POWER SOLUTIONS INTERNATIONAL, INC. 10-K

Item 9A. Controls and Procedures. Evaluation of Disclosure Controls and Procedures The term “disclosure controls and procedures” is defined in Rule 13a-15(e) of the Exchange Act, as “controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Act are recorded, processed, summarized and reported, within the time periods specified in the SEC rules and forms.” The Company’s disclosure controls and procedures are designed to ensure that material information relating to the Company and its consolidated subsidiaries is accumulated and communicated to its management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of its disclosure controls and procedures as of December 31, 2021. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of December 31, 2021, because of the previously reported material weaknesses in internal control over financial reporting described below. Management’s Report on Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting. As defined in Rules 13a-15(f) and 15d(f) under the Exchange Act, internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of the Company’s financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Because of its inherent limitations, the Company’s internal control over financial reporting may not prevent or detect all misstatements, including the possibility of human error, the circumvention or overriding of controls, or fraud. Effective internal control can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. A material weakness is a control deficiency, or a combination of control deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021 based on the criteria established by the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO Framework”). As a result of management’s review of the Company’s financial and accounting records and the other work completed by the management team and its advisers, management concluded that, as of December 31, 2021, the Company had material weaknesses relating to certain internal controls. These material weaknesses are summarized below, and remediation efforts completed or underway are outlined in the “Ongoing Remediation of Material Weaknesses in Internal Control over Financial Reporting” section below. These material weaknesses were previously reported in the Annual Report on Form 10-K for the fiscal year ended December 31, 2020, and have been updated, as necessary, to reflect the control environment as of December 31, 2021. In September 2020, the Company settled the investigations by the SEC and USAO into the Company’s past revenue recognition practices. As part of the settlement, among other undertakings, the Company committed to remediate the deficiencies in its internal control over financial reporting that constituted material weaknesses by April 30, 2021. 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 material weaknesses. Due to the progress achieved in remediating the material weaknesses as noted in Changes in Internal Control over Financial Reporting below, the Company formally requested an additional extension from the SEC to remediate the three remaining material weaknesses below. As of December 31, 2021, the Company did not maintain an effective control environment, primarily attributable to the following identified material weaknesses: Information Technology Skillset and Competency: The Company did not have sufficient resources with appropriate levels of information technology (“IT”) knowledge to adequately support the organization including, but not limited to, the design and implementation of robust IT general controls (“ITGC”) to support internal control over financial reporting, the oversight of the Company’s applications, systems and related training to the IT system user group. 74 Information Technology: The Company continues to make progress on the design of ITGCs. However, IT General Controls were not consistently operating effectively. Warranty Reserves: The Company did not have sufficiently defined and implemented procedures or controls to ensure the completeness and accuracy of the warranty accrual. Specifically, during 2021, the Company identified an issue where certain warranty claims were not processed timely which impacted the estimation of the Company’s warranty reserve. Warranty reserves have been included in the previously reported Reserves and Accruals material weakness. Ongoing Remediation of Material Weaknesses in Internal Control over Financial Reporting Management is committed to the continued implementation of remediation efforts to address the material weaknesses. The remediation efforts summarized below, which have been or will be implemented, are intended to both address the identified material weaknesses and to enhance the Company’s overall internal control environment. Skillset and Competency: The Company continues to assess the level of and technical skills in its IT function to support the design and implementation of ITGCs. The IT function has been reorganized under the leadership of the Chief Information Officer who reports to the Chief Executive Officer. The Company also hired an IT Security lead and is actively recruiting for certain technical IT positions. The Company has continued to experience turnover in its IT function. The IT function will continue to receive control related training, consider additional hiring, and supplement with temporary resources. The Company will continue to assess IT skillset and competency during 2022. Information Technology: • The Company has reconstructed its ITGC framework to focus on controls that mitigate key financial reporting risks. • The Company has designed and is implementing controls over access, change management and IT operations to ensure that access rights are restricted to appropriate individuals, and that data integrity is maintained via effective change management controls over system updates and the transfer of data between systems. • The Company continues to adjust its Enterprise Resource Planning (“ERP”) System to work towards improvement and automation of ITGC’s as well as other business process application controls. • The Company also continues to enhance procedures to validate the information produced by the entity and end user computing to compensate while the ITGC controls are being improved. Warranty Reserves: To reduce the risk of untimely warranty claims processing, the Company is implementing improvements to centrally receive and monitor incoming claims including transitioning customers to the use of a warranty claims submission portal. The organization is in the process of onboarding customers on the portal platform. When fully implemented and operational, the Company believes the measures described above will remediate the control deficiencies that have led to the material weaknesses it has identified and will strengthen its internal control over financial reporting. The Company is committed to continuing to improve its internal control processes and it will continue to review its financial reporting controls and procedures. As the Company continues to evaluate and work to improve its internal control over financial reporting, it may determine that a need exists to take additional measures to address control deficiencies or modify certain remediation measures described above. Conclusion As a result of the material weaknesses described above, management has concluded that, as of December 31, 2021, the Company’s internal control over financial reporting was ineffective. In light of the material weaknesses in internal control over financial reporting, prior to filing this Annual Report on Form 10-K, the Company completed substantive procedures, including extensive temporary manual procedures and other measures as needed, to assist with meeting the objectives otherwise fulfilled by effective internal control over financial reporting. These procedures included, but were not limited to, conducting additional analysis and substantive procedures. These additional procedures have allowed the Company to conclude that, notwithstanding the material weaknesses in its internal control over financial reporting described above, the consolidated financial statements included herein fairly present, in all material respects, the Company’s financial condition, results of operations and cash flows for the periods presented in conformity with U.S. GAAP. Changes in Internal Control over Financial Reporting 75 As previously disclosed under “Item 9A – Controls and Procedures” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020, management concluded that its internal control over financial reporting was not effective based on the material weaknesses identified. As of December 31, 2021, the Company has completed remediation of the following previously reported material weaknesses: (i) Control Environment, (ii) Segregation of Duties, (iii) Revenue Accounting, (iv) Reserves and Accruals (other than Warranty Reserves), (v) Period-End Close/Accounting Documentation, and (vi)Data Maintenance: Control Environment: Since 2017, the Company has either replaced or appointed new Board and Audit Committee members, a Chief Executive Officer, a Chief Financial Officer, a Chief Commercial Officer, a Chief Information Officer and a Vice President, Internal Audit. These changes, along with the actions of these individuals and other senior management, have collectively improved the tone of integrity, transparency and support of the Company’s updated Code of Business Conduct and Ethics. The Company updates its Code of Business Conduct and Ethics annually and implemented an ongoing training and certification program to help ensure employees understand and comply with the Code. The Company has also implemented a new case management application and formally documented its complaint reporting and investigative protocols. The Company continues to enhance the program to provide communications and training to employees across the entire organization regarding the importance of integrity and accountability. The Company has established a process to timely identify and address internal control weaknesses throughout the control environment. Segregation of Duties: • The Company has established standards governing the segregation of incompatible duties across the organization. • The Company has implemented a technical upgrade to its ERP and revised system access across the Company to improve the segregation of incompatible duties. • The Company has designed various processes and controls to adequately segregate job responsibilities and system access throughout the organization and implemented applicable mitigating internal controls. Revenue Accounting: • The Company has designed and implemented policies and procedures to ensure that critical inputs affecting the accuracy and timeliness of revenue recognition and related reserves and sales allowances are communicated to the accounting department on a timely basis. • The Company has established and implemented improved review and approval controls across the Company to ensure that revenue, including that of nonroutine revenue transactions, is recognized consistently in accordance with the terms of the contracts with customers and U.S. GAAP. • The Company has developed and implemented sales transaction review procedures to ensure key transactions are appropriately reviewed and evaluated by the accounting department. Reserves and Accruals: The Company has enhanced controls over the review and approval of key reserves and accruals, including sales allowances and excess and obsolete inventory. While the Company has also enhanced controls over warranty reserves (which were included in the previously reported Reserves and Accruals material weakness), it is still in the process of improving the warranty claim processing process. The Company has disclosed a separate Warranty Reserves material weakness in the current filing. Period-End Close/Accounting Documentation: The Company has designed and implemented procedures and controls over the period-end close process and related documentation including, but not limited to, period-end checklists, review and approval of journal entries, taxes, inventory in-transit, account roll forwards and reconciliations, general-ledger account maintenance and financial statement analysis / thresholds. Data Maintenance: • The Company has designed and implemented procedures and controls to appropriately identify and assess changes made to data repositories that could significantly impact data integrity and the internal control framework, including, but not limited to, (i) creating centralized, complete and accurate data repositories, (ii) maintaining customer and vendor master files, employee data files, perpetual inventory records, inventory physical and cycle counts, and stock compensation agreements, and (iii) communicating an enterprise data management policy and record retention policy. 76 • The Company has developed procedures to ensure the completeness and accuracy of the data used in the design and operation of internal controls. As part of the overall remediation plan, the Company designed and implemented review and approval controls over data utilized in various accounting processes. These controls address the accuracy, timely recording and completeness of data used in the determination of significant accounting estimates, reserves and valuations as well as impacted presentation and disclosures in accordance with U.S. GAAP. Other than the remediation of the material weaknesses and ongoing remediation efforts described above, there have been no further changes in the Company’s internal control over financial reporting during the year ended December 31, 2021 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting. Item 9B. Other Information. None. 77 Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections. Not applicable. 78 PART III Item 10. Directors, Executive Officers and Corporate Governance. The information required by this item is incorporated by reference herein from the 2022 Proxy Statement to be filed with the SEC no later than 120 days after December 31, 2021. If the Proxy Statement is not filed with the SEC by such time, such information will be included in an amendment to this Annual Report by such time. See also Information about the Company’s Executive Officers in Part I of this Annual Report on Form 10-K. The Company has adopted a code of business conduct and ethics that is applicable to its directors, officers and employees and is available on its website under the "Governance Documents/Committee Charters" tab within the "Governance" subsection of the "Investors" section of its website at https://investors.psiengines.com/committee-chartersgovernance-documents. The Company intends to include on its website any amendments to, or waivers from, a provision of the code of ethics that applies to its principal executive officer, principal financial officer or controller that relates to any element of the code of ethics definition contained in Item 406(b) of Regulation S-K. Item 11. Executive Compensation. The information required by this item is incorporated by reference herein from the 2022 Proxy Statement to be filed with the SEC no later than 120 days after December 31, 2021. If the Proxy Statement is not filed with the SEC by such time, such information will be included in an amendment to this Annual Report by such time. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The information required by this item is incorporated by reference herein from the 2022 Proxy Statement to be filed with the SEC no later than 120 days after December 31, 2021. If the Proxy Statement is not filed with the SEC by such time, such information will be included in an amendment to this Annual Report by such time. Item 13. Certain Relationships and Related Transactions, and Director Independence. The information required by this item is incorporated by reference herein from the 2022 Proxy Statement to be filed with the SEC no later than 120 days after December 31, 2021. If the Proxy Statement is not filed with the SEC by such time, such information will be included in an amendment to this Annual Report by such time. Item 14. Principal Accounting Fees and Services. The information required by this item is incorporated by reference herein from the 2022 Proxy Statement to be filed with the SEC no later than 120 days after December 31, 2021. If the Proxy Statement is not filed with the SEC by such time, such information will be included in an amendment to this Annual Report by such time. 79 PART IV Item 15. Exhibits, Financial Statement Schedules. The following Financial Statements are filed as a part of this report: Page Report of Independent Registered Public Accounting Firm 41 Consolidated Balance Sheets as of December 31, 2021 and 2020 43 Consolidated Statements of Operations for 2021 and 2020 44 Consolidated Statements of Stockholders’ Equity (Deficit) for 2021 and 2020 45 Consolidated Statements of Cash Flows for 2021 and 2020 46 Notes to Consolidated Financial Statements 47 All other schedules for which provision is made in the applicable accounting regulations of the SEC are not required under the related instructions or are inapplicable and, therefore, have been omitted. EXHIBIT INDEX The following documents listed below that have been previously filed with the SEC (1934 Act File No. 001-35944) are incorporated herein by reference: Incorporated by Reference Herein Exhibit No. Exhibit Description Form Exhibit Filing Date File No. 2.1 † Agreement and Plan of Merger dated April 29, 2011, by and among Format, Inc., PSI Merger Sub, Inc. and The W Group, Inc. 8-K 2.1 05/05/2011 000-52213 2.2 Stock Purchase Agreement, dated as of April 1, 2014, by and among Power Solutions International, Inc., Carl L. Trent, Kenneth C. Trent and CKT Holdings, Inc. 8-K 10.1 04/02/2014 001-35944 3.1 Certificate of Incorporation of Power Solutions International, Inc., a Delaware corporation, originally filed with the Secretary of State of the State of Delaware on August 12, 2011. S-1/A 3.4 08/19/2011 333-174543 3.2 Amended and Restated Bylaws of Power Solutions International, Inc. 8-K 3.1 08/18/2015 001-35944 3.3 Form of Certificate of Designation of Series B Convertible Perpetual Preferred Stock of Power Solutions International, Inc. 8-K 3.1 03/27/2017 001-35944 3.4 Second Amended and Restated Bylaws of Power Solutions International, Inc., dated as of December 23, 2020. 8-K 3.1 12/31/2020 001-35944 4.1 Description of the registrant’s securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. 10-K 4.11 05/04/2020 001-35944 10.1 †† Power Solutions International, Inc. 2012 Incentive Compensation Plan. 8-K 10.3 06/07/2012 000-52213 10.2 †† Amendment No. 1 to the Power Solutions International, Inc. 2012 Incentive Compensation Plan. DEF14A Appendix A 08/02/2013 001-35944 10.3 †† Form of Restricted Stock Agreement by and between Power Solutions International, Inc. and each eligible employee. 8-K 10.1 06/20/2013 001-35944 10.4 †† Form of Indemnification Agreement by and between Power Solutions International, Inc. and certain Indemnitees. 8-K 10.1 01/09/2014 001-35944 10.5 Amended and Restated Lease Agreement, dated as of April 1, 2014, by and between Professional Power Products, Inc. and 448 W. Madison LLC. 8-K 10.2 04/02/2014 001-35944 10.6 Lease Agreement, dated as of October 1, 2014, by and between Power Solutions International, Inc. and Hamilton Lakes Commerce Center #4 Limited Partnership. 8-K 10.2 10/01/2014 001-35944 10.7 Lease Agreement, dated as of December 1, 2017, by and between Power Solutions International, Inc. and James Campbell Company LLC. 10-K 10.26 05/16/2019 001-35944 10.8 First Lease Amendment, dated as of July 11, 2018, by and between Power Solutions International, Inc. and Centerpoint Properties Trust, in connection with that certain Industrial Building Lease dated as of March 13, 2012, with respect to that certain premises located at 101 Mittel Drive (formerly 801 EC Drive) in Wood Dale, Illinois. 8-K 10.1 07/18/2018 001-35944 80 Incorporated by Reference Herein Exhibit No. Exhibit Description Form Exhibit Filing Date File No. 10.9 Second Lease Amendment, dated as of July 11, 2018, by and between Power Solutions International, Inc. and CenterPoint Properties Trust, in connection with that certain Industrial Building Lease dated as of February 28, 2012, as further amended by that certain First Lease Amendment dated June 1, 2012, with respect to that certain premises located at 201 Mittel Drive, Wood Dale, Illinois. 8-K 10.2 07/18/2018 001-35944 10.10 ††† Addendum dated as of July 31, 2014, to Supply Agreement dated December 11, 2007, by and between Power Solutions International, Inc. and Doosan Infracore Co., Ltd., as amended. 8-K 10.1 08/06/2014 001-35944 10.11 Asset Purchase Agreement dated as of May 4, 2015 by and among Power Solutions International, Inc., Powertrain Integration Acquisition, LLC, as the Buyer, and Powertrain Integration, LLC and its principals, as the Seller. 8-K 10.1 05/06/2015 001-35944 10.12 Form of Investor Rights Agreement between Power Solutions International, Inc. and Weichai America Corp. 8-K 10.3 03/27/2017 001-35944 10.13 Shareholders Agreement by and among Power Solutions International, Inc., Weichai America Corp. and the Founding Stockholders, dated as of March 20, 2017. 8-K 10.4 03/27/2017 001-35944 10.14 ††† Strategic Collaboration Agreement between Weichai Power Co. Ltd. and Power Solutions International, Inc., dated March 20, 2017. 8-K 10.5 03/27/2017 001-35944 10.15 Securities Exchange Agreement, dated as of November 30, 2017, by and among Power Solutions International, Inc., and Weichai America Corp. 8-K 10.1 12/05/2017 001-35944 10.16 †† Employment Agreement, dated June 15, 2017, by and between Power Solutions International, Inc. and John P. Miller. 8-K/A 10.1 06/21/2017 001-35944 10.17 †† Employment Agreement, dated November 28, 2017, by and between Power Solutions International, Inc. and Kenneth Winemaster. 8-K 10.1 12/04/2017 001-35944 10.18 Amendment to the Power Solutions International, Inc. 2012 Incentive Compensation Plan (As Amended July 31, 2013). 10-K 10.40 05/16/2019 001-35944 10.19 Addendum #10, dated as of September 16, 2019, to Supply Agreement, dated as of December 11, 2007, by and between Power Solutions International, Inc. and Doosan Infracore Co., Ltd., as amended. 8-K 10.1 10/02/2019 001-35944 10.20 First Amendment to Strategic Collaboration Agreement, dated as of March 26, 2020, by and between the Company and Weichai Power. 8-K 10.1 04/01/2020 001-35944 10.21 Credit Agreement, dated as of March 27, 2020, between the Company and Standard Chartered Bank, as administrative agent. 8-K 10.1 04/06/2020 001-35944 10.22 †† Confidential Consulting Agreement 10-Q 10.1 05/04/2019 001-35944 10.23 First Amendment to Credit Agreement and Limited Waiver, dated as of December 28, 2020, among the Company, certain subsidiaries of the Company party thereto, the lenders party thereto and Standard Chartered Bank, as administrative agent. 8-K 10.1 12/31/2020 001-35944 10.24 Shareholder’s Loan Agreement, dated as of December 28, 2020, between the Company and Weichai America Corp. 8-K 10.2 12/31/2020 001-35944 10.25 Employment Agreement, dated as of February 15, 2021, between the Company and Lance Arnett 8-K 10.1 02/16/2021 001-35944 10.26 Separation Agreement and Release, dated as of February 15, 2021, between the Company and John P. Miller 8-K 10.2 02/16/2021 001-35944 10.27 Retirement Agreement and Release, dated as of December 14, 2021, between the Company and Kenneth Winemaster 8-K 10.1 12/17/2021 001-35944 10.28 Shareholder’s Loan Agreement, dated as of December 10, 2021, between the Company and Weichai America Corp. 8-K 10.1 12/16/2021 001-35944 10.29 Second Amended and Restated Uncommitted Revolving Credit Agreement, dated as of March 25, 2022, among the Company, certain subsidiaries of the Company party thereto, the lenders party thereto and Standard Chartered Bank, as administrative agent. 8-K 10.1 03/28/2022 001-35944 10.30 Second Amended and Restated Shareholder’s Loan Agreement, dated as of March 25, 2022, between the Company and Weichai America Corp. 8-K 10.2 03/28/2022 001-35944 10.31 First Amended and Restated Shareholder’s Loan Agreement, dated as of March 25, 2022, between the Company and Weichai America Corp. 8-K 10.3 03/28/2022 001-35944 10.35 * †† Description of Long-Term Incentive Plan 21.1 * Subsidiaries of Power Solutions International, Inc. 23.1 * Consent of BDO USA, LLP 81 Incorporated by Reference Herein Exhibit No. Exhibit Description Form Exhibit Filing Date File No. 31.1 * Certification of Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 * Certification of Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 ** Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 ** Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 101.INS * XBRL Instance Document. 101.SCH * XBRL Taxonomy Extension Schema Document. 101.CAL * XBRL Taxonomy Extension Calculation Linkbase Document. 101.LAB * XBRL Taxonomy Extension Labels Linkbase Document. 101.PRE * XBRL Taxonomy Extension Presentation Linkbase Document. 101.DEF * XBRL Taxonomy Definition Linkbase Document. * Filed with this Report. ** This exhibit shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that Section. Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933, as amended, or the Exchange Act. † Exhibits and schedules omitted pursuant to Item 601(b)(2) of Regulation S-K. The registrant agrees to furnish a supplemental copy of an omitted exhibit or schedule to the SEC upon request. †† Management contract or compensatory plan or arrangement. ††† Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been separately filed with the SEC. Item 16. Form 10-K Summary. None. 82 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 31st day of March, 2021. POWER SOLUTIONS INTERNATIONAL, INC. By: /s/ Donald P. Klein Name: Donald P. Klein Title: Chief Financial Officer (Principal Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 31st day of March, 2021. Signature Title /s/ Lance Arnett Chief Executive Officer Lance Arnett (Principal Executive Officer) /s/ Donald P. Klein Chief Financial Officer Donald P. Klein (Principal Financial and Accounting Officer) /s/ Fabrizio Mozzi Chairman of the Board and Director Fabrizio Mozzi /s/ Shaojun Sun Vice Chairman of the Board and Director Shaojun Sun /s/ Lei Lei Director Lei Lei /s/ Sidong Shao Director Sidong Shao /s/ Kenneth W. Landini Director Kenneth W. Landini /s/ Frank P. Simpkins Director Frank P. Simpkins /s/ Hong He Director Hong He 83