POWER SOLUTIONS INTERNATIONAL, INC. annual report, FY2021

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Power Solutions International, Inc. — FY2021 Form 10-K

Business and reporting period: PSI designs, manufactures and sells emission-certified engines and integrated power systems for power systems, industrial and transportation markets. It reports as one segment. This summary covers the fiscal year ended December 31, 2021, compared with FY2020.

Financial performance and liquidity

  • Revenue: $456.3 million, up 9% from $417.6 million. Industrial sales increased to $153.3 million from $131.0 million, and transportation sales rose to $179.8 million from $137.3 million. Power systems sales declined to $123.1 million from $149.3 million.
  • Profitability: Gross profit fell 29% to $41.3 million from $58.4 million; gross margin contracted to 9.0% from 14.0%. Operating loss widened to $41.6 million from $21.7 million. Net loss increased to $48.5 million from $23.0 million; diluted loss per share was $2.12 versus $1.00.
  • Non-GAAP measures: Adjusted EBITDA was a loss of $12.4 million, compared with positive $3.0 million in 2020. Adjusted net loss was $26.7 million versus $11.1 million. These company-defined measures are not substitutes for GAAP results.
  • Costs and margins: Cost of sales rose 16% to $415.0 million, exceeding revenue growth. Management cited higher materials, freight and tariff costs, elevated warranty expenses and unfavorable product mix. Warranty costs were $22.8 million, up from $19.5 million; the year-end warranty reserve was $32.9 million.
  • Operating expenses and interest: Total operating expenses increased 3% to $82.8 million. SG&A rose 12% to $57.9 million, including higher legal and indemnification costs; R&D expense declined 12% to $22.4 million. Interest expense increased to $7.3 million from $5.7 million.
  • Cash flow: Operating activities used $61.5 million, compared with $7.6 million used in 2020. Capital expenditures were $2.0 million. Cash, cash equivalents and restricted cash totaled $9.7 million at year-end, including $6.3 million of unrestricted cash.
  • Debt and balance sheet: Total borrowings were approximately $180.9 million at year-end. Total current liabilities were $283.3 million against current assets of $230.2 million; stockholders’ deficit was $42.0 million. Management and the auditor identified substantial doubt about PSI’s ability to continue as a going concern.

Material changes and notable items

  • Revenue growth was concentrated in transportation and industrial, partly offset by weaker power systems demand. The company attributed transportation growth partly to sales of GM 6.0L engines; it recognized $103.7 million of 6.0L engine revenue in 2021.
  • Margin deterioration and higher losses reflected cost inflation, supply-chain and shipping disruption, tariffs, warranty costs and mix. PSI said it was unable to recover higher costs adequately through pricing during 2021.
  • Cash use from operations increased sharply, primarily due to the higher net loss and weaker working-capital cash generation, including inventory purchases and lower receivables collections. Inventory increased to $142.2 million from $108.2 million.
  • Incremental financial-reporting, internal-control remediation, government-investigation and other legal expenses totaled $19.7 million, versus $15.3 million in 2020. Indemnification costs were $15.7 million in 2021; the company said future SEC-related indemnification amounts could not be estimated.
  • PSI breached financial covenants in multiple 2021 quarters; Standard Chartered waived the defaults. In March 2022, after year-end, the lender extended the $130 million facility to the earlier of March 24, 2023 or lender demand. The facility remains uncommitted, secured by substantially all assets and callable on demand. Weichai also extended two shareholder loan maturities; the third loan’s maturity was November 30, 2022, and PSI said it intended to seek an extension.
  • The company reduced headcount by about 100 positions, or 12.5%, and expects annualized savings of about $1.3 million from exiting and subleasing a facility.
  • Customer concentration was significant: two customers accounted for 21% and 17% of 2021 sales. Weichai owned approximately 51% of PSI’s common stock as of March 2022.

Outlook, risks and controls

  • Management outlook: PSI expected 2022 sales to increase at least 3% from 2021 and targeted gross profit as a percentage of sales to improve by at least 5 percentage points. It anticipated growth in industrial and power systems, partly offset by lower transportation sales. Management cautioned that supply-chain constraints, inflation, commodity volatility and COVID-19 could undermine the outlook.
  • Customer and supply risks: PSI expected significantly lower 2022 transportation sales as prepaid GM 6.0L inventory was exhausted and a large customer secured alternative supply. Hyster-Yale indicated it would obtain alternative supply for certain engines beginning in late 2022, with expected volume declines from 2023. Doosan purchase shortfalls resulted in a $1.6 million 2021 expense.
  • Going concern and financing: PSI stated it may lack sufficient cash to repay debt as it comes due without additional financing. Future liquidity depends on refinancing or extending debt, lender support, covenant compliance and improved operating results; there is no assurance these plans will succeed. The auditor’s financial-statement opinion was unqualified but included a going-concern uncertainty.
  • Internal controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at year-end because of remaining material weaknesses involving IT expertise, IT general controls and warranty reserves. The company reported remediation progress, but the remaining weaknesses were not remediated by year-end.
  • Other risks and contingencies: Risks include warranty and product-liability exposure, regulatory certification requirements, oil and gas market volatility, dependence on suppliers, tariffs, litigation and unresolved indemnification obligations. Directors’ and officers’ insurance for the disclosed pending matters was substantially exhausted. The common stock had been delisted from Nasdaq and traded on the OTC market.

Most important facts for investors to verify

  • Whether PSI can refinance or extend debt before maturities, maintain covenant compliance and secure lender support despite the demand feature of its main facility.
  • Whether the 2022 sales and gross-margin targets were achieved, particularly given weaker transportation volumes and the projected recovery in power systems and industrial markets.
  • Whether warranty claims and reserves stabilize, and whether the remaining internal-control material weaknesses are remediated.
  • The extent and timing of additional indemnification, litigation or regulatory-related costs, including any remaining SEC-related obligations.
  • Whether working capital, cash generation and customer concentration improve; also monitor alternative sourcing by major customers and supplier purchase commitments.