weichai Transactions, the Company sought to expand its range of products and its presence in the Pacific Rim.
The Company and Weichai executed the Collaboration Agreement in order to achieve their respective objectives, enhance the cooperation alliance and share experiences, expertise and resources. Among other things, the Collaboration Arrangement established a joint steering committee, permitted Weichai to second a limited number of technical, marketing, sales,
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procurement and finance personnel to work at the Company and established several collaborations related to stationary natural-gas applications and Weichai diesel engines. The Collaboration Agreement also provides for the steering committee to create various subcommittees with operating roles and otherwise governs the treatment of intellectual property of parties prior to the collaboration and the intellectual property developed during the collaboration. The Collaboration Agreement had a term of three years that was set to expire in March 2020. On March 26, 2020, the Collaboration Agreement was extended for an additional term of three years. For the years ended December 31, 2021 and 2020, sales to Weichai were not material. The Company purchased $12.4 million and $18.6 million of inventory from Weichai during 2021 and 2020, respectively.
PSI also entered into a series of Shareholder Loan agreements with Weichai. See Note 6. Debt , included in Item 8. Financial Statements and Supplementary Data , for additional information.
Incremental Financial Reporting, Internal Control Remediation, and Government Investigation and Other Legal Matter Expenses
Incremental financial reporting, internal control remediation and government investigation and other legal matter expenses consist of professional services fees related to the Company’s efforts to restate prior period financial statements, prepare, audit and file delinquent financial statements, and remediate internal control material weaknesses as well as fees and reserves related to Company, SEC, and USAO investigations. Since August 2016, the Company has experienced a substantial and disruptive diversion of management resources to address various accounting, financial reporting and financial issues. During that time, the Company determined that it was necessary to restate financial results for 2014 and 2015 as well as the first quarter of 2016 and, since then, has also focused on becoming timely on all of its SEC financial reporting requirements, which was achieved with the filing of the Annual Report on Form 10-K for the year ended December 31, 2019. Additionally, the SEC and the USAO conducted investigations into the Company’s financial reporting, revenue recognition practices and related conduct. These investigations were completed and settled in September 2020 (see Note 10. Commitments and Contingencies , included in Part II. Item 8. Financial Statements and Supplementary Data , for additional information). Incremental financial reporting, internal control remediation, and government investigation and other legal matter expenses, included in the 2021 and 2020 operating results, were $19.7 million and $15.3 million, respectively.
Recent Trends and Business Outlook
Impact of COVID-19, Oil and Gas Market Volatility, Supply Chain Challenges, Legal Costs
The COVID-19 pandemic has resulted in the implementation of significant governmental measure s to control the spread of the virus, including quarantines, travel restrictions, business shutdowns, and restrictions on the movement of people in the United States and abroad. These factors, in turn, have impacted and may continue to impact the Company’s operations, financial condition, and demand for its goods and services, as well as its overall ability to react timely to mitigate any further impact of the COVID-19 pandemic. In April 2020, the Company aggressively implemented contingency actions as a result of the expected significant negative impacts of these factors. The Company’s temporary cost reduction measures included, among others, reduced hours of operations of the Company’s production facilities; reduced pay for salaried employees between 10% and 30%, depending on the employee’s position; suspended the Company’s 401-(k) plan match; deferred spending on certain R&D programs; and minimized discretionary expenses and consulting services.
The measures with regard to pay for salaried employees and the suspension of the Company’s 401-(k) match plan match were in effect through December 31, 2020. As of the date of this 2021 Annual Report, the Company continues to judiciously manage its expenses through the continuation of certain measures, including the restriction of all non-essential travel and minimized discretionary expenses and consulting services. The Company continues to review operating expenses, including prioritizing certain R&D investments in support of the Company’s long-term growth objectives. During 2021, the Company took rightsizing actions to align its staffing with current needs, while also streamlining certain roles. These actions, when coupled with attrition, contributed to the reduction of approximately 100 position s, or approximately 12.5% of the Company’s headcount. Also, the Company continues to review its facilities footprint in light of its current and planned business mix and its evolving needs. To date, these efforts resulted in the exit and sublease of its Hanover Park, IL materials and warehousing facility which is expected to generate annualized savings of approximately $1.3 million , with approximately $0.9 million expected to be realized in 2022.
The full impact of the COVID-19 pandemic continues to evolve as of the date of this 2021 Annual Report.
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. At year-end 2021, crude oil prices were 55% above prices at year-end 2020, a meaningful improvement. However, U.S. rig counts have been slower to return as the average count for 2021 was up 10% versus 2020 and average rig counts remain significantly below the full year averag e during 2019. Meanwhile, the Company believes that capital spending within the U.S. oil markets during 2021 remained well below 2019 levels. These
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factors have contributed to a continued challenging environment for the sale of the Company’s oil and gas related products durin g 2021. A significant portion of the Company’s sales and profitability has historically been 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 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 shipping-related costs. Additionally, the Company experienced higher tariff costs as a result of the non-renewal of certain tariff exclusions. The Company is working to mitigate the impact of these matters through price increases and other measures, such as seeking certain tariff exclusions, where possible. However, during 2021 the Company was unable to adequately recover these higher costs. The potential for continued disruptions, economic uncertainty, and unfavorable spending on behalf of the Company’s customers with oil and gas exposure may have a material adverse impact on the timing of delivery of customer orders and the levels of future customer orders.
Lastly, during 2021, the Company continued to incur substantial legal costs related to governmental investigations matters and its obligations to indemni fy certain former officers and employees of the Company. Specifically, spending activity was elevated during 2021 due to the USAO trial involving former officers and employees of the Company that occurred during the year. With a verdict reached in the USAO trial matter involving former officers and employees in September 2021, the Company believes its costs related to the matter will cease. However, at this time, the Company is not able to estimate the potential future amount of its indemnity obligations related to the pending SEC matter involving prior officers and employees. See Note 10. Commitments and Contingencies for further discussion of the Company’s indemnification obligations. Accordingly, the above challenges may continue to have a material adverse impact on the Company’s future results of operations, financial position and liquidity.
The Company expects its sales in 2022 to increase by at least 3% versus 2021 levels, a result of expectations for strong growth in the industrial and power systems end markets, partly mitigated by a reduction in sales in the transportation end market. Gross profit as a percentage of sales is targeted to improve by at least 5 percentage points in 2022, a function of lower warranty expense, pricing actions, improved cost recovery and cost savings initiatives. Notwithstanding this outlook, which is being driven in part by expectations for an improvement in supply chain dynamics, including timelier availability of parts, and a continuation of favorable economic conditions within the United States and across the Company’s various markets, the Company cautions that significant uncertainty remains as a result of supply chain challenges, inflationary costs, commodity volatility, and the COVID-19 pandemic, among other factors.
GM 6.0L Engine Off ering : The Company had an exclusive third-party agreement with GM through December 31, 2019 to purchase and distribute GM 6.0L engines to on-highway customers. With the GM announcement that it will discontinue its production of the GM 6.0L engine, the Company conducted last-time buys of this engine during 2019 through 2021 (including the purchase of certain engines where prepayment was provided), to ensure adequate supply to certain transportation customers. The Company experienced very strong sales of this product within its transportation end market during 2021 particularly with a large customer. At December 31, 2021, the Company had fully exhausted its stock of engines where prepayment was provided and holds a small quantity of other GM 6.0L engines which it expects to deliver to customers throughout 2022. The Company does not have a supply agreement with GM for its successor product to the GM 6.0L engine; however, it will source the 6.0L through a GM designate third party manufacturer. With the exhaustion of 6.0L engine inventory during 2021 where prepayment was received, coupled with its large customer obtaining future supply through alternative means, the Company anticipates significantly reduced sales within its transportation end market in 2022 as compared to 2021. To service customers in the future, the Company has obtained access to a 6.0L engine that another manufacturer will be producing.
Hyster-Yale Supply Arrangement : Hyster-Yale has indicated that it will be obtaining alternative supply beginning in late 2022 for several high-volume engines that the Company currently provides, including the 2.0L and 2.4L engines sourced from the Company’s supplier SAME. As a result of this, the Company expects to see a decline in sales volumes to Hyster-Yale beginning in 2023. The Company believes it is positioned to continue its relationship in a moderated capacity with this customer in 2023 and beyond.
Strategic Initiatives/Growth Strategies : The Company has initiated a set of business objectives aimed at improving profitability, streamlining processes, strengthening the business and focusing on achieving growth in higher-return product lines. Central to this plan is the Company’s increased emphasis on power systems product offerings through new product development and investments, in addition to leveraging the Company’s relationship with Weichai. With the introduction of numerous natural gas and diesel engines over the past few years, coupled with its existing strong product lineup, despite economic disruptions related to the COVID-19 pandemic, and supply chain challenges, the Company believes that it has a solid foundation to achieve long-term growth, particularly within the power systems market.
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Results of Operations
Results of operations for the year ended December 31, 2021 compared with the year ended December 31, 2020 :
(in thousands, except per share amounts) For the Year Ended December 31,
2021 2020 Change % Change
Net sales $ 456,255 $ 417,639 $ 38,616 9 %
Cost of sales 414,984 359,191 55,793 16 %
Gross profit 41,271 58,448 (17,177) (29) %
Gross margin % 9.0 % 14.0 % (5.0) %
Operating expenses:
Research, development and engineering expenses 22,435 25,375 (2,940) (12) %
Research, development and engineering expenses as a % of sales 4.9 % 6.1 % (1.2) %
Selling, general and administrative expenses 57,871 51,744 6,127 12 %
Selling, general and administrative expenses as a % of sales 12.7 % 12.4 % 0.3 %
Amortization of intangible assets 2,535 3,053 (518) (17) %
Total operating expenses 82,841 80,172 2,669 3 %
Operating loss (41,570) (21,724) (19,846) 91 %
Other expense, net:
Interest expense 7,307 5,714 1,593 28 %
Loss on debt extinguishment and modifications — 497 (497) (100) %
Other expense (income), net 1 (1,240) 1,241 (100) %
Total other expense, net 7,308 4,971 2,337 47 %
Loss before income taxes (48,878) (26,695) (22,183) 83 %
Income tax benefit (406) (3,713) 3,307 (89) %
Net loss $ (48,472) $ (22,982) $ (25,490) 111 %
Loss per common share:
Basic $ (2.12) $ (1.00) $ (1.12) 112 %
Diluted $ (2.12) $ (1.00) $ (1.12) 112 %
Non-GAAP Financial Measures:
Adjusted net loss * $ (26,749) $ (11,091) $ (15,658) 141 %
Adjusted loss per share * $ (1.16) $ (0.48) $ (0.68) 142 %
EBITDA * $ (34,165) $ (12,781) $ (21,384) 167 %
Adjusted EBITDA * $ (12,442) $ 3,015 $ (15,457) NM
NM Not meaningful
* See reconciliation of non-GAAP financial measures to GAAP results below
Net Sales
Net sales increased $38.6 million, or 9%, compared to 2020, as a result of sales increases of $42.5 million and $22.3 million within the transportation and industrial end markets, respectively, partly offset by a decrease of $26.2 million in the power systems end market. The increase within the transportation end market was primarily driven by higher sales within the medium duty truck market partly attributable to lower sales volumes during 2020 due to the acceleration of shipments of certain engines during the fourth quarter of 2019, in combination with the continued sell down and exhaustion of certain 6.0L engines during 2021 that were previously prepaid by a customer under a long-term supply agreement. Partly mitigating these higher sales were lower sales of products used in the terminal tractor market. Higher industrial end market sales reflect increased demand for products used across a range of applications, with the largest increases attributable to those products used in the material handling/forklift, arbor care and industrial cleaning equipment markets. Lower power systems end market sales were driven by decreased demand for the Company’s power generation products, especially for demand response products and those used within the oil and gas industry.
Gross Profit
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Gross profit decreased by $17.2 million, or 29%, to $41.3 million in 2021, compared to $58.4 million in 2020. Gross margin was 9.0% and 14.0% in 2021 and 2020, respectively. The decline in gross margin is primarily due to material cost increases, higher freight and tariff costs, higher warranty expenses, and unfavorable product mix, partly mitigated by the impact of higher sales. For 2021, warranty costs were $22.8 million, an increase of $3.3 million compared to warranty costs of $19.5 million last year, due largely to higher charges within the transportation end market and lower recognized recoveries during 2021.
Research, Development and Engineering Expenses
Research, development and engineering expenses in 2021 were $22.4 million, a decrease of $2.9 million, or 12%, from 2020 levels, primarily as a result of lower project activity, coupled with lower wages and benefits driven by reduced headcount.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) increased in 2021 by $6.1 million, or 12%, compared to 2020. The increase was primarily due to higher legal expenses mostly related to the Company’s indemnification obligations of former officers and employees specifically related to elevated spending activity during 2021 as a result of the USAO’s trial, which concluded in September 2021 (see additional discussion in Note 10. Commitments and Contingencies of Item 8. Financial Statements and Supplementary Data) . As previously disclosed, the Company exhausted its directors’ and officers’ insurance during the early part of 2020. The company also experienced higher wages and benefits expense during 2021 as 2020 included salary reductions and other cost containment actions. In addition, there were higher severance costs largely related to rightsizing actions in 2021 as compared to 2020, due in part to certain actions that the Company took near the end of 2021. These increases were partly offset by lower financial reporting costs during 2021, largely driven by continued efficiencies and lower staffing needs since completing the financial restatement and becoming a timely filer of its SEC filings.
Interest Expense
Interest expense increased $1.6 million to $7.3 million in 2021 from $5.7 million in 2020 largely due to higher average outstanding debt and a higher overall effective interest rate on the Company’s debt during 2021, including fees, as compared to prior year. See Note 6. Debt , included in Item 8. Financial Statements and Supplementary Data for additional information.
Loss on Extinguishment of Debt
There was no loss on the extinguishment of debt during 2021. The Company recognized a loss on the extinguishment of debt for the year ended December 31, 2020 of $0.5 million.
See Note 6. Debt, included in Item 8. Financial Statements and Supplementary Data , for additional information.
Other Expense (Income), Net
Other expense (income), net experienced a loss of less than $0.1 million during 2021 compared to income of $1.2 million during 2020 primarily due to the receipt of life insurance proceeds upon the death of a former employee and equity earnings from the Company’s joint venture.
Refer to Note 15. Related Party Transactions , in Item 8. Financial Statements and Supplementary Data , for further discussion of the Company’s joint venture.
Income Tax (Benefit) Expense
The Company recorded an income tax benefit of $0.4 million in 2021 , a decrease of $3.3 million, as compared to an income tax benefit of $3.7 million in 2020. The Company’s pretax loss was $48.9 million in 2021, compare d to pretax loss of $26.7 million in 2020. The Company continues to record a full valuation allowance against deferred tax assets which offsets the tax benefits associated with the pre-tax loss for both the 2021 and 2020 periods. The income tax benefits for 2020 is primarily attributable to the enactment of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) in the period.
See Note 11. Income Taxes , included in Item 8. Financial Statements and Supplementary Data , for additional information related to the Company’s income tax provision.
Non-GAAP Financial Measures
In addition to the results provided in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) above, this report also includes non-GAAP (adjusted) financial measures. Non-GAAP financial measures provide insight into selected financial information and should be evaluated in the context in which they are presented. These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation from, or as a substitute for, financial information presented in compliance with U.S. GAAP, and non-GAAP financial measures as reported by the Company may not be comparable to similarly titled amounts reported by other companies. The non-GAAP financial measures should be considered in conjunction with the consolidated financial statements, including the related notes, and Item 7.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report. Management does not use these non-GAAP financial measures for any purpose other than the reasons stated below.
Non-GAAP Financial Measure Comparable GAAP Financial Measure
Adjusted net income (loss) Net income (loss)
Adjusted earnings (loss) per share Earnings (loss) per common share – diluted
EBITDA Net income (loss)
Adjusted EBITDA Net income (loss)
The Company believes that Adjusted net loss, Adjusted (loss) earnings per share, EBITDA, and Adjusted EBITDA provide relevant and useful information, which is widely used by analysts, investors and competitors in its industry as well as by the Company’s management in assessing the performance of the Company. Adjusted net (loss) income is defined as net income as adjusted for certain items that the Company believes are not indicative of its ongoing operating performance. Adjusted (loss) earnings per share is a measure of the Company’s diluted net (loss) earnings per share adjusted for the impact of special items. EBITDA provides the Company with an understanding of earnings before the impact of investing and financing charges and income taxes. Adjusted EBITDA further excludes the effects of other non-cash and certain other items that do not reflect the ordinary earnings of the Company’s operations.
Adjusted net loss, Adjusted (loss) earnings per share, EBITDA, and Adjusted EBITDA are used by management for various purposes, including as a measure of performance of the Company’s operations and as a basis for strategic planning and forecasting. Adjusted net loss, Adjusted (loss) earnings per share, and Adjusted EBITDA may be useful to an investor because these measures are widely used to evaluate companies’ operating performance without regard to items excluded from the calculation of such measures, which can vary substantially from company to company depending on the accounting methods, the book value of assets, the capital structure and the method by which the assets were acquired, among other factors. They are not, however, intended as an alternative measure of operating results or cash flow from operations as determined in accordance with U.S. GAAP.
The following table presents a reconciliation from Net loss to Adjusted net loss:
(in thousands) For the Year Ended December 31,
2021 2020
Net loss $ (48,472) $ (22,982)
Stock-based compensation 1
394 607
Loss on debt extinguishment 2
— 497
Severance 3
1,595 332
Incremental financial reporting 4
— 1,783
Internal control remediation 5
1,283 1,314
Governmental investigations and other legal matters 6
18,451 12,193
Life insurance proceeds 7
— (930)
Discrete income tax items 8
— (3,905)
Adjusted net loss $ (26,749) $ (11,091)
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The following table presents a reconciliation from Loss per common share – diluted to Adjusted loss per share:
For the Year Ended December 31,
2021 2020
Loss per common share – diluted $ (2.12) $ (1.00)
Stock-based compensation 1
0.02 0.03
Loss on debt extinguishment 2
— 0.02
Severance 3
0.07 0.01
Incremental financial reporting 4
— 0.08
Internal control remediation 5
0.06 0.06
Governmental investigations and other legal matters 6
0.81 0.53
Life insurance proceeds 7
— (0.04)
Discrete income tax items 8
— (0.17)
Adjusted loss per share – diluted $ (1.16) $ (0.48)
Diluted shares (in thousands) 22,908 22,872
The following table presents a reconciliation from Net loss to EBITDA and Adjusted EBITDA:
(in thousands) For the Year Ended December 31,
2021 2020
Net loss $ (48,472) $ (22,982)
Interest expense 7,307 5,714
Income tax (benefit) expense (406) (3,713)
Depreciation 4,871 5,147
Amortization of intangible assets 2,535 3,053
EBITDA (34,165) (12,781)
Stock-based compensation 1
394 607
Loss on debt extinguishment 2
— 497
Severance 3
1,595 332
Incremental financial reporting 4
— 1,783
Internal control remediation 5
1,283 1,314
Governmental investigations and other legal matters 6
18,451 12,193
Life insurance proceeds 7
— (930)
Adjusted EBITDA $ (12,442) $ 3,015
1. Amounts reflect non-cash stock-based compensation expense.
2. Amount represents the loss on the extinguishment of the Wells Fargo Credit Agreement and the Unsecured Senior Notes in April 2020 as further discussed in Note 6. Debt of Item 8. Financial Statements and Supplementary Data .
3. Amounts represent severance and other post-employment costs for certain former employees of the Company.
4. Amounts represent professional services fees related to the Company’s efforts to restate prior period financial statements, prepare, audit and file delinquent financial statements with the SEC, as well as tax compliance matters impacted by the restatement of prior period financial statements. The amount exclu des $2.0 million of recurring audit fees in 2020, respectively.
5. Amounts represent professional services fees related to the Company’s efforts to remediate internal control material weaknesses including certain costs to upgrade IT systems.
6. The amounts include $15.7 million and $7.1 million for 2021 and 2020, respectively, related to indemnification of certain former officers of the Company. The Company is obligated to pay legal costs of certain former officers and employees in accordance with Company bylaws and certain indemnification agreements. As further discussed in Note 10. Commitments and Contingencies of Item 8. Financial Statements and Supplementary Data , the Company fully exhausted its historical primary directors’ and officers’ insurance coverage in connection with these matters during the first quarter of 2020. Also included are professional services fees and reserves related to certain other legal matters.
7. Amount represents a life insurance payment to the Company related to the death of a former employee.
8. Amount consists of the impact of the CARES Act and a change in the deferred tax liability related to an indefinite-lived intangible asset.
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Cash Flows
Cash was impacted as follows:
(in thousands) For the Year Ended December 31,
2021 2020 Change % Change
Net cash used in operating activities $ (61,478) $ (7,594) $ (53,884) NM
Net cash provided by (used in) investing activities 398 (1,412) 1,810 (128) %
Net cash provided by financing activities 46,545 33,270 13,275 40 %
Net (decrease) increase in cash, cash equivalents, and restricted cash $ (14,535) $ 24,264 $ (38,799) NM
Capital expenditures $ (1,968) $ (2,402) $ 434 (18) %
2021 Cash Flows
Cash Flow from Operating Activities
Net cash used in operations was $61.5 million in 2021 compared to net cash used in operations of $7.6 million in 2020 resulting in an increase of $53.9 million in cash used in operating activities year-over-year. This was primarily due to an increase in the net loss of $25.5 million and a decrease in cash generated from working capital of $30.6 million, partially offset by an increase of $2.4 million in non-cash adjustments. The decrease in cash generated from working capital in the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily related to lower accou nts receivable collections and an increase in cash outflows associated with inventory purchases and a net increase in liabilities. The increase in the cash outflow for inventory for the year ended December 31, 2021 compared to the same period in 2020 was largely due to increased purchases of inventory during the year ended December 31, 2021 to support expected growth in 2021, some of which did not occur due to supply chain shortages, coupled with expected sales in 2022. The net increase in liabilities was largely due to increased accounts payable related to the previously discussed increased inventory purchases as well as due to the timing of management of payables, partly offset by a decline in accrued expenses. The increase in non-cash adjustments was primarily due to increased amortization of deferred financing fees.
Cash Flow from Investing Activities
Net cash provided by investing activities was $0.4 million for the year ended December 31, 2021 compared to cash used in investing activities of $1.4 million for year ended December 31, 2020, respectively. For the year ended December 31, 2021 , cash provided by investing activities primarily related to a return of investment upon the liquidation of a joint venture partly offset by capital expenditures associated with normal maintenance of the Company’s facilities. For the year ended December 31, 2020 , cash used in investing activities was primarily related to capital expendit ures associated with normal maintenance of the Company’s facilities, partly offset by proceeds from corporate-owned life insurance.
Cash Flow from Financing Activities
The Company generated $46.5 million in cash from financing activities in the year ended December 31, 2021 compared to $33.3 million in cash generated by financing activities in the year ended December 31, 2020. The cash generated by financing activities for the year ended December 31, 2021 was primarily attributable to cash received under the series of Shareholder’s Loan Agreements with Weichai, compared to net borrowing s under the Company’s revolving credit facility for the year ended December 31, 2020 partly offset by repayment of the Company’s senior secured notes. See additional discussion below and in Note 6. Debt in Item 8. Financial Statements and Supplementary Data related to the amendments of the Company’s debt arrangements .
Liquidity and Capital Resources
On March 26, 2021, the Company amended its $130.0 million uncommitted senior secured revolving credit agreement with Standard Chartered (the “Amended and Restated Credit Agreement”). The Amended and Restated Credit Agreement allows the Company to borrow up to $130.0 million, is uncommitted, and was su bject to maturity on March 25, 2022. Borrowings under the Amended and Restated Credit Agreement incurred 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 Credit Agreement, which were deferred and amortized over the term of the Amended and Restated Credit Agreement. The Amended and Restated Credit Agreement was secured by substantially all of the Company’s assets and included 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 Credit Agreement provided Standard Chartered the right to demand payment of any and
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all of the outstanding borrowings and other amounts owed under the Amended and Restated Credit Agreement at any point in time prior to the maturity date at Standard Chartered’s discretion. Furthermore, the Amended and Restated Credit Agreement granted Standard Chartered a power of attorney (POA) to submit a borrowing request to Weichai under the amended Shareholder’s Loan Agreement (see discussion below) if the Company did not submit a borrowing request to Weichai within five business days of receiving a request from Standard Chartered to submit said borrowing request. As of December 31, 2021, the Company had $130.0 million outstanding under the Amended and Restated Credit Agreement.
In connection with the Amended and Restated Credit Agreement, on March 26, 2021, the Company entered into the First Amended and Restated Shareholder’s Loan Agreement with Weichai (the “First Shareholder’s Loan Agreement.”) The First Shareholder’s Loan provided the Company with a $130.0 million secured subordinated loan facility that expires on April 25, 2022. Under the First Shareholder’s Loan, Weichai is obligated to advance funds solely for purposes of repaying outstanding borrowings under the Amended and Restated Credit Agreement if the Company is unable to repay such borrowings. Any potential borrowings under the First Shareholder’s Loan Agreement were to be at LIBOR plus 4.50% per annum. As of December 31, 2021, there were no borrowings under the First Shareholder’s Loan Agreement.
As discussed above, the Amended and Restated Credit Agreement included financial covenants which were effective for the Company beginning with the three months ended June 30, 2021 and each of the third and fourth quarters of 2021. The financial covenants include an interest coverage ratio and a minimum EBITDA threshold as further defined in the Amended and Restated Credit Agreement. For the three months ended June 30, 2021 and September 30, 2021, the Company did not meet the defined minimum interest coverage nor EBITDA requirements. A breach of the financial covenants under the Amended and Restated Credit Agreement constitutes an event of default which, if not cured or waived, could result in the obligations under the Amended and Restated Uncommitted Revolving Credit Agreement being accelerated. On November 9, 2021, the Company entered into a waiver with Standard Chartered, which waived the financial covenant defaults for the quarters ended June 30 and September 30, 2021. In connection with the waiver, a waiver fee of $0.6 million was remitted to Standard Chartered in November 2021. Further, the Company breached the financial covenants for the three months ended December 31, 2021; however. it received a waiver from Standard Chartered for no additional fee as part of the March 25, 2022 amendment and restatement to the Amended and Restated Credit Agreement as described below.
On July 14, 2021, the Company entered into an additional Shareholder’s Loan Agreement (the “Second Shareho lder’s Loan Agreement”) with Weichai. The Second Shareholder’s Loan Agreement provided the Company with a $25.0 million uncommitted facility that is subordinated to the Amended and Restated Credit Agreement and any borrowing requests made under the Second Shareholder’s Loan Agreement are subject to Weichai’s discretionary approval. Borrowings under the Second Shareholder’s Loan Agreement incurred interest at LIBOR plus 4.50% and were to be used for general corporate purposes, except for certain legal expenditures which required additional approval from Weichai. The Second Shareholder’s Loan Agreement expires on May 20, 2022 with any outstanding principal and accrued interest due upon maturity. As of December 31, 2021 , the Company had $25.0 million outstanding under the Second Shareholder’s Loan Agreement.
On December 10, 2021, the Company entered into an additional Shareholder’s Loan Agreement (the “Third Shareholder’s Loan Agreement”) with Weichai. The Third Shareholder’s Loan Agreement provides the Company with a $50.0 million uncommitted facility that is subordinated to the Amended and Restated Credit Agreement and any borrowing requests made under the Third Shareholder’s Loan Agreement are subject to Weichai’s discretionary approval. Borrowings under the Third Shareholder’s Loan Agreement bear interest at LIBOR plus 4.50% and can be used for general corporate purposes, except for certain legal expenditures which require additional approval from Weichai. The Third Shareholder’s Loan Agreement expires on November 30, 2022 with any outstanding principal and accrued interest due upon maturity. As of December 31, 2021, the Company had $25.0 million outstanding under the Second Shareholder’s Loan Agreement.
As of December 31, 2021, the Company’s total outstanding debt obligations under the Amended and Restated Credit Agreement, the Second Shareholder’s Loan Agreement and the Third Shareholder’s Loan Agreement were $180.9 million in the aggregate, and its cash and cash equivalents were $6.3 million . See Item 8 Financial Statements and Supplementary Data , Note 6. Debt , for additional information.
On March 25, 2022, the Company amended and restated its $130.0 million Amended and Restated Credit Agreement by entering into the Second Amended and Restated Uncommitted Revolving Credit Agreement with Standard Chartered. The Second Amended and Restated Uncommitted Revolving Credit Agreement extends the maturity date of loans outstanding under its previous credit facility to the earlier of March 24, 2023 or the demand of Standard Chartered. As of the second amendment and restatement, Standard Chartered agreed to waive any existing event of default under the existing credit agreement, resulting from the breach of the financial covenants for the quarter ended December 31, 2021. No additional fee was incurred with this waiver. The Second Amended and Restated Uncommitted Revolving Credit Agreement is subject to customary events of default and covenants, including minimum consolidated EBITDA and Consolidated Interest Coverage Ratio covenants for the second and third quarters of 2022. Borrowings under the Second Amended and Restated Credit Agreement will incur interest at either the alternate base rate or the Secured Overnight Financing Rate (“SOFR”) plus 2.95% per annum. In addition, the Company paid fees of $1.8 million related to the Second Amended and Restated Uncommitted Revolving Credit Agreement,
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which will be deferred and amortized over the term of the Second Amended and Restated Uncommitted Revolving Credit Agreement. The Second Amended and Restated Uncommitted Revolving Credit Agreement continues to be secured by substantially all of the Company’s assets and contains the same prov isions as described above with respect to Standard Chartered’s demand rights and its power of attorney (POA). As of March 25, 2022, the Company had $130.0 million outstanding under the Second Amended and Restated Credit Agreement.
In connection with the Second Amended and Restated Uncommitted Revolving Credit Agreement, on March 24, 2022, the Company also amended two of the three shareholder’s loan agreements with Weichai, to among other things, extend the maturities thereof. The amended First Shareholder’s Loan Agreement (the “Amended First Shareholder’s Loan Agreement”) continues to provide the Company with a $130.0 million subordinated loan under w hich Weichai is obligated to advance funds solely for purposes of repaying outstanding borrowings under the Second Amended and Restated Uncommitted Revolving Credit Agreement if the Company is unable to pay such borrowings. The amended second shareholder’s loan agreement (the “Amended Second Shareholder’s Loan Agreement”) continues to provide the Company with a $25.0 million subordinated loan at the discretion of Weichai. The maturity of the Amended First Shareholder’s Loan Agreement was extende d to April 24, 2023 and the maturity of the Amended Second Shareholder’s Loan Agreement was extended to May 20, 2023. Borrowings under both agreements will bear interest at an annual rate equal to SOFR plus 4.65% per annum. Further, if the applicable term SOFR is negative, the interest rate per annum shall be deeme d as 4.65% per annum. If the interest rate for any loan is lower than Weichai’s borrowing cost, the interest rate for such loan shall be equal to Weichai’s borrowing cost plus 1%. Both of the agreements are subject to customary events of default and covenants. The Company has covenanted to secure any amounts borrowed under either of the agreements upon payment in full of all amounts outstanding under the Second Amended and Restated Uncommitted Revolving Credit Agreement. As of March 24, 2022, there were no borrowings under the Amended First Shareholder’s Loan Agreement and $25.0 million under the Amended Second Shareholder’s Loan Agreement.
The Company intends to work with Weichai to extend the Third Shareholder’s Loan Agreement as the maturity date approaches. As of March 24, 2022, PSI had borrowed $35.7 million unde r the Third Shareholder’s Loan Agreement.
As of December 31, 2021, Accounts Payable were approximately $93.3 million reflective of elevated inventory, costs incurred related to the Company’s indemnification obligations and the management of timing of payables.
Significant uncertainties exist about the Company’s ability to refinance, extend, or repay its outstanding indebtedness under its existing debt arrangements, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Second Amended and Restated Credit Agreement or shareholder’s loan agreements in the future. Without additional financing, the Company anticipates that it will not have sufficient cash and cash equivalents to repay the outstanding indebtedness under the Company’s existing debt arrangements as they become due. Management currently plans to seek an extension and/or replacement of its existing debt arrangements or seek additional liquidity from its current or other lenders before the maturity dates in 2022 and 2023 as discussed above. There can be no assurance that the Company will be able to successfully complete a refinancing on acceptable terms or repay this outstanding indebtedness when required or if at all.
Additionally, 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. At year-end 2021, crude oil prices were 55% above prices at year-end 2020, a meaningful improvement. However, U.S. rig counts have been slower to return as the average count for 2021 was up 10% versus 2020 and average rig counts remain significantly below the full year average during 2019. Meanwhile, the Company believes that capital spending within the U.S. oil markets during 2021 remained well below 2019 levels. These factors have contributed to a continued challenging environment for the sale of the Company’s oil and gas related products during 2021. A significant portion of the Company’s sales and profitability has historically been 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 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 shipping-related costs. Additionally, the Company experienced higher tariff costs as a result of the non-renewal of certain tariff exclusions. The Company is working to mitigate the impact of these matters through price increases and other measures, such as seeking certain tariff exclusions, 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.
Lastly, during 2021, the Company incurred significantly higher legal costs due to its obligation to indemnify certain former officers and employees as a result of exhaustion of its directors and officers insurance during the early part of 2020. In particular, spending activity was elevated during the first nine months of 2021 as a result of the USAO trial involving former officers and employees of the Company. With a verdict reached in the USAO trial matter involving former officers and employees in September 2021, the Company believes its costs related to the matter will cease. However, at this time, the
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Company is not able to estimate the potential future amount of its indemnity obligations related to the pending SEC matter involving prior officers and employees. See Note 10. Commitments and Contingencies for further discussion of the Company’s indemnification obligations. Accordingly, the above challenges may continue to have a material adverse impact on the Company’s future results of operations, financial position, and liquidity.
Due to uncertainties surrounding the Company’s future ability to refinance, extend, or repay its outstanding indebtedness under its existing debt arrangements, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Second Amended and Restated Credit Agreement or shareholder’s loan agreements 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. If the Company does not have sufficient liquidity to fund its business activities, it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
At December 31, 2021, the Company had five outstanding letters of credit totaling $2.1 million. See Item 8. Financial Statements and Supplementary Data, Note 10. Commitments and Contingencies for additional information related to the Company’s off-balance sheet arrangements and the outstanding letters of credit.
Commitments and Contingencies
Legal matters are further discussed in Note 10. Commitments and Contingencies , included in Item 8. Financial Statements and Supplementary Data . See Part I. Item 1A. Risk Factors for further discussion of legal risks to the Company.
Critical Accounting Policies and Estimates
The Company’s consolidated financial statements are prepared in accordance with U.S. GAAP. Preparation of these financial statements requires the Company to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company’s most critical accounting policies and estimates are those most important to the portrayal of its financial condition and results of operations and which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. The Company has identified the following as its most critical accounting policies and judgments. Although management believes that its estimates and assumptions are reasonable, they are based on information available when they are made and, therefore, may differ from estimates made under different assumptions or conditions.
The Company’s significant accounting policies are discussed in Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data , and should be reviewed in connection with the following discussion of accounting policies that require difficult, subjective and complex judgments.
Revenue Recognition
The Company determines the amount of revenue to be recognized through the following steps:
• identification of the contract, or contracts with a customer;
• identification of the performance obligations in the contract;
• determination of the transaction price;
• allocation of the transaction price to the performance obligations in the contract; and
• recognition of revenue when, or as, the Company satisfies the performance obligations.
Revenue for the Company is generated from contracts that may include a single performance obligation or multiple performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account for revenue recognition. Revenue is measured at the transaction price which is based on the amount of consideration that the Company expects to receive in exchange for transferring the promised goods or services to the customer. The transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company is required to estimate the total consideration expected to be received from contracts with customers. The consideration expected to be received may be variable based on the specific terms of the contract and the Company’s past practices.
For contracts with multiple performance obligations, the Company allocates the total transaction price to distinct performance obligations based on directly observable data, if available, or the Company’s best estimate of the stand-alone selling price of each distinct performance obligation. The primary method used to estimate the stand-alone selling price is the cost plus a margin approach.
The Company applies significant judgment in order to identify and determine the number of performance obligations, determine the total transaction price, allocate the transaction price to each performance obligation, and determine the appropriate timing of revenue recognition.
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The Company’s payment terms are less than one year, and its sales arrangements do not contain any significant financing components.
Timing of revenue recognition. The Company recognizes revenue related to performance obligations in its contracts with customers when control passes to the customer. Control passes to the customer when the customer has the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. For the majority of the Company’s products, revenue is recognized at a point in time when the products are shipped or delivered to the customer based on the shipping terms as that is the point in time when control passes to the customer.
The Company also recognizes revenue over time primarily when the Company’s performance obligations include: enhancing a customer-controlled asset (generally when an engine is provided by the customer), constructing an asset with no alternative future use and the Company has an enforceable right to payment throughout the period as the services are performed or providing an extended warranty beyond the Company’s standard warranty. The Company recognizes revenue throughout the manufacturing process when constructing an asset based on labor hours incurred because the customer receives the benefit of the asset as the product is constructed. The Company believes labor hours incurred relative to total estimated labor hours at completion faithfully depicts the transfer of control to the customer. The Company recognizes revenue related to extended warranty programs based on the passage of time over the extended warranty period.
Inventories
The Company’s inventories consist primarily of engines and parts. Engines are valued at the lower of cost plus estimated freight-in or net realizable value. Parts are valued at the lower of cost (first-in, first out) or net realizable value. Net realizable value approximates replacement cost.
It is the Company’s policy to review inventories on a continuous basis for obsolete, excess and slow-moving items and to record valuation adjustments for such items in order to eliminate non-recoverable costs from inventory. The Company writes down inventory for an estimated amount equal to the difference between the cost of the inventory and the estimated realizable value. Additionally, an inventory reserve is provided based upon the Company’s estimate of future demand for the quantity of inventory on hand. In determining an estimate of future demand, multiple factors are taken into consideration, including (i) customer purchase orders and customer projected demand, (ii) historical sales/usage for each inventory item and (iii) utilization within a current or anticipated future power system. These factors are primarily based upon quantifiable information, and therefore the Company has not experienced significant differences in inventory valuation due to variances in the Company’s estimation of future demand.
Goodwill Impairment
Goodwill represents the excess of purchase price and related costs over the values assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is not amortized, but instead it is tested for impairment annually, or more frequently if circumstances indicate that a possible impairment may exist.
The Company performs its annual impairment test using the discounted cash flow method which involves the Company’s management making estimates with respect to a variety of factors that will significantly impact the future performance of the business, including the following:
• future volume projections;
• estimated margins on sales;
• estimated growth rate for SG&A costs;
• future effective tax rate; and
• weighted-average cost of capital (“WACC”) used to discount future performance of the Company.
Because these estimates form a basis for the determination of whether or not the impairment charge should be recorded, these estimates are considered to be critical accounting estimates. The Company completed its 2021 annual impairment test as of October 1, 2021 and concluded that there were no impairments. See Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data for further discussion.
As of December 31, 2021, the Company has $29.8 million of goodwill. Significant adverse changes to the Com pany’s business environment and future cash flows could cause the recognition of impairment charges, which could be material, in future periods. As a result of the ongoing COVID-19 pandemic and its impacts on the global economy, it is reasonably possible that the Company will continue to be adversely impacted which may result in the recognition of material goodwill impairment charges.
Impairment of Long-Lived Assets
Long-lived assets, other than goodwill which is separately tested for impairment, are evaluated for impairment whenever events indicate that the carrying amount of such assets may not be recoverable. Potential indicators of impairment may include a
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deteriorating business climate, an asset remaining idle for more than a short period of time, advances in technology, or plans to discontinue use of, or change, in the business model for the operation in which a long-lived asset is used. The Company evaluates long-lived assets for impairment by comparing the carrying value of the long-lived assets with the estimated future net undiscounted cash flows expected to result from the use of the assets, including cash flows from disposition. If the future net undiscounted cash flows are less than the carrying value, the Company then calculates an impairment loss. The impairment loss is calculated by comparing the long-lived asset’s carrying value with its estimated fair value, which may be based on estimated future discounted cash flows. The Company also periodically reevaluates the useful lives of its long-lived assets due to advances and changes in its technologies.
The Company’s impairment loss calculations contain critical estimates because they require the Company’s management to make assumptions and to apply judgment to estimate future cash flows and long-lived asset fair values, including forecasting useful lives of the long-lived assets and selecting discount rates.
If actual results are not consistent with the assumptions used, the Company could experience an impairment triggering event and be exposed to losses that could be material. As a result of the ongoing COVID-19 pandemic and its impacts on the global economy, it is reasonably possible that the Company will continue to be adversely impacted which may result in the recognition of material impairment charges related to its long-lived assets.
Warranty
The Company offers a standard limited warranty on the workmanship of its products that in most cases covers defects for a defined period. Warranties for certified emission products are mandated by the EPA and/or the CARB and are generally longer than the Company’s standard warranty on certain emission-related products. The Company’s products may also carry limited warranties from suppliers. The Company’s warranties generally apply to engines fully manufactured by the Company and to the modifications the Company makes to supplier base products. Costs related to supplier warranty claims are often times borne by the supplier and passed through to the end customer. The Company estimates and records a liability and related charges to income for its warranty program at the time products are sold to customers. Estimates are based on historical experience and reflect management’s best estimates of expected costs at the time products are sold. 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. As of December 31, 2021 and 2020, the Company had warranty reserves of $32.9 million and $31.5 million, respectively.
The Company records adjustments to preexisting warranties for changes in its estimate of warranty costs for products sold in prior fiscal years in the period in which it is determined that actual costs may differ from the Company’s initial or previous estimates. Such adjustments typically occur when new information received by the Company indicates claims experience deviates from historical and expected trends. During 2021, the Company recognized a charge for adjustments to preexisting warranties of $9.4 million compared to a charge of $8.7 million in 2020. Warranty costs may differ from those estimated if actual claim rates are higher or lower than historical rates. For example if claims are 10% higher this would result in $3.3 million of additional warranty expense.
When the Company identifies cost effective opportunities to address issues in products sold or corrective actions for safety issues, it initiates product recalls or field campaigns. As a result of the uncertainty surrounding the nature and frequency of product recalls and field campaigns, the liability for such actions is generally recorded when the Company commits to a product recall or field campaign. In each subsequent quarter after a recall or field campaign is initiated, the recorded warranty liability balance is analyzed, reviewed and adjusted, if necessary, to reflect any changes in the anticipated average cost of repair or number of repairs to be completed prospectively.
When collection is reasonably assured, the Company also estimates the amount of warranty claim recoveries to be received from its suppliers. Warranty costs and recoveries are included in Cost of sales in the Consolidated Statements of Operations.
Impact of New Accounting Standards
For information about recently issued accounting pronouncements, see Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data .
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this item.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.