POWER SOLUTIONS INTERNATIONAL, INC. 10-K

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, 2022 and 2021, 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. 25 For 2022, net sales increased $25.1 million, or 5%, compared to 2021, as a result of sales increases of $56.4 million and $71.4 million within the power systems and industrial end markets, respectively, partly offset by a decrease of $102.7 million in the transportation end market. Gross margin was 18.4% and 9.0% during 2022 and 2021, respectively. Gross profit increased during 2022 by $47.3 million compared to 2021, while operating expenses decreased by $18.9 million as compared to 2021. Interest expense increased by $5.7 million in 2022 versus 2021. Also, the Company recorded an income tax expense of $0.3 million for 2022 versus a benefit of $0.4 million for 2021. Collectively, these factors contributed to a $59.7 million increase in the net income, which totaled $11.3 million in 2022 compared to net loss of $48.5 million in 2021. Diluted earnings per share was $0.49 in the 2022 period compared to diluted loss per share of $2.12 in 2021. Adjusted net income, which excludes certain items described below that the Company believes are not indicative of its ongoing operating performance, was $15.7 million in 2022 compared to Adjusted net loss of $26.7 million in 2021. Adjusted income per share was $0.69 in 2022 compared to Adjusted loss per share of $1.16 in 2021. Adjusted earnings before interest expense, income taxes, depreciation and amortization (“EBITDA”) was an income of $35.8 million in 2022 compared to Adjusted EBITDA loss of $12.4 million in 2021. Adjusted net income (loss), Adjusted earnings (loss) per share and Adjusted EBITDA are non-GAAP financial measures. For a reconciliation of each of these measures to the nearest applicable GAAP financial measure, as well as additional information 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 2022 and 2021 are presented below: (in thousands) For the year ended December 31, 2022 For the Year Ended December 31, 2021 Geographic Area % of Total % of Total United States $ 349,488 73 % $ 406,077 89 % North America (outside of United States) 16,437 3 % 8,616 2 % Pacific Rim 80,681 17 % 25,457 5 % Europe 18,452 4 % 7,457 2 % Others 16,275 3 % 8,648 2 % Total $ 481,333 100 % $ 456,255 100 % (in thousands) For the year ended December 31, 2022 For the Year Ended December 31, 2021 End Market % of Total % of Total Power Systems $ 179,491 37 % $ 123,132 27 % Industrial 224,669 47 % 153,289 34 % Transportation 77,173 16 % 179,834 39 % Total $ 481,333 100 % $ 456,255 100 % During 2022, t he Company sold over 47,000 engines of which approximately 70% utilized propane or natural gas as their fuel source and 12% utilized gasoline. The remaining 18% of engines were dual fuel gasoline/propane, diesel and service/base engines. 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. 26 The Company and Weichai executed the Collaboration Agreement in order to achieve their respective objectives, enhance the cooperation alliance and share experiences, expertise and resources. Among other things, the Collaboration Arrangement established a joint steering committee, permitted Weichai to second a limited number of technical, marketing, sales, procurement and finance personnel to work at the Company and established several collaborations related to stationary natural-gas applications and Weichai diesel engines. The Collaboration Agreement also provides for the steering committee to create various subcommittees with operating roles and otherwise governs the treatment of intellectual property of parties prior to the collaboration and the intellectual property developed during the collaboration. The Collaboration Agreement was extended for three years in March 2020 and was set to expire in March 2023 . On March 22, 2023, the Collaboration Agreement was extended for an additional term of three years. The Company’s sales to Weichai were $0.6 million and $0.5 million during 2022 and 2021, respectively. The Company purchased $13.3 million and $12.4 million of inventory from Weichai during 2022 and 2021, 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 2022 and 2021 operating results, were $3.6 million and $19.7 million, respectively. Recent Trends and Business Outlook COVID-19 Update and Recent Business Impacts The COVID-19 pandemic 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. As of the date of this 2022 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. Starting in 2021 and throughout 2022, the Company took rightsizing actions to align its staffing with current needs, while also streamlining certain roles. During 2021, the glo bal economy began recovering after the global pandemic that led to challenging market conditions across certain areas of the Company’s business and continued to improve during 2022. Average crude oil prices began to improve in 2021 after the unprecedented decreases seen during the global pandemic and reached the highest average price in five years during 2022. R ig counts in the U.S. oil markets increased during 2021 and through 2022, however the average rig counts remain slightly below pre-pandemic levels. The Company also believes that capital spending within the areas of the oil and gas market that it participates in, remains below pre-pandemic levels. While the Company saw an increase of sales to customers with traditional exposure to the oil and gas markets during 2022, as compared to the prior year, sales remain below pre-pandemic levels. 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 continued to experience delays in its supply chain during 2022 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 continues to experience ongoing tariff costs for products that did not receive tariff exclusions. The Company is working to mitigate the impact of these matters through price increases and other measures, such as seeking certain tariff 27 exclusions, where possible. The potential for continued supply chain 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. During 2022, the Company experienced a significant reduction in 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, these legal costs were significantly higher in 2020 and 2021. 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’s costs related to the matter ceased. Accordingly, the Company saw a substantial decline in these costs during 2022. Additionally, in June 2022, the SEC matter concerning former officers and employees was settled. As a result, the Company’s potential future costs for indemnity obligations related to this matter should cease. Meanwhile, the Company continues to be party to several legal contingencies. Se e Note 10. Commitments and Contingencies for further discussion of the Company’s indemnification obligations. The Company expects its sales in 2023 to increase by about 3% versus 2022 levels, a result of expectations for strong growth in the power systems end markets paired with a less significant increase of sales in the industrial and transportation end markets. Gross profit as a percentage of sales is targeted to remain relatively consistent in 2023, a result of the lower warranty expense, pricing actions, improved cost recovery and cost savings initiatives set forth in 2022. 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, rising interest rates, and the prolonged impacts of 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. 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 designated 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 2023 and future periods. 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 some alternative supply beginning in late 2023 for several high-volume engines that the Company currently provides, including the 2.0L and 2.4L engines. As a result of this, the Company expects to see a decline in sales volumes to Hyster-Yale beginning in 2024. The Company believes it is positioned to continue its relationship in a moderated capacity with this customer in 2024 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. 28 Results of Operations Results of operations for the year ended December 31, 2022 compared with the year ended December 31, 2021 : (in thousands, except per share amounts) For the Year Ended December 31, 2022 2021 Change % Change Net sales (from related parties $2,749 and $493 for the year ended December 31, 2022 and December 31, 2021, respectively) $ 481,333 $ 456,255 $ 25,078 5 % Cost of sales (from related parties $2,262 and $346 for the year ended December 31, 2022 and December 31, 2021, respectively) 392,770 414,984 (22,214) (5) % Gross profit 88,563 41,271 47,292 115 % Gross margin % 18.4 % 9.0 % 9.4 % Operating expenses: Research, development and engineering expenses 18,896 22,435 (3,539) (16) % Research, development and engineering expenses as a % of sales 3.9 % 4.9 % (1.0) % Selling, general and administrative expenses 42,941 57,871 (14,930) (26) % Selling, general and administrative expenses as a % of sales 8.9 % 12.7 % (3.8) % Amortization of intangible assets 2,124 2,535 (411) (16) % Total operating expenses 63,961 82,841 (18,880) (23) % Operating income (loss) 24,602 (41,570) 66,172 159 % Other expense, net: Interest expense 13,028 7,307 5,721 78 % Other expense, net — 1 (1) NM Total other expense, net 13,028 7,308 5,720 78 % Income (Loss) before income taxes 11,574 (48,878) 60,452 124 % Income tax expense (benefit) 304 (406) 710 NM Net income (loss) $ 11,270 $ (48,472) $ 59,742 123 % Earnings (Loss) per common share: Basic $ 0.49 $ (2.12) $ 2.61 123 % Diluted $ 0.49 $ (2.12) $ 2.61 123 % Non-GAAP Financial Measures: Adjusted net income (loss) * $ 15,735 $ (26,749) $ 42,484 159 % Adjusted income (loss) per share * $ 0.69 $ (1.16) $ 1.85 159 % EBITDA * $ 31,292 $ (34,165) $ 65,457 192 % Adjusted EBITDA * $ 35,757 $ (12,442) $ 48,199 NM NM Not meaningful * See reconciliation of non-GAAP financial measures to GAAP results below Net Sales Net sales increased $25.1 million, or 5%, compared to 2021, as a result of sales increases of $56.4 million and $71.4 million within the power systems and industrial end markets, respectively, partly offset by a decrease of $102.7 million in the transportation end market , which was expected during the year as the Company focuses on driving improved long-term profitability. Further, overall sales in 2022 continued to reflect supply chain challenges that impacted the Company’s ability to timely meet certain orders. Higher power systems end market sales were attributable to increased sales across various categories, including within demand response, standby, and to customers that have traditionally served the oil and gas market. Higher industrial end market sales are primarily due to increased demand for products across various applications, with the largest increase attributable to products used within the material handling/forklift market. The decreased sales within the transportation end market were primarily attributable to lower sales in the medium duty truck market, coupled with lower sales of school bus products. 29 Gross Profit Gross profit increased by $47.3 million, or 115%, to $88.6 million in 2022, compared to $41.3 million in 2021. Gross margin was 18.4% and 9.0% in 2022 and 2021, respectively. The increase in gross margin is primarily due to lower warranty expense, improved mix and pricing actions. For the year ended December 31, 2022, warranty costs were $6.4 million, a decrease of $16.4 million compared to warranty costs of $22.8 million last year, due largely to lower charges for transportation end market engines during the year ended December 31, 2022 in part attributable to a contract revision. A majority of the warranty activity is attributable to products sold within the transportation end market. Research, Development and Engineering Expenses R&D expenses in 2022 were $18.9 million, a decrease of $3.5 million, or 16%, from 2021 levels, primarily due to lower wages and benefits driven by reduced headcount and the timing of projects. Selling, General and Administrative Expenses Selling, general and administrative (“SG&A”) decreased in 2022 by $14.9 million, or 26%, compared to 2021. The decrease w as primarily due to lower legal costs related to the Company’s indemnification obligations of former officers and employees, due largely to decreased spending activity during the year ended December 31, 2022 in relation to the USAO’s trial involving former officers and employees, which concluded in September 2021 (see additional discussion in Note 10. Commitments and Contingencies of Item 8. Financial Statements and Supplementary Data). These decreased costs were partially offset by an increase in incentive compensation expense. Interest Expense Interest expense increased $5.7 million to $13.0 million in 2022 from $7.3 million in 2021 largely due to higher average outstanding debt and a higher overall effective interest rate on the Company’s debt during 2022, including fees, as compared to prior year. See Note 6. Debt , included in Item 8. Financial Statements and Supplementary Data for additional information. Income Tax Expense The Company recorded an income tax expense of $0.3 million in 2022, a decrease of $0.7 million, as compared to an income tax benefit of $0.4 million in 2021. The Company’s pretax income was $11.6 million in 2022, compared to pretax loss of $48.9 million in 2021. The Company continues to record a full valuation allowance against deferred tax assets, which offsets the tax expense associated with the pre-tax income for the 2022 period and the tax benefits associated with the pre-tax loss for the 2021 period. The income tax expense for 2022 is primarily related to the Company’s deferred tax liability related to indefinite-lived assets which cannot serve as a source of income for the realization of deferred tax assets . The income tax benefit for 2021 is primarily attributable to the ability to carry back 2013 R&D credits back to 2012 under the CARES Act. 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. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report. Management does not use these non-GAAP financial measures for any purpose other than the reasons stated below. Non-GAAP Financial Measure Comparable GAAP Financial Measure Adjusted net income (loss) Net income (loss) Adjusted earnings (loss) per share Earnings (loss) per common share – diluted EBITDA Net income (loss) Adjusted EBITDA Net income (loss) The Company believes that Adjusted net income (loss), Adjusted (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. 30 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 income (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 income (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 income (loss) to Adjusted net income (loss): (in thousands) For the Year Ended December 31, 2022 2021 Net income (loss) $ 11,270 $ (48,472) Stock-based compensation 1 385 394 Severance 2 462 1,595 Internal control remediation 3 467 1,283 Governmental investigations and other legal matters 4 3,151 18,451 Adjusted net income (loss) $ 15,735 $ (26,749) 31 The following table presents a reconciliation from Income (Loss) per common share – diluted to Adjusted income (loss) per share – diluted: For the Year Ended December 31, 2022 2021 Income (loss) per common share – diluted $ 0.49 $ (2.12) Stock-based compensation 1 0.02 0.02 Severance 2 0.02 0.07 Internal control remediation 3 0.02 0.06 Governmental investigations and other legal matters 4 0.14 0.81 Adjusted income (loss) per share – diluted $ 0.69 $ (1.16) Diluted shares (in thousands) 22,948 22,908 The following table presents a reconciliation from Net income (loss) to EBITDA and Adjusted EBITDA: (in thousands) For the Year Ended December 31, 2022 2021 Net income (loss) $ 11,270 $ (48,472) Interest expense 13,028 7,307 Income tax expense (benefit) 304 (406) Depreciation 4,566 4,871 Amortization of intangible assets 2,124 2,535 EBITDA 31,292 (34,165) Stock-based compensation 1 385 394 Severance 2 462 1,595 Internal control remediation 3 467 1,283 Governmental investigations and other legal matters 4 3,151 18,451 Adjusted EBITDA $ 35,757 $ (12,442) 1. Amounts reflect non-cash stock-based compensation expense. 2. Amounts represent severance and other post-employment costs for certain former employees of the Company. 3. Amounts represent professional services fees related to the Company’s efforts to remediate internal control material weaknesses including certain costs to upgrade IT systems. 4. The amounts include an expense of $0.1 million and $15.7 million, for the years ended December 31, 2022 and 2021, respectively, for professional services fees related to costs to indemnify certain former officers and employees 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. Cash Flows Cash was impacted as follows: (in thousands) For the Year Ended December 31, 2022 2021 Change % Change Net cash used in operating activities $ (8,845) $ (61,478) $ 52,633 86 % Net cash (used in) provided by investing activities (1,354) 398 (1,752) NM Net cash provided by financing activities 28,367 46,545 (18,178) 39 % Net increase (decrease) in cash, cash equivalents, and restricted cash $ 18,168 $ (14,535) $ 32,703 NM Capital expenditures $ (1,354) $ (1,968) $ 614 31 % 32 2022 Cash Flows Cash Flow from Operating Activities Net cash used in operations was $8.8 million in 2022 compared to net cash used in operations of $61.5 million in 2021 resulting in a decrease of $52.6 million in cash used in operating activities year-over-year. The decrease in cash used by operating activities primarily resulted from the $59.7 million increase in earnings while collections of customer accounts receivable were lower than the prior year, and the Company had higher cash paid against accounts payable contributing to a $6.7 million increase of cash used by working capital accounts. Cash outflows associated with other noncurrent liabilities have increased, and are offset by the decrease in inventory purchases and the decrease in non-cash adjustments. Cash Flow from Investing Activities Net cash used in investing activities was $1.4 million for the year ended December 31, 2022 compared to cash provided by investing activities of $0.4 million for year ended December 31, 2021, respectively. For the year ended December 31, 2022 , capital expenditures associated with the Company’s facilities were lower by $0.6 million versus the prior year. 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. Cash Flow from Financing Activities The Company generated $28.4 million in cash from financing activities in the year ended December 31, 2022 compared to $46.5 million in cash generated by financing activities in the year ended December 31, 2021. The cash generated by financing activities for the year ended December 31, 2022 and 2021 was primarily attributable to cash received under the series of Shareholder’s Loan Agreements with Weichai . 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 The Company’s sources of funds are cash flows from operations, borrowings made pursuant to our credit facilities, shareholder’s loan agreements, and cash and cash equivalents on hand. Principal uses of funds consist of payments of principal interest on our debt facilities and shareholder’s loan agreements, capital expenditures, and working capital needs. As of December 31, 2022 , the Company’s total outstanding debt obligations under the Second Amended and Restated Credit Agreement, the second Amended Shareholder’s Loan Agreement, the third Amended Shareholder's Loan Agreement , the fourth Amended Shareholder's Loan Agreement and for finance leases and other debt were $211.0 million in the aggregate, and its cash and cash equivalents were $24.3 million. See Item 8. Financial Statements and Supplementary Data , Note 6. Debt, for additional information. 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 Third 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 2023 and 2024. 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. As of December 31, 2022 and 2021 , Accounts Payable were approximately $76.4 million and $93.3 million, respectively, reflective of less inventory and costs incurred related to the Company’s indemnification obligations. During 2021, the glo bal economy began recovering after the global pandemic that led to challenging market conditions across certain areas of the Company’s business and continued to improve during 2022. Average crude oil prices began to improve in 2021 after the unprecedented decreases seen during the global pandemic and reached the highest average price in five years during 2022. R ig counts in the U.S. oil markets increased during 2021 and through 2022, however the average rig counts remains slightly below pre-pandemic levels. The Company also believes that capital spending within the areas of the oil and gas market that it participates in, remains below pre-pandemic levels. While the Company saw an increase of sales to customers with traditional exposure to the oil and gas markets during 2022, as compared to the prior year, sales remain below pre-pandemic levels. 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 continued to experience delays in its supply chain during all of 2022 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 continues to experience ongoing tariff costs for products that did not receive tariff exclusions. The Company is working to mitigate the impact of these matters through price increases and other measures, such as seeking certain tariff 33 exclusions, where possible. The potential for continued supply chain 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. 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’s costs related to the matter ceased . Accordingly, the Company saw a substantial decline in these costs during 2022. Additionally, in June 2022, the SEC matter concerning former officers and employees was settled. As a result, the Company’s potential future costs for indemnity obligations related to this matter should cease. See Item 8. Financial Statements and Supplementary Data, Note 10. Commitments and Contingencies for further discussion of the Company’s indemnification obligations. Lastly, in addition to incurring higher total debt levels during 2022, the Company’s debt is tied to the London Inter-Bank Offered Rate (“LIBOR”) and the Secured Overnight Financing Rate (“SOFR”), both of which have seen significant increases during the year. As a result of these factors, the Company’s interest expense has increased and is subject to further increases. 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 Third 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, 2022, 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 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 34 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 customers that include multiple performance obligations, judgment is required to determine whether performance obligations specified in these contracts are distinct and should be accounted for as separate revenue transactions for recognition purposes. For such arrangements, revenue is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are generally determined based on the prices charged to customers or using expected cost plus margin. 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. 35 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 . See Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data for further discussion. Impairment of Long-Lived Assets Long-lived assets, other than goodwill which is separately tested for impairment, are evaluated for impairment whenever events indicate that the carrying amount of such assets may not be recoverable. Potential indicators of impairment may include a deteriorating business climate, an asset remaining idle for more than a short period of time, advances in technology, or plans to discontinue use of, or change, in the business model for the operation in which a long-lived asset is used. The Company evaluates long-lived assets for impairment by comparing the carrying value of the long-lived assets with the estimated future net undiscounted cash flows expected to result from the use of the assets, including cash flows from disposition. If the future net undiscounted cash flows are less than the carrying value, the Company then calculates an impairment loss. The impairment loss is calculated by comparing the long-lived asset’s carrying value with its estimated fair value, which may be based on estimated future discounted cash flows. The Company also periodically reevaluates the useful lives of its long-lived assets due to advances and changes in its technologies. The Company’s impairment loss calculations contain critical estimates because they require the Company’s management to make assumptions and to apply judgment to estimate future cash flows and long-lived asset fair values, including forecasting useful lives of the long-lived assets and selecting discount rates. 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. 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. Warranty costs may differ from those estimated if actual claim rates are higher or lower than historical rates. 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. 36