UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 | |
For the quarterly period ended June 29, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 | |
For the transition period from __________ to __________
Commission File Number: 000-02382
(Exact name of Registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||
(Address of principal executive offices) | (Zip Code) | ||
Registrant's telephone number, including area code: (952 ) 937-4000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer ☐ | Emerging growth company | |||
Non-accelerated filer ☐ | Smaller reporting company | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
As of August 1, 2019, there were 19,334,452 shares of common stock outstanding.
MTS Systems Corporation
Quarterly Report on Form 10-Q
For the Three Months Ended June 29, 2019
Table of Contents
1
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
MTS SYSTEMS CORPORATION
Consolidated Balance Sheets
(in thousands, except per share data)
June 29, 2019 | September 29, 2018 | |||||||
(Unaudited) | (Note) | |||||||
Assets | ||||||||
Current assets | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Accounts receivable, net of allowance for doubtful accounts of $5,430 and $5,004, respectively | ||||||||
Unbilled accounts receivable, net | ||||||||
Inventories, net | ||||||||
Prepaid expenses and other current assets | ||||||||
Total current assets | ||||||||
Property and equipment, net | ||||||||
Goodwill | ||||||||
Intangible assets, net | ||||||||
Other long-term assets | ||||||||
Deferred income taxes | ||||||||
Total assets | $ | $ | ||||||
Liabilities and Shareholders' Equity | ||||||||
Current liabilities | ||||||||
Current maturities of long-term debt, net | $ | $ | ||||||
Accounts payable | ||||||||
Accrued payroll and related costs | ||||||||
Advance payments from customers | ||||||||
Accrued warranty costs | ||||||||
Accrued income taxes | ||||||||
Accrued dividends | ||||||||
Other accrued liabilities | ||||||||
Total current liabilities | ||||||||
Long-term debt, less current maturities, net | ||||||||
Deferred income taxes | ||||||||
Non-current accrued income taxes | ||||||||
Defined benefit pension plan obligation | ||||||||
Other long-term liabilities | ||||||||
Total liabilities | ||||||||
Shareholders' Equity | ||||||||
Common stock, $0.25 par value; 64,000 shares authorized: 18,736 and 17,856 shares issued and outstanding as of June 29, 2019 and September 29, 2018, respectively | ||||||||
Additional paid-in capital | ||||||||
Retained earnings | ||||||||
Accumulated other comprehensive income (loss) | ( | ) | ||||||
Total shareholders' equity | ||||||||
Total liabilities and shareholders' equity | $ | $ | ||||||
Note: The Consolidated Balance Sheet as of September 29, 2018 has been derived from the audited consolidated financial statements at that date.
The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.
2
MTS SYSTEMS CORPORATION
Consolidated Statements of Income (Unaudited)
(in thousands, except per share data)
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Revenue | ||||||||||||||||
Product | $ | $ | $ | $ | ||||||||||||
Service | ||||||||||||||||
Total revenue | ||||||||||||||||
Cost of Sales | ||||||||||||||||
Product | ||||||||||||||||
Service | ||||||||||||||||
Total cost of sales | ||||||||||||||||
Gross profit | ||||||||||||||||
Operating expenses | ||||||||||||||||
Selling and marketing | ||||||||||||||||
General and administrative | ||||||||||||||||
Research and development | ||||||||||||||||
Total operating expenses | ||||||||||||||||
Income from operations | ||||||||||||||||
Interest expense, net | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Other income (expense), net | ( | ) | ||||||||||||||
Income before income taxes | ||||||||||||||||
Income tax provision (benefit) | ( | ) | ||||||||||||||
Net income | $ | $ | $ | $ | ||||||||||||
Earnings per share | ||||||||||||||||
Basic | ||||||||||||||||
Earnings per share | $ | $ | $ | $ | ||||||||||||
Weighted average common shares outstanding | ||||||||||||||||
Diluted | ||||||||||||||||
Earnings per share | $ | $ | $ | $ | ||||||||||||
Weighted average common shares outstanding | ||||||||||||||||
Dividends declared per share | $ | $ | $ | $ | ||||||||||||
The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.
3
MTS SYSTEMS CORPORATION
Consolidated Statements of Comprehensive Income (Unaudited)
(in thousands)
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Net income | $ | $ | $ | $ | ||||||||||||
Other comprehensive income (loss), net of tax | ||||||||||||||||
Foreign currency translation gain (loss) adjustments | ( | ) | ( | ) | ( | ) | ||||||||||
Derivative instruments | ||||||||||||||||
Unrealized net gain (loss) | ( | ) | ( | ) | ||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ( | ) | ||||||||||
Defined benefit pension plan | ||||||||||||||||
Unrealized net gain (loss) | ( | ) | ( | ) | ||||||||||||
Net (gain) loss reclassified to earnings | ||||||||||||||||
Currency exchange rate gain (loss) | ( | ) | ||||||||||||||
Other comprehensive income (loss) | ( | ) | ( | ) | ( | ) | ||||||||||
Comprehensive income (loss) | $ | $ | $ | $ | ||||||||||||
The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.
4
MTS SYSTEMS CORPORATION
Consolidated Statements of Shareholders' Equity (Unaudited)
(in thousands)
Three Months Ended June 29, 2019 | |||||||||||||||||||||||
Common Stock | Additional Paid-In Capital | Accumulated Other Comprehensive Income (Loss) | Total Shareholders' Equity | ||||||||||||||||||||
Shares Issued | Amount | Retained Earnings | |||||||||||||||||||||
Balance, March 30, 2019 | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||
Total comprehensive income | — | — | — | ( | ) | ||||||||||||||||||
Conversion of tangible equity units | ( | ) | — | — | — | ||||||||||||||||||
Exercise of stock options | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | |||||||||||||||||||||
Issuance for employee stock purchase plan | — | — | — | — | — | — | |||||||||||||||||
Common stock purchased and retired | ( | ) | ( | ) | ( | ) | — | — | ( | ) | |||||||||||||
Dividends, $0.30 per share | — | — | — | ( | ) | — | ( | ) | |||||||||||||||
Balance, June 29, 2019 | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||
Nine Months Ended June 29, 2019 | |||||||||||||||||||||||
Common Stock | Additional Paid-In Capital | Accumulated Other Comprehensive Income (Loss) | Total Shareholders' Equity | ||||||||||||||||||||
Shares Issued | Amount | Retained Earnings | |||||||||||||||||||||
Balance, September 29, 2018 | $ | $ | $ | $ | $ | ||||||||||||||||||
Total comprehensive income | — | — | — | ( | ) | ||||||||||||||||||
Cumulative effect of accounting change | — | — | — | ( | ) | — | ( | ) | |||||||||||||||
Conversion of tangible equity units | ( | ) | — | — | — | ||||||||||||||||||
Exercise of stock options | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | |||||||||||||||||||||
Issuance for employee stock purchase plan | — | — | |||||||||||||||||||||
Common stock purchased and retired | ( | ) | ( | ) | ( | ) | — | — | ( | ) | |||||||||||||
Dividends, $0.90 per share | — | — | — | ( | ) | — | ( | ) | |||||||||||||||
Balance, June 29, 2019 | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||
5
Three Months Ended June 30, 2018 | |||||||||||||||||||||||
Common Stock | Additional Paid-In Capital | Accumulated Other Comprehensive Income (Loss) | Total Shareholders' Equity | ||||||||||||||||||||
Shares Issued | Amount | Retained Earnings | |||||||||||||||||||||
Balance, March 31, 2018 | $ | $ | $ | $ | $ | ||||||||||||||||||
Total comprehensive income | — | — | — | ( | ) | ||||||||||||||||||
Exercise of stock options | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | |||||||||||||||||||||
Issuance for employee stock purchase plan | — | — | |||||||||||||||||||||
Common stock purchased and retired | ( | ) | ( | ) | ( | ) | — | — | ( | ) | |||||||||||||
Dividends, $0.30 per share | — | — | — | ( | ) | — | ( | ) | |||||||||||||||
Balance, June 30, 2018 | $ | $ | $ | $ | $ | ||||||||||||||||||
Nine Months Ended June 30, 2018 | |||||||||||||||||||||||
Common Stock | Additional Paid-In Capital | Accumulated Other Comprehensive Income (Loss) | Total Shareholders' Equity | ||||||||||||||||||||
Shares Issued | Amount | Retained Earnings | |||||||||||||||||||||
Balance, September 30, 2017 | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||
Total comprehensive income | — | — | — | ||||||||||||||||||||
Cumulative effect of accounting change | — | — | ( | ) | — | — | |||||||||||||||||
Exercise of stock options | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | |||||||||||||||||||||
Issuance for employee stock purchase plan | — | — | |||||||||||||||||||||
Common stock purchased and retired | ( | ) | ( | ) | ( | ) | — | — | ( | ) | |||||||||||||
Dividends, $0.90 per share | — | — | — | ( | ) | — | ( | ) | |||||||||||||||
Balance, June 30, 2018 | $ | $ | $ | $ | $ | ||||||||||||||||||
The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.
6
MTS SYSTEMS CORPORATION
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
Nine Months Ended | ||||||||
June 29, 2019 | June 30, 2018 | |||||||
Cash Flows from Operating Activities | ||||||||
Net income | $ | $ | ||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities | ||||||||
Stock-based compensation | ||||||||
Fair value adjustment to acquired inventory | ||||||||
Net periodic pension benefit cost | ||||||||
Depreciation and amortization | ||||||||
(Gain) loss on sale or disposal of property and equipment | ||||||||
Amortization of debt issuance costs | ||||||||
Deferred income taxes | ( | ) | ( | ) | ||||
Bad debt provision (recovery), net | ||||||||
Other | ( | ) | ||||||
Changes in operating assets and liabilities | ||||||||
Accounts receivable and unbilled accounts receivable | ( | ) | ||||||
Inventories, net | ( | ) | ||||||
Prepaid expenses | ( | ) | ( | ) | ||||
Accounts payable | ( | ) | ( | ) | ||||
Accrued payroll and related costs | ( | ) | ( | ) | ||||
Advance payments from customers | ( | ) | ||||||
Accrued warranty costs | ( | ) | ( | ) | ||||
Other assets and liabilities | ( | ) | ||||||
Net Cash Provided by (Used in) Operating Activities | ||||||||
Cash Flows from Investing Activities | ||||||||
Purchases of property and equipment | ( | ) | ( | ) | ||||
Proceeds from sale of property and equipment | ||||||||
Purchases of business, net of acquired cash | ( | ) | ||||||
Other | ( | ) | ||||||
Net Cash Provided by (Used in) Investing Activities | ( | ) | ( | ) | ||||
Cash Flows from Financing Activities | ||||||||
Proceeds from issuance of long-term debt | ||||||||
Payment of long-term debt | ( | ) | ( | ) | ||||
Payment of debt component of tangible equity units | ( | ) | ( | ) | ||||
Payment of debt issuance costs for revolving credit facility | ( | ) | ||||||
Receipts under short-term borrowings | ||||||||
Payments under short-term borrowings | ( | ) | ( | ) | ||||
Cash dividends | ( | ) | ( | ) | ||||
Proceeds from exercise of stock options and employee stock purchase plan | ||||||||
Payments to purchase and retire common stock | ( | ) | ( | ) | ||||
Net Cash Provided by (Used in) Financing Activities | ( | ) | ||||||
Effect of Exchange Rate Changes on Cash and Cash Equivalents | ( | ) | ||||||
Cash and Cash Equivalents | ||||||||
Increase (decrease) during the period | ( | ) | ||||||
Balance, beginning of period | ||||||||
Balance, end of period | $ | $ | ||||||
Supplemental Disclosures | ||||||||
Cash paid during the period for | ||||||||
Interest | $ | $ | ||||||
Income taxes | ||||||||
Non-cash investing and financing activities | ||||||||
Dividends declared not yet paid | ||||||||
The accompanying Notes to Consolidated Financial Statements (Unaudited) are an integral part of these consolidated financial statements.
7
MTS SYSTEMS CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
(Dollars and shares in thousands, unless otherwise noted)
NOTE 1 BASIS OF PRESENTATION
The consolidated financial statements include the accounts of MTS Systems Corporation and its wholly owned subsidiaries. Significant intercompany account balances and transactions have been eliminated.
The terms "MTS," "we," "us," "the Company" or "our" in this Quarterly Report on Form 10-Q, unless the context otherwise requires, refer to MTS Systems Corporation and its wholly owned subsidiaries.
Changes to Significant Accounting Policies
The following accounting policies have been updated since our fiscal year 2018 Annual Report on Form 10-K.
Revenue Recognition
As described in Note 2, we adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), followed by related amendments, on September 30, 2018 under the modified retrospective transition method. Our new revenue recognition accounting policy and disclosures relative to this guidance are included in Note 3.
NOTE 2 RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Leases
In February 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-02, Leases (Topic 842), followed by related amendments (collectively, "the new lease standard"), which requires lessees to recognize most leases on the balance sheet for the rights and obligations created by those leases. Under the new lease standard, a company recognizes a right-of-use asset, representing the right to use the underlying asset for the lease term, and a corresponding lease liability for all leases with terms greater than 12 months. The new lease standard requires enhanced disclosures regarding the amount, timing and uncertainty of cash flows arising from a company's leases. Adoption of the new lease standard is required for annual periods beginning after December 15, 2018, including interim periods within that annual period, which is our fiscal year 2020. The new guidance is required to be adopted using a modified retrospective transition method, and an optional transition method may be elected to use the effective date as the date of initial application on transition.
We intend to adopt the new lease standard for our fiscal year 2020 under the optional transition method with an effective date of September 29, 2019. As a result, we will not adjust our comparative period financial information or make the new required lease disclosures for periods before the effective date, and we will record the impact from adoption as a cumulative-effect reduction to retained earnings as of the effective date. We are currently planning to elect the package of practical expedients to not reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs, and we are currently evaluating the other practical expedients available under the new lease standard. We continue to make progress with preparation for the adoption and implementation of the new lease standard, including assessing the completeness of our lease arrangements, evaluating practical expedients and accounting policy elections, revising our lease-related accounting policies, assessing impacts to controls, and implementing a lease software solution. We anticipate the adoption of the new lease standard will result in an increase in assets and liabilities on our Consolidated Balance Sheet. The impact on our Consolidated Statement of Income and Consolidated Statement of Cash Flows is being evaluated. We continue to evaluate the impact that these changes in methodology will have on our financial condition, results of operations and disclosures.
8
Other
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, followed by related amendments, which changes the accounting for credit losses on instruments measured at amortized cost by adding an impairment model that is based on expected losses rather than incurred losses. An entity will recognize as an allowance its estimate of expected credit losses, which is believed to result in more timely recognition of such losses as the standard eliminates the probable initial recognition threshold. Adoption of the standard is required for annual periods beginning after December 15, 2019, including interim periods within that annual period, which is our fiscal year 2021. The new guidance is required to be adopted using a modified retrospective approach with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period of adoption. Early adoption is permitted for annual periods beginning after December 15, 2018, including interim periods within that annual period, which is our fiscal year 2020. We have not yet evaluated the impact the adoption of this guidance may have on our financial condition, results of operations or disclosures.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurements (Topic 820): Disclosure Framework–Changes to the Disclosure Requirements for Fair Value Measurement, which eliminates, amends and adds disclosure requirements for fair value measurements. The standard is required to be adopted for annual periods beginning after December 15, 2019, including interim periods within that annual period, which is our fiscal year 2021. Certain disclosures in the new guidance are to be applied using a retrospective approach while other disclosures are to be applied using a prospective approach. Early adoption is permitted. We have not yet evaluated the impact the adoption of this guidance may have on our financial condition, results of operations or disclosures.
In August 2018, the FASB issued ASU No. 2018-14, Compensation–Retirement Benefits–Defined Benefit Plans–General (Subtopic 715-20): Disclosure Framework–Changes to the Disclosure Requirements for Defined Benefit Plans, which eliminates, amends and adds disclosure requirements for defined benefit pension and other postretirement plans. The standard is required to be adopted for annual periods ending after December 15, 2020, which is our fiscal year 2021. The new guidance is to be applied using a retrospective approach with early adoption permitted. We have not yet evaluated the impact the adoption of this guidance may have on our financial condition, results of operations or disclosures.
Adopted
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), followed by related amendments (collectively, "the new revenue standard" or "ASC 606"), to provide a single, comprehensive revenue recognition model for all contracts with customers. Under the new revenue standard, a company recognizes revenue to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration a company expects to receive in exchange for those goods or services. Determination of when and how revenue is recognized is based on a five-step analysis. Enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from a company's contracts with customers are required.
We adopted the new revenue standard on September 30, 2018 for our fiscal year 2019 under the modified retrospective transition method. As of September 30, 2018, we recorded a cumulative-effect reduction to the opening balance of our fiscal year 2019 retained earnings of $6,227 , net of tax, for the net deferral of previously recognized revenue and related cost of sales, partially offset by the capitalization and deferral of pre-contract costs. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. See Note 3 for our new revenue recognition accounting policy and disclosures relative to this guidance.
In March 2016, the FASB issued ASU No. 2016-04, Liabilities—Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products, which amends existing guidance on extinguishing financial liabilities for certain prepaid stored-value products. The standard requires recognition of the expected breakage amount or the value that is ultimately not redeemed either proportionally in earnings as redemption occurs or when redemption is remote, if issuers are not entitled to breakage. We adopted the standard on a modified retrospective basis for the annual period ending September 28, 2019, including interim periods within that annual period. The adoption of this guidance had no impact on our financial condition, results of operations or disclosures.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory, which requires companies to account for the income tax effects of intercompany sales and transfers of assets other than inventory when the transfer occurs. Existing guidance required companies to defer the income tax effects of intercompany transfers of assets until the asset has been sold to an outside party or otherwise recognized. We adopted the standard on a modified retrospective basis for the annual period ending September 28, 2019, including interim periods within that annual period. The adoption of this guidance had no impact on our financial condition, results of operations or disclosures.
9
In March 2017, the FASB issued ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which changes how employers that sponsor defined benefit pension or other postretirement benefit plans present the net periodic benefit cost in the income statement. The standard requires the service cost component of net periodic benefit cost to be presented in the same income statement line items as other employee compensation costs arising from services rendered during the period, with only the service cost component eligible for capitalization in assets. Other components of the net periodic benefit cost are to be stated separately from the line items that include the service cost and outside of operating income. These components are not eligible for capitalization in assets. We adopted the standard for the annual period ending September 28, 2019, including interim periods within that annual period, retrospectively for the presentation in the income statement of the service cost component and the other components of net periodic pension cost and prospectively for the capitalization in assets of the service cost component of net periodic pension cost. The adoption of this guidance did not have a material impact on our current or prior year financial condition, results of operations or disclosures. Therefore, the comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which amends the hedge accounting model in Accounting Standards Codification (ASC) 815 to enable entities to better portray the economics of their risk management activities in the financial statements and enhance the transparency and understandability of hedge results. We early adopted the standard on a modified retrospective basis for the annual period ending September 28, 2019, including interim periods within that annual period. The adoption of this guidance had no impact on our current or prior year financial condition, results of operations or disclosures.
NOTE 3 REVENUE
Adoption
We adopted the new revenue standard on September 30, 2018 for our fiscal year 2019 under the modified retrospective transition method. We applied the new revenue standard to all contracts which were not completed as of the effective date and elected not to apply contract modification guidance retrospectively. As a result of adoption, we recorded a cumulative-effect reduction to the opening balance of our fiscal year 2019 retained earnings of $6,227 , net of tax, for the net deferral of previously recognized revenue and related cost of sales, partially offset by the capitalization and deferral of pre-contract costs.
The timing of revenue recognition for the majority of our products and contracts remains substantially unchanged under the new revenue standard, with the exception of certain contracts in our Test & Simulation segment (Test & Simulation). Dependent on contract-specific terms that evidence customer control of the work in process or an enforceable right to payment with no alternative use, certain contracts have a delay in revenue recognition until the customer takes control of the product, while certain contracts accelerate the recognition of revenue over the life of the contract. Under the new revenue standard, certain costs to obtain contracts (i.e., pre-contract costs) are capitalized at contract inception and recognized as revenue is earned. While we do not expect the adoption of the new revenue standard to have a significant impact on annual revenue recognized, our financial condition or results of operations, we do expect that it will have an impact on the timing of revenue recognition in interim periods.
10
The impact of adopting the new revenue standard on our Consolidated Statements of Income and Consolidated Balance Sheets is as follows:
Consolidated Statements of Income | Three Months Ended June 29, 2019 | |||||||||||
As Reported | Balances without Adoption of ASC 606 | Effect of Change | ||||||||||
Revenue | $ | $ | $ | |||||||||
Cost of sales | ||||||||||||
Gross profit | ||||||||||||
Selling and marketing | ||||||||||||
Income tax provision (benefit) | ||||||||||||
Net income | ||||||||||||
Nine Months Ended June 29, 2019 | ||||||||||||
As Reported | Balances without Adoption of ASC 606 | Effect of Change | ||||||||||
Revenue | $ | $ | $ | |||||||||
Cost of sales | ||||||||||||
Gross profit | ||||||||||||
Selling and marketing | ||||||||||||
Income tax provision (benefit) | ||||||||||||
Net income | ||||||||||||
Consolidated Balance Sheets | June 29, 2019 | |||||||||||
As Reported | Balances without Adoption of ASC 606 | Effect of Change | ||||||||||
Assets | ||||||||||||
Accounts receivable, net | $ | $ | $ | ( | ) | |||||||
Unbilled accounts receivable, net | ||||||||||||
Inventories, net | ||||||||||||
Prepaid expenses and other current assets | ||||||||||||
Other long-term assets | ||||||||||||
Deferred income taxes | ||||||||||||
Liabilities and Shareholders' Equity | ||||||||||||
Advance payments from customers | ||||||||||||
Accrued income taxes | ||||||||||||
Other accrued liabilities | ||||||||||||
Deferred income taxes | ( | ) | ||||||||||
Other long-term liabilities | ||||||||||||
Accumulated other comprehensive income (loss) | ( | ) | ( | ) | ||||||||
Retained earnings | ||||||||||||
11
The cumulative effect of the changes made to our September 29, 2018 Consolidated Balance Sheet from the modified retrospective adoption of the new revenue standard is as follows:
Consolidated Balance Sheets | ||||||||||||
Balance at September 29, 2018 | Adjustments due to ASC 606 Adoption | Balance at September 30, 2018 | ||||||||||
Assets | ||||||||||||
Accounts receivable, net | $ | $ | ( | ) | $ | |||||||
Unbilled accounts receivable, net | ( | ) | ||||||||||
Inventories, net | ||||||||||||
Prepaid expenses and other current assets | ||||||||||||
Other long-term assets | ||||||||||||
Deferred income taxes | ||||||||||||
Liabilities and Shareholders' Equity | ||||||||||||
Advance payments from customers | ||||||||||||
Other accrued liabilities | ( | ) | ||||||||||
Deferred income taxes | ( | ) | ||||||||||
Other long-term liabilities | ||||||||||||
Retained earnings | ( | ) | ||||||||||
Revenue Recognition
Revenue is recognized when control of the promised goods or services is transferred to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for transferring those goods or providing those services. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are known, the contract has commercial substance and collectability of consideration is probable.
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 under the new revenue standard. A contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Many of our contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. In situations when our contract includes distinct goods or services that are substantially the same and have the same pattern of transfer to the customer over time, they are recognized as a series of distinct goods or services. For contracts with multiple performance obligations, we allocate the contract's transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract.
We do not adjust the promised amount of consideration for the effects of a significant financing component if we expect, at contract inception, that the period between when we transfer a promised good or service to a customer and when the customer pays for that good or service will be one year or less.
Revenue is recorded net of taxes collected from customers, and taxes collected are recorded as current liabilities until remitted to the relevant government authority. Shipping and handling costs associated with outbound freight after control of a product has transferred are accounted for as a fulfillment cost and are included in cost of sales in the Consolidated Statements of Income.
The following is a description of the product offerings, end markets, typical revenue transactions and payment terms for each of our two reportable segments. See Note 15 for further information on reportable segments.
Test & Simulation
Test & Simulation manufactures and sells equipment and related software and services which are used by customers to characterize a product's mechanical properties or performance. Our solutions simulate forces and motions that customers expect their products to encounter in use or are necessary to properly characterize the product's performance. Primary Test & Simulation markets include transportation, infrastructure, energy, aerospace, materials science, medical, flight training and amusement parks. A typical system is a comprehensive solution which includes a reaction frame to hold the prototype specimen; a hydraulic or electro-mechanical power source; actuators to create the force or motion; and a computer controller with specialized software to coordinate the actuator movement and to measure, record and manipulate results. Our portfolio of Test & Simulation solutions includes standard, configurable testing products; engineered products which combine standard product configurations with a moderate degree of customization per customer specifications; and highly customized, highly
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engineered testing solutions built to address the customer's unique business need, which can include development of first-of-a-kind technology. To complement our Test & Simulation products, we provide our customers with a spectrum of services to maximize product performance including installation, product life cycle management, professional training, calibration and metrology, technical consulting and onsite and factory repair and maintenance. In addition, we sell a variety of accessories and spare parts. The manufacturing cycle for a typical system ranges from weeks to 12 months, depending on the complexity of the system and the availability of components, and can be up to three years for larger, more complex systems. For certain contracts, the order to revenue cycle may extend beyond the manufacturing cycle, such as when the manufacturing start date is driven by the customer's project timeline or when the contract terms require equipment installation and commissioning and customer acceptance prior to point-in-time revenue recognition.
Test & Simulation contracts often have multiple performance obligations, most commonly due to the contract covering multiple phases of the product life cycle (i.e., equipment design and production, installation and commissioning, extended warranty and software maintenance). The primary method used to estimate standalone selling price is the expected cost plus a margin approach under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.
Test & Simulation revenue is recognized either over time as work progresses or point-in-time, depending on contract-specific terms and the pattern of transfer of control of the product or service to the customer. Revenue from services is recognized in the period the service is performed or ratably over the period of the related service contract. Equipment revenue is recognized over time when: (i) control is transferred to the customer over time as work progresses; or (ii) contract terms evidence customer control of the work in process or an enforceable right to payment with no alternative use. Equipment revenue is recognized over time using costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying the performance obligation. Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer. Equipment contract costs include materials, component parts, labor and overhead costs.
Equipment revenue is recognized point-in-time when either: (i) control is transferred to the customer at a point-in-time when obligations under the terms of the contract are satisfied; or (ii) contract terms do not evidence customer control of the work in process or an enforceable right to payment with no alternative use, and consequently revenue is deferred as work progresses. Satisfaction of performance obligations under the terms of the contract occurs either upon product shipment (as evidenced by delivery or shipment terms), completion of equipment installation and commissioning, or customer acceptance.
For our Test & Simulation contracts with customers, payment terms vary and are subject to negotiation. Typical payment terms include progress payments based on specified events or milestones. For some contracts, we are entitled to receive an advance payment.
Sensors
Our Sensors segment (Sensors) manufactures and sells high-performance sensors which provide measurements of vibration, pressure, position, force and sound in a variety of applications. Our Sensors products are used to enable automation, enhance precision and safety, and lower our customers' production costs by improving performance and reducing downtime. Primary Sensors markets include automotive, aerospace and defense, industrial, and research and development. Our Sensors products are sold as configurable, standard units; utilize piezoelectric or magnetostriction technology; and are ideal for use in harsh operating environments to provide accurate and reliable sensor information. To complement our Sensors products, we also provide spare parts and services. The cycle from contract inception to shipment of equipment is typically one to three months , with the exception of certain high-volume contracts which are fulfilled in a series of shipments over an extended period.
Our Sensors contracts generally have a single performance obligation which is satisfied at a point in time. The performance obligation is a stand-alone sensor product, accessory, service or software license. Sensors contracts are generally fixed-price purchase order fulfillment contracts, and the transaction price is equal to the observable consideration in the contract. Revenue is recognized when obligations under the terms of the contract with our customer are satisfied; generally this occurs with the transfer of control upon product shipment (as evidenced by shipment or delivery terms) or with the performance of the service. Certain contracts are measured using the as invoiced practical expedient as we have a right to consideration from a customer in an amount that corresponds directly with the value to the customer of our performance completed to date.
For our Sensors contracts with customers, payment terms are generally within 90 days. The timing of satisfying our Sensors performance obligations does not vary significantly from the typical timing of payment. For certain high-volume contracts, we are entitled to receive an advance payment.
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Disaggregation of Revenue
We disaggregate our revenue by reportable segment, sales type (product or service), the timing of recognition of revenue for transfer of goods or services to customers (point-in-time or over time), and geographic market based on the billing location of the customer. See Note 15 for further information on our reportable segments and intersegment revenue.
Three Months Ended June 29, 2019 | ||||||||||||||||
Test & Simulation | Sensors | Intersegment | Total | |||||||||||||
Sales type | ||||||||||||||||
Product | $ | $ | $ | ( | ) | $ | ||||||||||
Service | ||||||||||||||||
Total revenue | $ | $ | $ | ( | ) | $ | ||||||||||
Timing of recognition | ||||||||||||||||
Point-in-time | $ | $ | $ | ( | ) | $ | ||||||||||
Over time | ||||||||||||||||
Total revenue | $ | $ | $ | ( | ) | $ | ||||||||||
Geographic market | ||||||||||||||||
Americas | $ | $ | $ | ( | ) | $ | ||||||||||
Europe | ||||||||||||||||
Asia | ||||||||||||||||
Total revenue | $ | $ | $ | ( | ) | $ | ||||||||||
Nine Months Ended June 29, 2019 | ||||||||||||||||
Test & Simulation | Sensors | Intersegment | Total | |||||||||||||
Sales type | ||||||||||||||||
Product | $ | $ | $ | ( | ) | $ | ||||||||||
Service | ||||||||||||||||
Total revenue | $ | $ | $ | ( | ) | $ | ||||||||||
Timing of recognition | ||||||||||||||||
Point-in-time | $ | $ | $ | ( | ) | $ | ||||||||||
Over time | ||||||||||||||||
Total revenue | $ | $ | $ | ( | ) | $ | ||||||||||
Geographic market | ||||||||||||||||
Americas | $ | $ | $ | ( | ) | $ | ||||||||||
Europe | ||||||||||||||||
Asia | ||||||||||||||||
Total revenue | $ | $ | $ | ( | ) | $ | ||||||||||
Contract Assets and Liabilities
Contract assets and contract liabilities are as follows:
June 29, 2019 | September 29, 2018 | |||||||
Contract assets | $ | $ | ||||||
Contract liabilities | ||||||||
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The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled accounts receivable (contract assets) and advance payments from customers (contract liabilities). Contract balances are classified as assets or liabilities on a contract-by-contract basis at the end of each reporting period. Contract liabilities represent payments received from customers at contract inception and at milestones per contract provisions. These payments are recorded in advance payments from customers and other long-term liabilities in our Consolidated Balance Sheets (current and non-current portions, respectively) and are liquidated as revenue is recognized. Conversely, when billing occurs subsequent to revenue recognition for contracts recognized over time, balances are recorded in unbilled accounts receivable, net in our Consolidated Balance Sheets. As customers are billed, unbilled accounts receivable balances are transferred to accounts receivable, net in the Consolidated Balance Sheets.
Significant changes in contract assets and contract liabilities are as follows:
Contract Assets | ||||
Balance, September 29, 2018 | $ | |||
Cumulative transition adjustment upon adoption | ( | ) | ||
Changes in estimated stage of completion | ||||
Transfers to accounts receivable, net | ( | ) | ||
Acquisitions1 | ||||
Other | ||||
Balance, June 29, 2019 | $ | |||
Contract Liabilities | ||||
Balance, September 29, 2018 | $ | |||
Cumulative transition adjustment upon adoption | ||||
Revenue recognized included in balance at beginning of period | ( | ) | ||
Increases due to payments received, excluding amounts recognized as revenue during period | ||||
Acquisitions1 | ||||
Other | ( | ) | ||
Balance, June 29, 2019 | $ | |||
1 See Note 16 for additional information regarding acquisitions.
Remaining Performance Obligations
As of June 29, 2019, we had approximately $227,000 of remaining performance obligations on contracts with an original expected duration of one year or more which are primarily related to Test & Simulation. As of June 29, 2019, we expect to recognize approximately 77 % of these remaining performance obligations as revenue within one year, an additional 19 % within two years and the balance thereafter. We do not disclose the value of remaining performance obligations for contracts with an original expected duration of one year or less.
Contract Estimates
For contracts recognized over time, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract. Contract estimates are based on various assumptions to project the outcome of future events that may span several years. These assumptions include labor productivity and availability, the complexity of the work to be performed, the cost and availability of materials, and internal and subcontractor performance.
Pricing is established at or prior to the time of sale with our customers, and we record sales at the agreed-upon selling price. The terms of a contract or the historical business practice can give rise to variable consideration due to but not limited to volume discounts, penalties and early payment discounts. We estimate variable consideration at the most likely amount we will receive from customers. We include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized for such transaction will not occur, or when the uncertainty associated with the variable consideration is resolved. In general, variable consideration in our contracts relates to the entire contract. As a result, the variable consideration is allocated proportionately to all performance obligations. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available to us at contract
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inception. There are no significant instances where variable consideration is constrained and not recorded at the initial time of sale.
As a significant change in one or more of these estimates could affect the profitability of our contracts, we review and update our contract-related estimates regularly. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the period it is identified. Our review of contract-related estimates has not resulted in adjustments that are significant to our results of operations.
Contract Modifications
When contracts are modified to account for changes in contract specifications and requirements, we consider whether the modification either creates new, or changes existing, enforceable rights and obligations. Contract modifications that are for goods or services that are not distinct from the existing contract, due to the significant integration with the original product or service provided, are accounted for as if they were part of that existing contract. The effect of a contract modification on the transaction price, and our measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis. When the modifications include additional performance obligations that are distinct and at a relative stand-alone selling price, they are accounted for as a new contract and performance obligation and recognized prospectively.
Warranties and Returns
For both Test & Simulation and Sensors, we provide a manufacturer's warranty on our products and systems which is included in customer contracts. At the time a sale is recognized, we record estimated future warranty costs. See Note 5 for further discussion of our product warranty liabilities. We also offer separately-priced extended warranties or service-type contracts on certain products for which revenue is recognized over the contractual period or as services are rendered.
Our sales terms generally do not allow for a right of return except for situations where the product fails. When the right of return exists, we recognize revenue for the transferred products at the expected amount of consideration for which we will be entitled.
Pre-contract Costs
NOTE 4 INVENTORIES
Inventories consist of material, labor and overhead costs and are stated at the lower of cost or net realizable value determined under the first-in, first-out accounting method. Certain inventories are measured using the weighted average cost method. Inventories, net are as follows:
June 29, 2019 | September 29, 2018 | |||||||
Components, assemblies and parts | $ | $ | ||||||
Customer projects in various stages of completion | ||||||||
Finished goods | ||||||||
Total inventories, net | $ | $ | ||||||
We adopted the new revenue standard effective September 30, 2018 under the modified retrospective transition method which impacted inventories, net. See Note 3 for the impact of this adoption on our Consolidated Balance Sheets.
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NOTE 5 WARRANTY OBLIGATIONS
Sales of our products and systems are subject to limited warranty obligations that are included in customer contracts. For sales that include installation services, warranty obligations generally extend for a period of 12 to 24 months from the date of either shipment or acceptance based on the contract terms. Product obligations generally extend for a period of 12 to 24 months from the date of purchase. Certain products offered in our Sensors segment include a lifetime warranty.
Under the terms of these warranties, we are obligated to repair or replace any components or assemblies deemed defective due to workmanship or materials. We reserve the right to reject warranty claims where it is determined that failure is due to normal wear, customer modifications, improper maintenance or misuse. We record general warranty provisions based on an estimated warranty expense percentage applied to current period revenue. The percentage applied reflects our historical warranty claims experience over the preceding 12 -month period. Both the experience percentage and the warranty liability are evaluated on an ongoing basis for adequacy. Warranty provisions are also recognized for certain unanticipated product claims that are individually significant.
Changes to accrued warranty costs are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Beginning accrued warranty costs | $ | $ | $ | $ | ||||||||||||
Warranty claims | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Warranty provisions | ||||||||||||||||
Adjustments to preexisting warranties | ( | ) | ||||||||||||||
Currency translation | ( | ) | ( | ) | ( | ) | ||||||||||
Ending accrued warranty costs | $ | $ | $ | $ | ||||||||||||
NOTE 6 CAPITAL ASSETS
Property and Equipment
Property and equipment, net are as follows:
June 29, 2019 | September 29, 2018 | |||||||
Land and improvements | $ | $ | ||||||
Buildings and improvements | ||||||||
Machinery and equipment | ||||||||
Assets held under capital leases | ||||||||
Total property and equipment | ||||||||
Less: Accumulated depreciation | ( | ) | ( | ) | ||||
Total property and equipment, net | $ | $ | ||||||
Goodwill
Changes to the carrying amount of goodwill are as follows:
Test & Simulation | Sensors | Total | ||||||||||
Balance, September 29, 2018 | $ | $ | $ | |||||||||
Acquisitions 1 | ||||||||||||
Currency translation | ( | ) | ( | ) | ( | ) | ||||||
Balance, June 29, 2019 | $ | $ | $ | |||||||||
1 See Note 16 for additional information regarding acquisitions.
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Intangible Assets
Intangible assets are as follows:
June 29, 2019 | ||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | Weighted Average Useful Life (in Years) | |||||||||||
Software development costs 2 | $ | $ | ( | ) | $ | |||||||||
Technology and patents | ( | ) | ||||||||||||
Trademarks and trade names | ( | ) | ||||||||||||
Customer lists | ( | ) | ||||||||||||
Land-use rights | ( | ) | ||||||||||||
Other | ( | ) | ||||||||||||
Trade names | — | Indefinite | ||||||||||||
Total intangible assets | $ | $ | ( | ) | $ | |||||||||
September 29, 2018 | ||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | Weighted Average Useful Life (in Years) | |||||||||||
Software development costs 2 | $ | $ | ( | ) | $ | |||||||||
Technology and patents | ( | ) | ||||||||||||
Trademarks and trade names | ( | ) | ||||||||||||
Customer lists | ( | ) | ||||||||||||
Land-use rights | ( | ) | ||||||||||||
Trade names | — | Indefinite | ||||||||||||
Total intangible assets | $ | $ | ( | ) | $ | |||||||||
2 | The gross carrying amount of software development costs as of June 29, 2019 and September 29, 2018 includes $ |
Amortization expense recognized related to finite-lived intangible assets is as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Amortization expense | $ | $ | $ | $ | ||||||||||||
Estimated future amortization expense related to finite-lived intangible assets is as follows:
Amortization Expense | |||
Remainder of 2019 | $ | ||
2020 | |||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
Thereafter | |||
Future amortization amounts presented above are estimates. Actual future amortization expense may be different due to fluctuations in foreign currency exchange rates, future acquisitions, impairments, changes in amortization periods or other factors.
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NOTE 7 FAIR VALUE MEASUREMENTS
In determining the fair value of financial assets and liabilities, we currently utilize market data or other assumptions that we believe market participants would use in pricing the asset or liability in the principal or most advantageous market and adjust for non-performance and/or other risk associated with the Company as well as counterparties, as appropriate. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
• | Level 1: Unadjusted quoted prices that are available in active markets for identical assets or liabilities accessible to us at the measurement date. |
• | Level 2: Inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability. |
• | Level 3: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date. |
The hierarchy gives the highest priority to Level 1, as this level provides the most reliable measure of fair value, while giving the lowest priority to Level 3.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities subject to fair value measurements on a recurring basis are as follows:
June 29, 2019 | ||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets | ||||||||||||||||
Currency contracts 1 | $ | $ | $ | $ | ||||||||||||
Interest rate swap 2 | ||||||||||||||||
Total assets | ||||||||||||||||
Liabilities | ||||||||||||||||
Currency contracts 1 | ||||||||||||||||
Total liabilities | $ | $ | $ | $ | ||||||||||||
September 29, 2018 | ||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets | ||||||||||||||||
Currency contracts 1 | $ | $ | $ | $ | ||||||||||||
Interest rate swap 2 | ||||||||||||||||
Total assets | ||||||||||||||||
Liabilities | ||||||||||||||||
Currency contracts 1 | ||||||||||||||||
Total liabilities | $ | $ | $ | $ | ||||||||||||
1 | Based on observable market transactions of spot currency rates and forward currency rates on equivalently-termed instruments. Carrying amounts of the financial assets and liabilities are equal to the fair value. See Note 8 for additional information on derivative financial instruments. |
2 | Based on London Interbank Offered Rate (LIBOR) and spot rates. Carrying amount of the financial asset is equal to the fair value. See Note 8 for additional information on derivative financial instruments. |
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
We measure certain financial instruments at fair value on a nonrecurring basis. These assets primarily include goodwill, intangible assets and other long-lived assets acquired either as part of a business acquisition, individually or with a group of other assets, as well as property and equipment. These assets were initially measured and recognized at amounts equal to the fair value determined as of the date of acquisition or purchase subject to changes in value only for foreign currency translation.
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Periodically, these assets are tested for impairment by comparing their respective carrying values to the estimated fair value of the reporting unit or asset group in which they reside. In the event any of these assets were to become impaired, we would recognize an impairment loss equal to the amount by which the carrying value of the reporting unit, impaired asset or asset group exceeds its estimated fair value. Fair value measurements of reporting units are estimated using an income approach involving discounted or undiscounted cash flow models that contain certain Level 3 inputs requiring management judgment, including projections of economic conditions and customer demand, revenue and margins, changes in competition, operating costs, working capital requirements and new product introductions. Fair value measurements of the reporting units associated with our goodwill balances and our indefinite-lived intangible assets are estimated at least annually in the fourth quarter of each fiscal year for purposes of impairment testing if a quantitative analysis is performed. Fair value measurements associated with our intangible assets, other long-lived assets and property and equipment are estimated when events or changes in circumstances such as market value, asset utilization, physical change, legal factors or other matters indicate that the carrying value may not be recoverable. See Note 6 for additional information on goodwill, indefinite-lived intangible assets, other long-lived assets and property and equipment.
Assets and Liabilities Not Measured at Fair Value
Certain financial instruments are not measured at fair value but are recorded at carrying amounts approximating fair value based on their short-term nature or variable interest rate. These financial instruments include cash and cash equivalents, accounts receivable, unbilled accounts receivable, accounts payable and short-term borrowings.
Other Financial Instruments
Other financial instruments subject to fair value measurements include debt, which is recorded at carrying value in the Consolidated Balance Sheets. The carrying amount and estimated fair values of our debt are as follows:
June 29, 2019 | ||||||||||||||||||||
Carrying Value | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||
Debt component of tangible equity units 1 | $ | $ | $ | $ | $ | |||||||||||||||
Tranche B term loan 2 | ||||||||||||||||||||
Total debt | $ | $ | $ | $ | $ | |||||||||||||||
September 29, 2018 | ||||||||||||||||||||
Carrying Value | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||
Debt component of tangible equity units 1 | $ | $ | $ | $ | $ | |||||||||||||||
Tranche B term loan 2 | ||||||||||||||||||||
Total debt | $ | $ | $ | $ | $ | |||||||||||||||
1 | The fair value of the |
2 | The fair value of the tranche B term loan is based on the most recently quoted market price for the outstanding debt instrument, adjusted for any known significant deviations in value. The estimated fair value of the debt obligation is not necessarily indicative of the amount that would be realized in a current market exchange. See Note 9 for additional information on debt instruments. |
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NOTE 8 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Our currency exchange contracts and interest rate swap are designated as cash flow hedges and qualify as hedging instruments. We also have derivatives that are not designated as cash flow hedges and, therefore, are accounted for and reported under foreign currency guidance. Regardless of designation for accounting purposes, we believe all of our derivative instruments are hedges of transactional risk exposures. The fair value of our outstanding designated and undesignated derivative assets and liabilities are reported in the Consolidated Balance Sheets as follows:
June 29, 2019 | ||||||||
Prepaid Expenses and Other Current Assets | Other Accrued Liabilities | |||||||
Designated hedge derivatives | ||||||||
Cash flow derivatives | $ | $ | ||||||
Interest rate swap | ||||||||
Total designated hedge derivatives | ||||||||
Undesignated hedge derivatives | ||||||||
Balance sheet derivatives | ||||||||
Total hedge derivatives | $ | $ | ||||||
September 29, 2018 | ||||||||
Prepaid Expenses and Other Current Assets | Other Accrued Liabilities | |||||||
Designated hedge derivatives | ||||||||
Cash flow derivatives | $ | $ | ||||||
Interest rate swap | ||||||||
Total designated hedge derivatives | ||||||||
Undesignated hedge derivatives | ||||||||
Balance sheet derivatives | ||||||||
Total hedge derivatives | $ | $ | ||||||
A reconciliation of the net fair value of designated hedge derivatives subject to master netting arrangements that are recorded in the Consolidated Balance Sheets to the net fair value that could have been reported in the Consolidated Balance Sheets are as follows:
Gross Recognized Amount | Gross Offset Amount | Net Amount Presented | Derivatives Subject to Offset | Cash Collateral Received | Net Amount | |||||||||||||||||||
June 29, 2019 | ||||||||||||||||||||||||
Assets | $ | $ | $ | $ | ( | ) | $ | $ | ||||||||||||||||
Liabilities | ( | ) | ||||||||||||||||||||||
September 29, 2018 | ||||||||||||||||||||||||
Assets | $ | $ | $ | $ | ( | ) | $ | $ | ||||||||||||||||
Liabilities | ( | ) | ||||||||||||||||||||||
Currency exchange contracts utilized to maintain the functional currency value of expected financial transactions denominated in foreign currencies are designated as cash flow hedges. Gains and losses related to changes in the market value of these contracts are reported as a component of accumulated other comprehensive income (AOCI) within shareholders' equity in the Consolidated Balance Sheets and reclassified to earnings in the same line item in the Consolidated Statements of Income and in the same period as the recognition of the underlying hedged transaction. We periodically assess whether our currency exchange contracts are effective and, when a contract is determined to be no longer effective as a hedge, we discontinue hedge accounting prospectively.
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As of June 29, 2019 and September 29, 2018, we had outstanding cash flow hedge currency exchange contracts with gross notional U.S. dollar equivalent amounts of $35,412 and $39,856 , respectively. Upon netting offsetting contracts to sell foreign currencies against contracts to purchase foreign currencies, irrespective of contract maturity dates, the net notional U.S. dollar equivalent amount of contracts outstanding was $28,176 and $29,315 as of June 29, 2019 and September 29, 2018, respectively. As of June 29, 2019, the net market value of the foreign currency exchange contracts was a net asset of $85 , consisting of $350 in assets and $265 in liabilities. As of September 29, 2018, the net market value of the foreign currency exchange contracts was a net asset of $816 , consisting of $989 in assets and $173 in liabilities.
The pretax amounts recognized in AOCI on currency exchange contracts, including (gains) losses reclassified into earnings in the Consolidated Statements of Income and gains (losses) recognized in other comprehensive income (loss) (OCI), are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Beginning unrealized net gain (loss) in AOCI | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||
Net (gain) loss reclassified into revenue | ( | ) | ( | ) | ( | ) | ||||||||||
Net gain (loss) recognized in OCI | ( | ) | ||||||||||||||
Ending unrealized net gain (loss) in AOCI | $ | $ | $ | $ | ||||||||||||
As of June 29, 2019, the amount projected to be reclassified from AOCI into earnings in the next 12 months was a net gain of $98 . The maximum remaining maturity of any forward or optional contract as of June 29, 2019 was 1.4 years.
Interest Rate Swap
On October 20, 2016, we entered into a floating to fixed interest rate swap agreement to mitigate our exposure to interest rate increases related to a portion of our tranche B term loan facility. The total notional amount of the interest rate swap was $225,000 as of June 29, 2019. The swap agreement expires April 3, 2021. As a result of this agreement, every month we pay fixed interest at 1.256 % in exchange for interest received at one month U.S. LIBOR. The market value of the interest rate swap as of June 29, 2019 was an asset of $1,664 . The interest rate swap has been designated as a cash flow hedge. As a result, changes in the fair value of the interest rate swap are recorded in AOCI within shareholders' equity in the Consolidated Balance Sheets.
The pretax amounts recognized in AOCI on the interest rate swap, including (gains) losses reclassified into earnings in the Consolidated Statements of Income and gains (losses) recognized in OCI, are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Beginning unrealized net gain (loss) in AOCI | $ | $ | $ | $ | ||||||||||||
Net (gain) loss reclassified into interest expense | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Net gain (loss) recognized in OCI | ( | ) | ( | ) | ||||||||||||
Ending unrealized net gain (loss) in AOCI | $ | $ | $ | $ | ||||||||||||
As of June 29, 2019, the amount projected to be reclassified from AOCI into earnings in the next 12 months was a net gain of $1,391 .
Foreign Currency Balance Sheet Derivatives
We also use foreign currency derivative contracts to maintain the functional currency value of monetary assets and liabilities denominated in non-functional foreign currencies. The gains and losses related to the changes in the market value of these derivative contracts are included in other income (expense), net in the Consolidated Statements of Income.
As of June 29, 2019 and September 29, 2018, we had outstanding foreign currency balance sheet derivative contracts with gross notional U.S. dollar equivalent amounts of $94,824 and $90,816 , respectively. Upon netting offsetting contracts by counterparty banks to sell foreign currencies against contracts to purchase foreign currencies, irrespective of contract maturity dates, the net notional U.S. dollar equivalent amount of contracts outstanding as of June 29, 2019 and September 29, 2018 was $27,833 and $28,271 , respectively. As of June 29, 2019 and September 29, 2018, the net market value of the foreign exchange balance sheet derivative contracts was a net liability of $225 and a net asset of $91 , respectively.
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The net gain (loss) recognized in the Consolidated Statements of Income on foreign exchange balance sheet derivative contracts is as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Net gain (loss) recognized in other income (expense), net | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||
NOTE 9 FINANCING
Long-term debt consists of the following:
June 29, 2019 | September 29, 2018 | |||||||
Long-term debt | ||||||||
Tranche B term loan, 1.00% amortizing per year, maturing July 5, 2023 | $ | $ | ||||||
Revolving credit facility, non-current portion, expiring July 5, 2022 | ||||||||
Tangible equity units, 8.75% coupon, maturing July 1, 2019 1 | ||||||||
Capital lease obligations | ||||||||
Total long-term debt | ||||||||
Less: Unamortized underwriting discounts, commissions and other expenses | ( | ) | ( | ) | ||||
Less: Current maturities of tranche B term loan debt 2, 3 | ( | ) | ( | ) | ||||
Less: Current maturities of TEU debt 2 | ( | ) | ( | ) | ||||
Less: Current maturities of capital lease obligations 2 | ( | ) | ( | ) | ||||
Total long-term debt, less current maturities, net | $ | $ | ||||||
1 | See Note 12 for additional information on our TEUs issued in the third quarter of fiscal year 2016. |
2 | In addition to the current maturities above, current maturities of long-term debt, net in the Consolidated Balance Sheets includes the current portion of unamortized underwriting discounts, commissions and other expenses of $ |
3 | As of June 29, 2019 and September 29, 2018, current maturities of tranche B term loan consist of the |
Tranche B Term Loan and Revolving Credit Facility
We have a credit agreement with U.S. Bank National Association and HSBC Bank USA, National Association as Co-Documentation Agents, Wells Fargo Bank, National Association as Syndication Agent, JPMorgan Chase Bank, N.A. as Administrative Agent and JP Morgan Chase Bank, N.A. and Wells Fargo Securities, LLC as Joint Bookrunners and Joint Lead Arrangers (the Credit Agreement). The Credit Agreement as amended provides for senior secured credit facilities consisting of a $150,000 revolving credit facility (the Revolving Credit Facility), which expires on July 5, 2022, and a $460,000 tranche B term loan facility (the Term Facility) which expires on July 5, 2023. The proceeds of the Revolving Credit Facility can be drawn upon to refinance existing indebtedness, for working capital and for other general corporate purposes, up to a maximum of $150,000 . The Term Facility amortizes in equal quarterly installments equal to 1 % of the original principal amount. The proceeds of the Term Facility were used for financing the acquisition of PCB Group, Inc. (PCB) in fiscal year 2016. Borrowings on the Revolving Credit Facility were used for financing the acquisition of E2M Technologies B.V. (E2M) in the first quarter of fiscal year 2019.
In the first quarter of fiscal year 2019, in conjunction with the E2M acquisition, we entered into a third amendment to the Credit Agreement to increase the borrowing capacity on the Revolving Credit Facility from $120,000 to $150,000 and extend the expiration date of the Revolving Credit Facility from July 5, 2021 to July 5, 2022. Additionally, the required performance levels under certain financial covenants were modified. During the nine months ended June 29, 2019, we incurred debt financing costs of $541 as a result of this amendment which were capitalized in current maturities of long-term debt, net and long-term debt, less current maturities, net in the Consolidated Balance Sheets.
The primary categories of borrowing include Alternate Base Rate (ABR) Borrowings (ABR Term Loans and ABR Revolving Loans), Swingline Loans and Eurocurrency Borrowings (Eurocurrency Term Loans and Eurocurrency Revolving Loans), each as defined in the Credit Agreement. ABR Borrowings and Swingline Loans made in U.S. dollars under the Credit Agreement
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bear interest at a rate per annum equal to the ABR plus the Applicable Rate (as defined in the Credit Agreement). The ABR is defined as the greater of (a) the Prime Rate (as defined in the Credit Agreement) in effect on such day, (b) the New York Federal Reserve Bank (NYFRB) rate (as defined in the Credit Agreement) in effect on such day plus ½ of 1.00%, or (c) the Adjusted LIBOR (as defined in the Credit Agreement) for a one-month interest period in dollars on such day plus 1.00 %. The ABR for ABR Term Loans shall not be less than 1.75 % per annum. The Applicable Rate for any ABR Revolving Loans will be based upon the leverage ratio applicable on such date. As of June 29, 2019, the Applicable Rate for ABR Term Loans was 2.25 % per annum.
Eurocurrency Borrowings made under the Credit Agreement bear interest at a rate per annum equal to the Adjusted LIBOR Rate plus the Applicable Rate. The Adjusted LIBOR Rate is defined as an interest rate per annum equal to (a) the LIBOR Rate for such interest period multiplied by (b) the Statutory Reserve Rate (as defined in the Credit Agreement). The Applicable Rate for any Eurocurrency Revolving Loan is based upon the leverage ratio applicable on such date. The Adjusted LIBOR Rate for Eurocurrency Term Loans shall not be less than 0.75 % per annum. Based on our leverage ratio as of June 29, 2019, the Applicable Rate for Eurocurrency Revolving Loans was 3.00 %. As of June 29, 2019, the Applicable Rate for Eurocurrency Term Loans was 3.25 % per annum, plus the applicable Adjusted LIBOR Rate of 2.41 %. The weighted average interest rate on Term Facility debt during the nine months ended June 29, 2019 was 5.67 %.
As of June 29, 2019, there was $80,391 of outstanding borrowings under the Revolving Credit Facility which is included in long-term debt, less current maturities, net in the Consolidated Balance Sheets. As of September 29, 2018, there were no outstanding borrowings under the Revolving Credit Facility. We had outstanding letters of credit drawn from the Revolving Credit Facility totaling $22,580 and $20,448 as of June 29, 2019 and September 29, 2018, respectively, leaving approximately $47,029 and $99,552 , respectively, of unused borrowing capacity. Commitment fees are payable on the unused portion of the Revolving Credit Facility at rates between 0.25 % and 0.40 % based on our leverage ratio. During the three and nine months ended June 29, 2019, commitment fees incurred totaled $52 and $176 , respectively. During the three and nine months ended June 30, 2018, commitment fees incurred totaled $94 and $250 , respectively.
The Credit Agreement governing the Term Facility requires us to prepay outstanding term loans, subject to certain exceptions, depending on the leverage ratio with (a) up to 50 % of the our annual Excess Cash Flow (as defined in the Credit Agreement) and (b) 100 % of the net cash proceeds of (i) certain asset sales and casualty and condemnation events, subject to reinvestment rights and certain other exceptions; and (ii) any incurrence or issuance of certain debt, other than debt permitted under the Credit Agreement. We may voluntarily prepay outstanding loans under the Term Facility at any time without premium or penalty. All obligations under the Credit Agreement are unconditionally guaranteed by certain of our existing wholly-owned domestic subsidiaries, and are secured, subject to certain exceptions, by substantially all of our assets and the assets of our subsidiary guarantors.
Under the Credit Agreement, we are subject to customary affirmative and negative covenants, including, among others, restrictions on our ability to incur debt, create liens, dispose of assets, make investments, loans, advances, guarantees, and acquisitions, enter into transactions with affiliates, and enter into any restrictive agreements and customary events of default (including payment defaults, covenant defaults, change of control defaults and bankruptcy defaults). The Credit Agreement also contains financial covenants, including the ratio of consolidated total indebtedness to adjusted consolidated earnings before income, taxes, depreciation and amortization (Adjusted EBITDA), as defined in the Credit Agreement, as well as the ratio of Adjusted EBITDA to consolidated interest expense. These covenants restrict our ability to purchase outstanding shares of our common stock. As of June 29, 2019 and September 29, 2018, we were in compliance with these financial covenants.
See Note 7 for additional information on the fair value of the tranche B term loan and the TEU debt.
Interest Rate Swap
On October 20, 2016, in order to mitigate our exposure to interest rate increases on our variable rate debt, we entered into a variable to fixed amortizing interest rate swap. See Note 8 for additional information on derivative financial instruments.
The interest rate swap will be reduced to the following notional amounts over the next three years:
Notional Amount | ||||
October 3, 2019 | $ | |||
October 3, 2020 | ||||
April 3, 2021 | ||||
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NOTE 10 STOCK-BASED COMPENSATION
We compensate our officers, directors and employees with stock-based compensation under the 2017 Stock Incentive Plan (the 2017 Plan) approved by our shareholders and administered under the supervision of our Board of Directors. As of June 29, 2019, a total of 968 shares were available for issuance under the 2017 Plan.
We make an annual stock grant under the 2017 Plan of stock options, restricted stock units and performance restricted stock units, as well as stock grants throughout the fiscal year. For fiscal years 2019, 2018 and 2017, the annual stock grant occurred in December 2018, April 2018 and April 2017, respectively.
Stock Options
During the nine months ended June 29, 2019, 231 stock options were granted at a weighted average fair value of $9.91 . During the nine months ended June 30, 2018, 245 stock options were granted at a weighted average fair value of $11.10 .
Restricted Stock Units and Performance Restricted Stock Units
We award restricted stock units to directors and key employees and performance restricted stock units to key employees. During the nine months ended June 29, 2019, we granted 129 restricted stock units and 40 performance restricted stock units to directors, officers and employees. During the nine months ended June 30, 2018, we granted 109 restricted stock units and 29 performance restricted stock units. The fair value of the restricted stock units and performance restricted stock units granted during the nine months ended June 29, 2019 and June 30, 2018 was $46.67 and $49.63 , respectively, representing the market value of our shares as of the date of grant less the present value of estimated foregone dividends over the vesting period.
Employee Stock Purchase Plan
NOTE 11 INCOME TAXES
The Tax Cuts and Jobs Act (the Tax Act) was enacted into law on December 22, 2017 and made significant changes to U.S. federal corporate tax law. Effective January 1, 2018, the Tax Act lowered the U.S. corporate tax rate from 35% to 21% and prompted various other changes to U.S. federal corporate tax law, including the establishment of a territorial-style system for taxing foreign-source income of domestic multinational corporations and a one-time deemed repatriation tax on untaxed foreign earnings. The Tax Act resulted in a U.S. federal blended statutory rate of 24.5 % for fiscal year 2018 and a rate of 21.0 % for fiscal year 2019.
Generally, the impacts of new tax legislation would be required to be recorded in the period of enactment, which was our first quarter of fiscal year 2018. However, in March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, which incorporates various SEC paragraphs from Staff Accounting Bulletin No. 118 into income tax accounting guidance effective immediately, allowing registrants to record provisional amounts during a one-year measurement period.
As of December 29, 2018, we completed our accounting for the tax effects of the Tax Act at the conclusion of the one-year measurement period. As a result, the income tax provision for the three months ended December 29, 2018 includes certain discrete benefits of $1,293 for Tax Act measurement period adjustments. The discrete benefits relate to $1,297 of additional dividends received deduction for certain foreign tax credits included in the mandatory deemed repatriation tax calculation, partially offset by $4 of expense for other Tax Act measurement period adjustments. The additional dividends received deduction is based on our assessment of the treatment under the applicable provisions of the Tax Act as written and enacted during the first quarter of fiscal year 2019. The Department of the Treasury provided regulatory updates during the three months ended June 29, 2019, causing us to change our assessment of the benefit associated with the dividends received deduction, and in the third quarter of fiscal year 2019 to reverse the entire benefit of $1,297 that was recorded in the first quarter of fiscal year 2019.
The effective tax rate for the nine months ended June 29, 2019 increased primarily due to certain discrete benefits in the prior year for the estimated impact of the Tax Act. Excluding the impact of certain discrete benefits in the prior year, the effective tax rate for the nine months ended June 29, 2019 decreased as compared to the same prior year period. Factors that affected the effective tax rate for the nine months ended June 29, 2019 included impacts of the Tax Act, such as elimination of the domestic manufacturing deduction and the implementation of the global intangible low-taxed income (GILTI) provision. These increases were offset by favorable aspects of the Tax Act, such as the decrease in the U.S. income tax rate and provisions for
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incentivizing foreign-derived intangible income (FDII). In the first quarter of fiscal year 2019, we made an accounting policy election to treat the future tax impacts of the GILTI provisions of the Tax Act as a period cost to the extent applicable.
The income tax benefit for the nine months ended June 30, 2018 included certain discrete benefits of $25,378 for the estimated impact of the Tax Act. The discrete benefits related to $32,264 of estimated benefit from the remeasurement of our estimated net deferred tax liabilities, partially offset by $6,886 of estimated expense associated with the mandatory deemed repatriation tax. The income tax benefit for fiscal year 2018 included certain discrete benefits of $25,008 for the estimated impact of the Tax Act. The discrete benefits primarily related to $31,647 of estimated benefit from the remeasurement of our estimated net deferred tax liabilities, partially offset by $6,639 of estimated expense associated with the mandatory deemed repatriation tax.
As of June 29, 2019, the liability for unrecognized tax benefits was $5,745 , of which $3,269 would favorably affect our effective tax rate, if recognized. As of September 29, 2018, the liability for unrecognized tax benefits was $6,158 , of which $3,740 would favorably affect our effective tax rate, if recognized. As of June 29, 2019, we do not expect significant changes in the amount of unrecognized tax benefits during the next twelve months.
NOTE 12 SHAREHOLDERS' EQUITY
Tangible Equity Units
During the third quarter of fiscal year 2016, we issued 1,150 TEUs in a registered public offering primarily to finance the acquisition of PCB, to repay amounts outstanding under our existing revolving credit facility and to pay related costs, fees and expenses. Total proceeds, net of underwriting discounts, commissions and other expenses were $110,926 . Each TEU has a stated amount of $100 per TEU and is comprised of a prepaid stock purchase contract and a senior amortizing note having a final installment payment date of July 1, 2019. We allocated the proceeds from the issuance of the TEUs between equity and debt based on the relative fair values of the respective components of each TEU. The fair value of the prepaid stock purchase contracts, net of underwriting discounts, commissions and other expenses, was recorded in additional paid-in capital in the Consolidated Balance Sheets. The fair value of the senior amortizing note, net of underwriting discounts, commissions and other expenses, was split between current maturities of long-term debt, net and long-term debt, less current maturities, net in the Consolidated Balance Sheets. Underwriting discounts, commissions and other costs directly associated with the TEU-related debt were amortized using the effective interest rate method over the three-year term of the instrument.
The aggregate values assigned upon issuance to each component of the TEUs, based on the relative fair value of the respective components, were as follows:
Equity Component | Debt Component | Total | |||||||||
Fair value price per TEU 1 | $ | $ | $ | ||||||||
Gross proceeds | $ | $ | $ | ||||||||
Less: Underwriting discounts and commissions | ( | ) | ( | ) | ( | ) | |||||
Less: Other expenses 2 | ( | ) | ( | ) | ( | ) | |||||
Issuance of TEUs, net | $ | $ | $ | ||||||||
1 | The fair value price allocation between equity and debt for each TEU was determined using a discounted cash flow model. |
2 | Other expenses include direct and incremental costs related to the issuance of the TEUs. |
Equity Component
Unless converted earlier at the option of the holder, each prepaid stock purchase contract automatically settle on July 1, 2019. If converted prior to the automatic settlement date at the option of the holder, the minimum of 1.9841 shares of our common stock are delivered to the holder of each prepaid stock purchase contract. On the automatic settlement date, a minimum of 1.9841 shares and a maximum of 2.3810 shares of our common stock, subject to adjustment based upon the applicable market value discussed below, will be delivered to the holder of each prepaid stock purchase contract at the settlement date.
The number of shares of our common stock issuable upon settlement of each purchase contract on July 1, 2019 will be determined as follows:
• | if the applicable market value is equal to or greater than the threshold appreciation price of $ |
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• | if the applicable market value is greater than the reference price of $ |
• | if the applicable market value is less than or equal to the reference price of $ |
The "applicable market value" is defined as the average of the daily volume-weighted average price of the common stock on each of the 20 consecutive trading days beginning on, and including, the 23 rd scheduled trading day immediately preceding July 1, 2019.
During the fourth quarter of fiscal year 2017, certain holders of our TEUs elected to early convert the equity component on 473 of our outstanding TEUs at the minimum conversion rate of 1.9841 which resulted in the issuance of 939 shares of our common stock. During the third quarter of fiscal year 2019, certain holders of our TEUs elected to early convert the equity component on 394 of our outstanding TEUs at the minimum conversion rate of 1.9841 which resulted in the issuance of 781 shares of our common stock. During fiscal year 2018, no holders of our TEUs elected to early convert the equity component of our outstanding TEUs.
Subsequent to the end of the third quarter of fiscal year 2019, on July 1, 2019, the remaining 283 outstanding TEUs were converted at the minimum conversion rate of 1.9841 which resulted in the issuance of approximately 560 shares of our common stock.
Debt Component
The amortizing senior note was issued with an initial principal amount of $27,386 , or $23.8136 per TEU. Equal quarterly cash installments of $2.1875 per amortizing note are paid, which in the aggregate are equivalent to a 8.75 % cash distribution per year with respect to each $100 stated amount per TEU. Each installment constitutes a payment of interest and partial repayment of principal. On July 1, 2019, subsequent to the end of the third quarter of fiscal year 2019, the final installment was paid.
Earnings Per Common Share
The TEUs have a dilutive effect on our earnings per share. The 1.9841 minimum shares to be issued are included in the calculation of basic weighted average shares outstanding. The 0.3969 difference between the minimum shares and the 2.3810 maximum shares are potentially dilutive, and accordingly, are included in our diluted earnings per share on a pro rata basis to the extent the applicable market value is higher than the reference price but less than the threshold appreciation price. See Note 13 for additional information regarding the calculation of earnings per share.
Capped Calls
In connection with the pricing of the TEUs sold in our public offering in fiscal year 2016, we purchased capped calls from third party banking institutions (Capped Calls) for $7,935 . The initial Capped Calls were for 2,282 equivalent shares of our common stock with a strike price of $50.40 , a cap price of $58.80 and an expiration date of July 1, 2019. The value of the Capped Calls is settled with shares of our common stock, based on the approximate market value of our common stock at such time, and could be settled as the TEUs were early converted or settled upon expiration on July 1, 2019 (Capped Call Expiration). During the fourth quarter of fiscal year 2017, we settled approximately 10 % of the Capped Calls, which resulted in us receiving and retiring 12 shares of our common stock. No Capped Calls were settled during the nine months ended June 29, 2019 and fiscal year 2018.
On June 13, 2018, we amended the agreements with third party banking institutions for the outstanding Capped Calls (Capped Call Agreements) to modify the timing of settlement to be only upon expiration for all outstanding Capped Calls. Per the Capped Call Agreements, the outstanding Capped Calls are for 2,054 equivalent shares of our common stock with a strike price of $50.40 and a cap price of $57.97 . The Capped Calls will be automatically settled upon Capped Call Expiration in the fourth quarter of fiscal year 2019 with shares of our common stock based on the average market value of our common stock as defined in the Capped Call Agreements.
NOTE 13 EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the daily weighted average number of common shares outstanding during the applicable period. The TEUs are assumed to be settled at the minimum settlement amount of 1.9841 shares per TEU when calculating weighted-average common shares outstanding for purposes of basic earnings per share.
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Using the treasury stock method, diluted earnings per share includes the potentially dilutive effect of common shares issued in connection with outstanding stock-based compensation options and grants. The potentially dilutive effect of common shares issued in connection with outstanding stock options is determined based on the average market price for the period. For diluted earnings per share, the TEUs are assumed to be settled at a conversion factor based on our daily volume-weighted average price per share of our common stock for the 20 consecutive trading days preceding the end of the current fiscal quarter not to exceed 2.3810 shares of common stock per TEU.
Under the treasury stock method, shares associated with certain stock options have been excluded from the diluted weighted average shares outstanding calculation because the exercise of those options would lead to a net reduction in common shares outstanding or anti-dilution. As a result, stock options to acquire 835 and 667 weighted common shares have been excluded from the diluted weighted average common shares outstanding calculation for the three months ended June 29, 2019 and June 30, 2018, respectively. Stock options to acquire 812 and 548 weighted common shares have been excluded from the diluted weighted average common shares outstanding calculation for the nine months ended June 29, 2019 and June 30, 2018, respectively.
In connection with the pricing of the TEUs, we purchased capped calls. The capped calls will not be reflected in the calculation of diluted earnings per share until settled as they will lead to a net reduction in common shares outstanding or anti-dilution. See Note 12 for additional information on our equity instruments.
Basic and diluted earnings per share are calculated as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Net income | $ | $ | $ | $ | ||||||||||||
Weighted average common shares outstanding | ||||||||||||||||
Effect of dilutive securities | ||||||||||||||||
Stock-based compensation | ||||||||||||||||
Weighted average dilutive common shares outstanding | ||||||||||||||||
Earnings per share | ||||||||||||||||
Basic | $ | $ | $ | $ | ||||||||||||
Diluted | ||||||||||||||||
NOTE 14 OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss), a component of shareholders' equity, consists of foreign currency translation adjustments, gains or losses on derivative instruments and defined benefit pension plan adjustments.
Income tax expense or benefit allocated to each component of other comprehensive income (loss) is as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
June 29, 2019 | ||||||||||||||||||||||||
Pre-tax | Tax | Net | Pretax | Tax | Net | |||||||||||||||||||
Foreign currency translation gain (loss) adjustments | $ | $ | — | $ | $ | ( | ) | $ | — | $ | ( | ) | ||||||||||||
Derivative instruments | ||||||||||||||||||||||||
Unrealized net gain (loss) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||
Defined benefit pension plan | ||||||||||||||||||||||||
Unrealized net gain (loss) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ||||||||||||||||||||
Currency exchange rate gain (loss) | ( | ) | — | ( | ) | — | ||||||||||||||||||
Other comprehensive income (loss) | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | ||||||||||
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Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
June 30, 2018 | ||||||||||||||||||||||||
Pre-tax | Tax | Net | Pretax | Tax | Net | |||||||||||||||||||
Foreign currency translation gain (loss) adjustments | $ | ( | ) | $ | — | $ | ( | ) | $ | ( | ) | $ | — | $ | ( | ) | ||||||||
Derivative instruments | ||||||||||||||||||||||||
Unrealized net gain (loss) | ( | ) | ( | ) | ||||||||||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
Defined benefit pension plan | ||||||||||||||||||||||||
Unrealized net gain (loss) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ||||||||||||||||||||
Currency exchange rate gain (loss) | — | — | ||||||||||||||||||||||
Other comprehensive income (loss) | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||||
The changes in the net-of-tax balances of each component of AOCI are as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
June 29, 2019 | ||||||||||||||||||||||||||||||||
Adjustments | Adjustments | |||||||||||||||||||||||||||||||
Foreign Currency Translation | Unrealized Derivative Instrument | Defined Benefit Pension Plan | Total | Foreign Currency Translation | Unrealized Derivative Instrument | Defined Benefit Pension Plan | Total | |||||||||||||||||||||||||
Beginning balance | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||||
Other comprehensive net gain (loss) reclassifications | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
Other comprehensive income (loss) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
Ending balance | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | ||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
June 30, 2018 | ||||||||||||||||||||||||||||||||
Adjustments | Adjustments | |||||||||||||||||||||||||||||||
Foreign Currency Translation | Unrealized Derivative Instrument | Defined Benefit Pension Plan | Total | Foreign Currency Translation | Unrealized Derivative Instrument | Defined Benefit Pension Plan | Total | |||||||||||||||||||||||||
Beginning balance | $ | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||||||||
Other comprehensive net gain (loss) reclassifications | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
Net (gain) loss reclassified to earnings | ( | ) | ( | ) | ||||||||||||||||||||||||||||
Other comprehensive income (loss) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
Ending balance | $ | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||||||
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The effect on certain line items in the Consolidated Statements of Income of amounts reclassified out of AOCI are as follows:
Three Months Ended | Nine Months Ended | Affected Line Item in the Consolidated Statements of Income | ||||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||||
Derivative instruments | ||||||||||||||||||
Currency exchange contracts gain (loss) | $ | $ | $ | $ | ( | ) | Revenue | |||||||||||
Interest rate swap contracts gain (loss) | Interest expense, net | |||||||||||||||||
Income tax benefit (expense) | ( | ) | ( | ) | ( | ) | Income tax provision (benefit) | |||||||||||
Total net gain (loss) on derivative instruments | ( | ) | Net income | |||||||||||||||
Defined benefit pension plan 1 | ||||||||||||||||||
Actuarial loss | ( | ) | ( | ) | Cost of sales | |||||||||||||
Actuarial loss | ( | ) | ( | ) | Selling and marketing | |||||||||||||
Actuarial loss | ( | ) | ( | ) | General and administrative | |||||||||||||
Actuarial loss | ( | ) | ( | ) | Other income (expense), net | |||||||||||||
Total actuarial loss | ( | ) | ( | ) | ( | ) | ( | ) | Income before income taxes | |||||||||
Income tax benefit | Income tax provision (benefit) | |||||||||||||||||
Total net loss on pension plan | ( | ) | ( | ) | ( | ) | ( | ) | Net income | |||||||||
Total net of tax reclassifications out of AOCI included in net income | $ | $ | $ | $ | ( | ) | ||||||||||||
1 |
NOTE 15 BUSINESS SEGMENT INFORMATION
Our Chief Executive Officer (the Chief Operating Decision Maker) regularly reviews financial information for our two reportable segments, Test & Simulation and Sensors. Test & Simulation manufactures and sells equipment and related software and services which are used by customers to characterize a product's mechanical properties or performance. Sensors manufactures and sells high-performance sensors which provide measurements of vibration, pressure, position, force and sound in a variety of applications.
In evaluating each segment's performance, our Chief Executive Officer focuses on income from operations. This measure excludes interest income and expense, income taxes and other non-operating items. Corporate expenses, including costs associated with various support functions such as human resources, information technology, legal, finance and accounting, and general and administrative costs are allocated to the reportable segments on the basis of revenue. The accounting policies of the reportable segments are the same as those described in Note 1 to the Consolidated Financial Statements found in our Annual Report on Form 10-K for the fiscal year ended September 29, 2018 and in Note 3 of this Quarterly Report on Form 10-Q.
Intersegment revenue is based on standard costs with reasonable mark-ups established between the reportable segments. All significant intersegment amounts are eliminated to arrive at consolidated financial results.
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Financial information by reportable segment is as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
June 29, 2019 | June 30, 2018 | June 29, 2019 | June 30, 2018 | |||||||||||||
Revenue | ||||||||||||||||
Test & Simulation | $ | $ | $ | $ | ||||||||||||
Sensors | ||||||||||||||||
Intersegment eliminations | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Total revenue | $ | $ | $ | $ | ||||||||||||
Income from operations | ||||||||||||||||
Test & Simulation | $ | $ | $ | $ | ||||||||||||
Sensors | ||||||||||||||||
Intersegment eliminations | ( | ) | ( | ) | ||||||||||||
Total income from operations | $ | $ | $ | $ | ||||||||||||
NOTE 16 BUSINESS ACQUISITIONS
On November 21, 2018, we acquired all ownership interests of E2M for a cash purchase price of $80,287 . Based in Amsterdam, Netherlands, E2M is a leading manufacturer of high force, electrically driven actuation systems, serving primarily the human-rated entertainment and training simulation markets. The acquisition of E2M expands our technology and product offerings for human-rated simulation systems and brings key regulatory approvals and customers in the flight simulation and entertainment markets. The transaction was accounted for under the acquisition method of accounting. The acquired assets, liabilities and operating results have been included in our financial statements within Test & Simulation from the date of acquisition. During the three and nine months ended June 29, 2019, we included $7,999 and $21,658 , respectively, of revenue from E2M in our Consolidated Statements of Income. We funded the acquisition of E2M primarily with borrowings on our Revolving Credit Facility. Costs of $1,133 associated with the acquisition of E2M were expensed as incurred. Pro forma information related to the acquisition of E2M has not been included as the impact on our consolidated results of operations was not considered material.
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The following table summarizes the preliminary fair value measurement of the assets acquired and liabilities assumed, net of cash acquired, as of the date of acquisition:
Fair Value | Finite-Lived Intangible Asset Lives (Years) | ||||
Asset (Liability) | |||||
Accounts receivable | $ | ||||
Unbilled accounts receivable | |||||
Inventories | |||||
Prepaid expenses and other current assets | |||||
Property and equipment | |||||
Intangible assets | |||||
Customer lists | |||||
Trademarks and trade names | |||||
Technology | |||||
Other intangible assets | |||||
Other long-term assets | |||||
Purchased goodwill | |||||
Accounts payable | ( | ) | |||
Accrued payroll and related costs | ( | ) | |||
Advance payments from customers | ( | ) | |||
Accrued income taxes | ( | ) | |||
Other accrued liabilities | ( | ) | |||
Deferred income taxes | ( | ) | |||
Net assets acquired | $ | ||||
Supplemental information | |||||
Consideration paid at closing | $ | ||||
Post-closing purchase price adjustment | |||||
Less: Cash acquired | ( | ) | |||
Purchase price, net of cash acquired | $ | ||||
The allocation of purchase price consideration is considered preliminary as of June 29, 2019 with provisional amounts primarily related to inventory for customer projects in various stages of completion, intangible assets and certain tax related items included as our allocation process has not been finalized. We expect to finalize the allocation of purchase price as soon as possible, but no later than one year from the acquisition date.
Goodwill was calculated as the difference between the acquisition date fair value of the total purchase price consideration and the fair value of the net assets acquired and represents the future economic benefits that we expect to achieve as a result of the acquisition. This resulted in a purchase price in excess of the fair value of identifiable net assets acquired. The purchase price also included the fair value of other assets that were not identifiable, not separately recognizable under accounting rules (e.g., assembled workforce) or of immaterial value. All of the goodwill was assigned to Test & Simulation. None of the goodwill is deductible for income tax purposes.
The preliminary fair value of the acquired intangible assets was $43,989 . The acquired intangible assets are being amortized on a straight-line basis over the useful lives identified in the table above.
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NOTE 17 SUBSEQUENT EVENTS
Issuance of Senior Unsecured Notes
On July 16, 2019, we issued $350,000 in aggregate principal amount of 5.750 % senior unsecured notes due 2027 (the Notes). The Notes were issued pursuant to an Indenture dated as of July 16, 2019 among us, the Guarantors (as defined therein) and Wells Fargo Bank, National Association, as trustee (the Indenture). The Notes will mature on August 15, 2027. Interest will accrue at the rate of 5.750 % per annum and will be payable semi-annually on each February 15 and August 15, with the first interest payment due on February 15, 2020. We used the net proceeds after discounts and expenses of approximately $344,000 from this offering to repay all outstanding debt under the Revolving Credit Facility, to repay a portion of the Term Facility and for general corporate purposes.
Termination of Interest Rate Swap
In connection with the repayment of a portion of the Term Facility, we terminated the associated interest rate swap. As of June 29, 2019, the interest rate swap had a total notional amount of $225,000 . The market value of the interest rate swap as of June 29, 2019 was an asset of $1,664 . See Note 8 for additional information on our interest rate swap.
Purchase of Assets
On August 5, 2019, we executed an agreement with Meggitt PLC (MGGT.L), to purchase the assets of their Endevco sensors business for a cash purchase price of approximately $70,000 . Founded in 1947, Endevco is a historic leader in high performance test & measurement sensors used primarily in the testing of new products. This strategic product line purchase brings together two iconic brands in the test & measurement sensors market, in PCB and Endevco, and further enhances our long-term strategy of growth and market leadership in our core businesses.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in nine sections:
• | Overview |
• | Financial Results |
• | Cash Flow Comparison |
• | Liquidity and Capital Resources |
• | Off-balance Sheet Arrangements |
• | Critical Accounting Policies |
• | Recently Issued Accounting Pronouncements |
• | Other Matters |
• | Forward-looking Statements |
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q. All dollar and share amounts are in thousands, unless otherwise noted.
Overview
MTS Systems Corporation's testing and simulation hardware, software and service solutions help customers accelerate and improve their design, development and manufacturing processes and are used for determining the mechanical behavior of materials, products and structures. Our high-performance sensors provide measurements of vibration, pressure, position, force and sound in a variety of applications. As of September 29, 2018, we had 3,400 employees and revenue of $778,032 for fiscal year 2018.
Further globalization and expansion of many industries along with growth in emerging markets, provide a strong and vibrant market base from which we can grow revenue. We have aligned our organizational structure to be more flexible to the demands of globalized and volatile markets by adjusting our structure to be more cost effective and nimble in responding to our customers' needs. We are looking ahead to delivering distinctive business performance through our commitment to sustain the differentiated competitive advantage that comes from offering an innovative portfolio of Test & Simulation and Sensors solutions that create value for customers and are delivered with total customer satisfaction.
Acquisition
On November 21, 2018, we acquired E2M Technologies B.V. (E2M) for a cash purchase price of $80,287. We funded the acquisition of E2M through borrowings on our Revolving Credit Facility. See Note 16 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of the acquisition of E2M.
Financing
On November 21, 2018, we amended the Credit Agreement to increase the size of our Revolving Credit Facility from $120,000 to $150,000 and to extend the expiration date to July 5, 2022. The size of the Revolving Credit Facility was increased to finance the purchase of E2M. See Note 9 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of the amendment to the Credit Agreement.
Conversion of 8.75% Tangible Equity Units (TEUs)
During the third quarter of fiscal year 2019, certain holders of our TEUs elected to early convert the equity component on 394 of our outstanding TEUs at the minimum conversion rate of 1.9841 which resulted in the issuance of 781 shares of our common stock.
Foreign Currency
Approximately 70% of our revenue has historically been derived from customers outside of the U.S. Our financial results are principally exposed to changes in exchange rates between the U.S. dollar and the Euro, the Japanese yen and the Chinese yuan. A change in foreign exchange rates could positively or negatively affect our reported financial results. The discussion below quantifies the impact of foreign currency translation on our financial results for the periods discussed.
Adoption of New Revenue Recognition Standard
In fiscal year 2019, we adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), followed by related amendments (collectively, "the new revenue standard" or "ASC 606"). See Note 2 and Note 3 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for the impact of this adoption on our Consolidated Income Statements and Consolidated Balance Sheets.
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Terms
The terms "MTS," "we," "us," "the Company" or "our" in this Quarterly Report on Form 10-Q, unless the context otherwise requires, refer to MTS Systems Corporation and its wholly owned subsidiaries.
Financial Results
Total Company
Results of Operations
The following tables compare results of operations, separately identifying the estimated impact of currency translation, the acquisition of E2M in the first quarter of fiscal year 2019 and restructuring costs incurred in the first quarter of fiscal year 2019.
Three Months Ended1 | ||||||||||||||||||||
Estimated | ||||||||||||||||||||
June 29, 2019 | Business Change | Acquisition2 | Currency Translation | June 30, 2018 | ||||||||||||||||
Revenue | $ | 232,209 | $ | 34,588 | $ | 7,999 | $ | (5,046 | ) | $ | 194,668 | |||||||||
Cost of sales | 147,106 | 26,851 | 5,685 | (3,814 | ) | 118,384 | ||||||||||||||
Gross profit | 85,103 | 7,737 | 2,314 | (1,232 | ) | 76,284 | ||||||||||||||
Gross margin | 36.6 | % | 39.2 | % | ||||||||||||||||
Operating expenses | ||||||||||||||||||||
Selling and marketing | 33,321 | 1,610 | 118 | (578 | ) | 32,171 | ||||||||||||||
General and administrative | 20,621 | 197 | 1,548 | (205 | ) | 19,081 | ||||||||||||||
Research and development | 8,160 | (960 | ) | 405 | (53 | ) | 8,768 | |||||||||||||
Total operating expenses | 62,102 | 847 | 2,071 | (836 | ) | 60,020 | ||||||||||||||
Income from operations | $ | 23,001 | $ | 6,890 | $ | 243 | $ | (396 | ) | $ | 16,264 | |||||||||
Nine Months Ended1 | ||||||||||||||||||||
Estimated | ||||||||||||||||||||
June 29, 2019 | Business Change | Acquisition / Restructuring3 | Currency Translation | June 30, 2018 | ||||||||||||||||
Revenue | $ | 668,436 | $ | 79,830 | $ | 21,658 | $ | (13,205 | ) | $ | 580,153 | |||||||||
Cost of sales | 417,678 | 60,404 | 15,878 | (9,720 | ) | 351,116 | ||||||||||||||
Gross profit | 250,758 | 19,426 | 5,780 | (3,485 | ) | 229,037 | ||||||||||||||
Gross margin | 37.5 | % | 39.5 | % | ||||||||||||||||
Operating expenses | ||||||||||||||||||||
Selling and marketing | 98,805 | 5,063 | 528 | (1,582 | ) | 94,796 | ||||||||||||||
General and administrative | 63,804 | 1,169 | 4,756 | (756 | ) | 58,635 | ||||||||||||||
Research and development | 23,008 | (4,045 | ) | 963 | (145 | ) | 26,235 | |||||||||||||
Total operating expenses | 185,617 | 2,187 | 6,247 | (2,483 | ) | 179,666 | ||||||||||||||
Income from operations | $ | 65,141 | $ | 17,239 | $ | (467 | ) | $ | (1,002 | ) | $ | 49,371 | ||||||||
1 | Financial results for fiscal year 2019 are presented in accordance with the new revenue standard adopted in the first quarter of fiscal year 2019. Prior period results have not been restated to reflect this change. The three and nine months ended June 29, 2019 include a favorable impact on income from operations related to the ASC 606 adoption of $7,977 and $11,268, respectively. While we do not expect the adoption of the new revenue standard to have a significant impact on annual operating results, we do expect that it will have an impact on the timing of revenue recognition in interim periods. |
2 | The Acquisition column includes revenues and costs from the acquisition of E2M and costs incurred as part of the acquisition of E2M. |
3 | The Acquisition / Restructuring column includes revenues and costs from the acquisition of E2M, costs incurred as part of the acquisition of E2M and restructuring costs. |
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See Notes 3, 16 and 17 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on the new revenue standard, restructuring and related costs, and the E2M acquisition, respectively.
Revenue | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Revenue | $ | 232,209 | $ | 194,668 | $ | 37,541 | 19.3 | % | $ | 668,436 | $ | 580,153 | $ | 88,283 | 15.2 | % | ||||||||||||||
Revenue for the three and nine months ended June 29, 2019 increased 19.3% and 15.2%, respectively, primarily driven by growth in both the Test & Simulation and Sensors businesses, partially offset by the unfavorable impact of currency translation. Test & Simulation revenue for the three and nine months ended June 29, 2019 increased $32,273 and $80,424, respectively, primarily driven by volume growth from conversion of robust beginning-of-year backlog across all sectors and the acquisition of E2M in the first quarter of fiscal year 2019. The increase was partially offset by the unfavorable impact of currency translation. Sensors revenue for the three and nine months ended June 29, 2019 increased $5,231 and $8,055, respectively, primarily driven by growth in the Sensors test sector from a multi-year contract with the U.S. Department of Defense, growth in the Sensors position sector in the first half of the fiscal year and growth in the Sensors industrial sector from strength in the energy market, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation and the E2M acquisition, revenue increased 17.8% and 13.8%, respectively.
Gross Profit | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Gross profit | $ | 85,103 | $ | 76,284 | $ | 8,819 | 11.6 | % | $ | 250,758 | $ | 229,037 | $ | 21,721 | 9.5 | % | ||||||||||||||
Gross margin | 36.6 | % | 39.2 | % | (2.6 | ) | ppts | 37.5 | % | 39.5 | % | (2.0 | ) | ppts | ||||||||||||||||
Gross profit for the three and nine months ended June 29, 2019 increased 11.6% and 9.5%, respectively, primarily driven by revenue growth in Test & Simulation and the gross profit contribution from the E2M acquisition. This increase was partially offset by increased compensation expense, the E2M inventory acquisition adjustment of $157 and $1,141, respectively, and the unfavorable impact of currency translation. Gross margin declined 2.6 and 2.0 percentage points, respectively, primarily due to higher compensation expense, revenue mix between Test & Simulation and Sensors, and the E2M inventory acquisition adjustment. This decrease was partially offset by favorable leverage on higher revenue volume and strong project execution in Test & Simulation. Excluding the impact of currency translation, the E2M acquisition, and restructuring costs incurred in both fiscal years, gross profit increased 9.6% and 8.1% and gross margin declined 2.8 and 2.0 percentage points, respectively.
Selling and Marketing Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Selling and marketing | $ | 33,321 | $ | 32,171 | $ | 1,150 | 3.6 | % | $ | 98,805 | $ | 94,796 | $ | 4,009 | 4.2 | % | ||||||||||||||
% of revenue | 14.3 | % | 16.5 | % | 14.8 | % | 16.3 | % | ||||||||||||||||||||||
Selling and marketing expense for the three months ended June 29, 2019 increased 3.6% primarily due to increased compensation expense to support sales growth, partially offset by the favorable impact of currency translation. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, selling and marketing expense increased 5.5%.
Selling and marketing expense for the nine months ended June 29, 2019 increased 4.2% primarily due to increased compensation and commissions expense to support sales growth and the addition of E2M expenses, partially offset by the favorable impact of currency translation. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, selling and marketing expense increased 5.5%.
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General and Administrative Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
General and administrative | $ | 20,621 | $ | 19,081 | $ | 1,540 | 8.1 | % | $ | 63,804 | $ | 58,635 | $ | 5,169 | 8.8 | % | ||||||||||||||
% of revenue | 8.9 | % | 9.8 | % | 9.5 | % | 10.1 | % | ||||||||||||||||||||||
General and administrative expense for the three months ended June 29, 2019 increased 8.1% primarily due to the addition of E2M expenses, higher compensation expense in Sensors and increased professional fees, partially offset by lower compensation expense in Test & Simulation. Excluding the impact of currency translation, E2M expenses, and restructuring costs incurred in both fiscal years, general and administrative expense increased 1.3%.
General and administrative expense for the nine months ended June 29, 2019 increased 8.8% primarily due to the addition of E2M expenses, acquisition-related expenses, higher compensation expense in Sensors and increased professional fees, partially offset by lower compensation expense in Test & Simulation. Excluding the impact of currency translation, E2M expenses, and restructuring costs incurred in both fiscal years, general and administrative expense increased 2.4%.
Research and Development Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Research and development | $ | 8,160 | $ | 8,768 | $ | (608 | ) | (6.9 | )% | $ | 23,008 | $ | 26,235 | $ | (3,227 | ) | (12.3 | )% | ||||||||||||
% of revenue | 3.5 | % | 4.5 | % | 3.4 | % | 4.5 | % | ||||||||||||||||||||||
Research and development (R&D) expense for the three months ended June 29, 2019 declined 6.9% primarily due to the shift of internal resources to capital projects in Test & Simulation, partially offset by the addition of E2M expenses. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, R&D expense decreased 9.5%.
R&D expense for the nine months ended June 29, 2019 declined 12.3% primarily due to the shift of internal resources to capital projects and lower compensation expense in Test & Simulation, partially offset by the addition of E2M expenses and continued investment in new product development in Sensors. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, R&D expense decreased 15.0%.
Income from Operations | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Income from operations | $ | 23,001 | $ | 16,264 | $ | 6,737 | 41.4 | % | $ | 65,141 | $ | 49,371 | $ | 15,770 | 31.9 | % | ||||||||||||||
% of revenue | 9.9 | % | 8.4 | % | 9.7 | % | 8.5 | % | ||||||||||||||||||||||
Income from operations for the three and nine months ended June 29, 2019 increased 41.4% and 31.9%, respectively, primarily due to increased gross profit on higher revenue volume and the impact of the E2M acquisition, partially offset by higher compensation expense and acquisition-related expenses. Excluding the impact of currency translation, the E2M acquisition, and restructuring costs incurred in both fiscal years, income from operations increased 36.2% and 31.4%, respectively.
Interest Expense, Net | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Interest expense, net | $ | 6,687 | $ | 6,249 | $ | 438 | 7.0 | % | $ | 20,873 | $ | 19,761 | $ | 1,112 | 5.6 | % | ||||||||||||||
Interest expense, net for the three and nine months ended June 29, 2019 increased primarily due to an increase in interest expense on the revolving credit facility drawn on in the first quarter of fiscal year 2019 to fund the acquisition of E2M, which was partially offset by a reduction in interest expense related to lower balances on the tranche B term loan, as well as current year favorable effects of our interest rate swap.
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Other Income (Expense), Net | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Other income (expense), net | $ | (124 | ) | $ | 30 | $ | (154 | ) | (513.3 | )% | $ | 195 | $ | 81 | $ | 114 | 140.7 | % | ||||||||||||
The decrease in other income (expense), net for the three months ended June 29, 2019 was primarily driven by a relative increase in losses on foreign currency transactions, partially offset by an increase in rental income.
The increase in other income (expense), net for the nine months ended June 29, 2019 was primarily driven by an increase in rental income, partially offset by a relative increase in losses on foreign currency transactions.
Income Tax Provision (Benefit) | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Income tax provision (benefit) | $ | 2,605 | $ | 1,066 | $ | 1,539 | 144.4 | % | $ | 6,217 | $ | (20,877 | ) | $ | 27,094 | 129.8 | % | |||||||||||||
Effective tax rate | 16.1 | % | 10.6 | % | 14.0 | % | (70.3 | )% | ||||||||||||||||||||||
The effective tax rate for the three months ended June 29, 2019 increased primarily due to higher earnings before tax and the reversal of a $1,297 discrete tax benefit originally recorded in the first quarter of fiscal year 2019 related to the Tax Cuts and Jobs Act (the Tax Act) as a result of regulatory updates issued during the third quarter of fiscal year 2019.
The effective tax rate for the nine months ended June 29, 2019 increased primarily due to certain discrete benefits of $25,378 in the prior year for the estimated impact of the Tax Act. Excluding the impact of these discrete benefits, the effective tax rate for the nine months ended June 30, 2018 would have been 15.2%. The decrease in the effective income tax rate was primarily due to the implementation of the lower 21% U.S. statutory rate for fiscal year 2019 as compared to the blended statutory rate of 24.5% effective in fiscal year 2018.
Net Income | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Net income | $ | 13,585 | $ | 8,979 | $ | 4,606 | 51.3 | % | $ | 38,246 | $ | 50,568 | $ | (12,322 | ) | (24.4 | )% | |||||||||||||
Diluted earnings per share | $ | 0.70 | $ | 0.47 | $ | 0.23 | 48.9 | % | $ | 1.97 | $ | 2.62 | $ | (0.65 | ) | (24.8 | )% | |||||||||||||
Net income and diluted earnings per share for the three months ended June 29, 2019 increased primarily due to higher income from operations in Test & Simulation, partially offset by lower income from operations in Sensors.
Net income and diluted earnings per share for the nine months ended June 29, 2019 decreased primarily due to an increase in the effective tax rate and lower income from operations in Sensors, partially offset by higher income from operations in Test & Simulation.
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Segment Results
Test & Simulation Segment
Results of Operations
The following tables compare results of operations for Test & Simulation, separately identifying the estimated impact of currency translation, the acquisition of E2M in the first quarter of fiscal year 2019 and restructuring costs incurred in the first quarter of fiscal year 2019. See Note 15 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on our reportable segments.
Three Months Ended1 | ||||||||||||||||||||
Estimated | ||||||||||||||||||||
June 29, 2019 | Business Change | Acquisition2 | Currency Translation | June 30, 2018 | ||||||||||||||||
Revenue | $ | 148,328 | $ | 27,526 | $ | 7,999 | $ | (3,252 | ) | $ | 116,055 | |||||||||
Cost of sales | 104,053 | 21,678 | 5,685 | (2,785 | ) | 79,475 | ||||||||||||||
Gross profit | 44,275 | 5,848 | 2,314 | (467 | ) | 36,580 | ||||||||||||||
Gross margin | 29.8 | % | 31.5 | % | ||||||||||||||||
Operating expenses | ||||||||||||||||||||
Selling and marketing | 18,450 | 1,136 | 118 | (283 | ) | 17,479 | ||||||||||||||
General and administrative | 10,829 | (1,502 | ) | 1,548 | (138 | ) | 10,921 | |||||||||||||
Research and development | 3,572 | (1,138 | ) | 405 | (2 | ) | 4,307 | |||||||||||||
Total operating expenses | 32,851 | (1,504 | ) | 2,071 | (423 | ) | 32,707 | |||||||||||||
Income from operations | $ | 11,424 | $ | 7,352 | $ | 243 | $ | (44 | ) | $ | 3,873 | |||||||||
Nine Months Ended1 | ||||||||||||||||||||
Estimated | ||||||||||||||||||||
June 29, 2019 | Business Change | Acquisition / Restructuring3 | Currency Translation | June 30, 2018 | ||||||||||||||||
Revenue | $ | 424,920 | $ | 66,877 | $ | 21,658 | $ | (8,111 | ) | $ | 344,496 | |||||||||
Cost of sales | 293,810 | 50,206 | 15,878 | (6,824 | ) | 234,550 | ||||||||||||||
Gross profit | 131,110 | 16,671 | 5,780 | (1,287 | ) | 109,946 | ||||||||||||||
Gross margin | 30.9 | % | 31.9 | % | ||||||||||||||||
Operating expenses | ||||||||||||||||||||
Selling and marketing | 54,313 | 3,364 | 528 | (779 | ) | 51,200 | ||||||||||||||
General and administrative | 35,716 | (1,228 | ) | 4,756 | (566 | ) | 32,754 | |||||||||||||
Research and development | 9,642 | (4,528 | ) | 963 | (8 | ) | 13,215 | |||||||||||||
Total operating expenses | 99,671 | (2,392 | ) | 6,247 | (1,353 | ) | 97,169 | |||||||||||||
Income from operations | $ | 31,439 | $ | 19,063 | $ | (467 | ) | $ | 66 | $ | 12,777 | |||||||||
1 | Financial results for fiscal year 2019 are presented in accordance with the new revenue standard adopted in the first quarter of fiscal year 2019. Prior period results have not been restated to reflect this change. The three and nine months ended June 29, 2019 include a favorable impact on income from operations related to the ASC 606 adoption of $7,977 and $11,268, respectively. While we do not expect the adoption of the new revenue standard to have a significant impact on annual operating results, we do expect that it will have an impact on the timing of revenue recognition in interim periods. |
2 | The Acquisition column includes revenues and costs from the acquisition of E2M and costs incurred as part of the acquisition of E2M. |
3 | The Acquisition / Restructuring column includes revenues and costs from the acquisition of E2M, costs incurred as part of the acquisition of E2M and restructuring costs. |
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See Notes 3, 16 and 17 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on the new revenue standard, restructuring and related costs, and the E2M acquisition, respectively.
Revenue | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Revenue | $ | 148,328 | $ | 116,055 | $ | 32,273 | 27.8 | % | $ | 424,920 | $ | 344,496 | $ | 80,424 | 23.3 | % | ||||||||||||||
Revenue for the three and nine months ended June 29, 2019 increased 27.8% and 23.3%, respectively, primarily driven by volume growth across all sectors from conversion of robust beginning-of-year backlog and the acquisition of E2M in the first quarter of fiscal year 2019. The increase was partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation and the E2M acquisition, revenue increased 23.7% and 19.4%, respectively.
Gross Profit | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Gross profit | $ | 44,275 | $ | 36,580 | $ | 7,695 | 21.0 | % | $ | 131,110 | $ | 109,946 | $ | 21,164 | 19.2 | % | ||||||||||||||
Gross margin | 29.8 | % | 31.5 | % | (1.7 | ) | ppts | 30.9 | % | 31.9 | % | (1.0 | ) | ppts | ||||||||||||||||
Gross profit for the three months ended June 29, 2019 increased 21.0% primarily due to higher revenue volume and the gross profit contribution from the E2M acquisition, partially offset by increased compensation expense. Gross margin declined 1.7 percentage points primarily driven by increased compensation expense and lower gross margin contribution from product mix, partially offset by leverage on higher revenue volume, lower warranty expense and the favorable impact of currency translation. Excluding the impact of currency translation, the E2M acquisition, and restructuring costs incurred in the prior year, gross profit increased 14.8% and gross margin declined 2.4 percentage points.
Gross profit for the nine months ended June 29, 2019 increased 19.2% primarily due to higher revenue volume and the gross profit contribution from the E2M acquisition, partially offset by increased compensation expense. Gross margin declined 1.0 percentage point primarily driven by increased compensation expense and the $1,141 E2M acquisition inventory adjustment, partially offset by leverage on higher revenue volume, strong project execution and the favorable impact of currency translation. Excluding the impact of currency translation, the E2M acquisition, and restructuring costs incurred in both fiscal years, gross profit increased 14.3% and gross margin declined 1.4 percentage points.
Selling and Marketing Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Selling and marketing | $ | 18,450 | $ | 17,479 | $ | 971 | 5.6 | % | $ | 54,313 | $ | 51,200 | $ | 3,113 | 6.1 | % | ||||||||||||||
% of revenue | 12.4 | % | 15.1 | % | 12.8 | % | 14.9 | % | ||||||||||||||||||||||
Selling and marketing expense for the three months ended June 29, 2019 increased 5.6% primarily due to higher compensation and bad debt expense, partially offset by the favorable impact of currency translation. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, selling and marketing expense increased 7.5%.
Selling and marketing expense for the nine months ended June 29, 2019 increased 6.1% primarily due to higher commissions and compensation expense, as well as the addition of E2M expenses, partially offset by the favorable impact of currency translation. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, selling and marketing expense increased 6.9%.
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General and Administrative Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
General and administrative | $ | 10,829 | $ | 10,921 | $ | (92 | ) | (0.8 | )% | $ | 35,716 | $ | 32,754 | $ | 2,962 | 9.0 | % | |||||||||||||
% of revenue | 7.3 | % | 9.4 | % | 8.4 | % | 9.5 | % | ||||||||||||||||||||||
General and administrative expense for the three months ended June 29, 2019 declined 0.8% primarily driven by lower compensation expense, partially offset by the addition of E2M expenses. Excluding the impact of currency translation, E2M expenses, and restructuring costs incurred in the prior year, general and administrative expense decreased 13.3%.
General and administrative expense for the nine months ended June 29, 2019 increased 9.0% primarily driven by the addition of E2M expenses and acquisition-related expenses, partially offset by lower compensation expense. Excluding the impact of currency translation, E2M expenses, and restructuring costs incurred in both fiscal years, general and administrative expense decreased 3.1%.
Research and Development Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Research and development | $ | 3,572 | $ | 4,307 | $ | (735 | ) | (17.1 | )% | $ | 9,642 | $ | 13,215 | $ | (3,573 | ) | (27.0 | )% | ||||||||||||
% of revenue | 2.4 | % | 3.7 | % | 2.3 | % | 3.8 | % | ||||||||||||||||||||||
R&D expense for the three months ended June 29, 2019 declined 17.1% primarily due to the shift of internal resources to capital projects, partially offset by the addition of E2M expenses. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, R&D expense decreased 23.9%.
R&D expense for the nine months ended June 29, 2019 declined 27.0% primarily due to the shift of internal resources to capital projects and lower compensation expense, partially offset by the addition of E2M expenses. Excluding the impact of currency translation, E2M expenses and restructuring costs incurred in the prior year, R&D expense decreased 33.5%.
Income from Operations | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Income from operations | $ | 11,424 | $ | 3,873 | $ | 7,551 | 195.0 | % | $ | 31,439 | $ | 12,777 | $ | 18,662 | 146.1 | % | ||||||||||||||
% of revenue | 7.7 | % | 3.3 | % | 7.4 | % | 3.7 | % | ||||||||||||||||||||||
Income from operations for the three months ended June 29, 2019 increased 195.0% primarily due to increased gross profit on higher revenue volume and lower R&D expenses, partially offset by higher compensation expense. Excluding the impact of currency translation, the E2M acquisition, and restructuring costs incurred in both fiscal years, income from operations increased 143.4%.
Income from operations for the nine months ended June 29, 2019 increased 146.1% primarily due to increased gross profit on higher revenue volume, partially offset by higher compensation and commissions expense. Excluding the impact of currency translation, the E2M acquisition, and restructuring costs incurred in both fiscal years, income from operations increased 125.5%.
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Sensors Segment
Results of Operations
The following tables compare results of operations for Sensors, separately identifying the estimated impact of currency translation. See Note 15 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on our reportable segments.
Three Months Ended | ||||||||||||||||
Estimated | ||||||||||||||||
June 29, 2019 | Business Change | Currency Translation | June 30, 2018 | |||||||||||||
Revenue | $ | 84,231 | $ | 7,025 | $ | (1,794 | ) | $ | 79,000 | |||||||
Cost of sales | 43,424 | 5,164 | (1,029 | ) | 39,289 | |||||||||||
Gross profit | 40,807 | 1,861 | (765 | ) | 39,711 | |||||||||||
Gross margin | 48.4 | % | 50.3 | % | ||||||||||||
Operating expenses | ||||||||||||||||
Selling and marketing | 14,871 | 474 | (295 | ) | 14,692 | |||||||||||
General and administrative | 9,792 | 1,699 | (67 | ) | 8,160 | |||||||||||
Research and development | 4,588 | 178 | (51 | ) | 4,461 | |||||||||||
Total operating expenses | 29,251 | 2,351 | (413 | ) | 27,313 | |||||||||||
Income (loss) from operations | $ | 11,556 | $ | (490 | ) | $ | (352 | ) | $ | 12,398 | ||||||
Nine Months Ended | ||||||||||||||||
Estimated | ||||||||||||||||
June 29, 2019 | Business Change | Currency Translation | June 30, 2018 | |||||||||||||
Revenue | $ | 244,556 | $ | 13,149 | $ | (5,094 | ) | $ | 236,501 | |||||||
Cost of sales | 124,916 | 10,431 | (2,896 | ) | 117,381 | |||||||||||
Gross profit | 119,640 | 2,718 | (2,198 | ) | 119,120 | |||||||||||
Gross margin | 48.9 | % | 50.4 | % | ||||||||||||
Operating expenses | ||||||||||||||||
Selling and marketing | 44,492 | 1,699 | (803 | ) | 43,596 | |||||||||||
General and administrative | 28,088 | 2,397 | (190 | ) | 25,881 | |||||||||||
Research and development | 13,366 | 483 | (137 | ) | 13,020 | |||||||||||
Total operating expenses | 85,946 | 4,579 | (1,130 | ) | 82,497 | |||||||||||
Income (loss) from operations | $ | 33,694 | $ | (1,861 | ) | $ | (1,068 | ) | $ | 36,623 | ||||||
Revenue | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased /(Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Revenue | $ | 84,231 | $ | 79,000 | $ | 5,231 | 6.6 | % | $ | 244,556 | $ | 236,501 | $ | 8,055 | 3.4 | % | ||||||||||||||
Revenue for the three months ended June 29, 2019 increased 6.6% primarily driven by growth in both the Sensors test sector from a multi-year contract with the U.S. Department of Defense and the Sensors industrial sector from strength in the energy market, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation, revenue increased 8.9%.
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Revenue for the nine months ended June 29, 2019 increased 3.4% primarily driven by growth in the Sensors test sector from a multi-year contract with the U.S. Department of Defense, growth in the Sensors position sector in the first half of the fiscal year and growth in the Sensors industrial sector from strength in the energy market, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation, revenue increased 5.6%.
Gross Profit | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Gross profit | $ | 40,807 | $ | 39,711 | $ | 1,096 | 2.8 | % | $ | 119,640 | $ | 119,120 | $ | 520 | 0.4 | % | ||||||||||||||
Gross margin | 48.4 | % | 50.3 | % | (1.9 | ) | ppts | 48.9 | % | 50.4 | % | (1.5 | ) | ppts | ||||||||||||||||
Gross profit for the three and nine months ended June 29, 2019 increased 2.8% and 0.4%, respectively, primarily due to increased revenue volume, partially offset by increased compensation expense and the unfavorable impact of currency translation. Gross margin declined 1.9 and 1.5 percentage points, respectively, primarily driven by increased compensation expense during the ramp-up of manufacturing capacity to support both new products and growth in order volume in a tight labor market. Excluding the impact of currency translation, gross profit increased 4.7% and 2.3%, respectively, and gross margin declined 2.0 and 1.6 percentage, respectively.
Selling and Marketing Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Selling and marketing | $ | 14,871 | $ | 14,692 | $ | 179 | 1.2 | % | $ | 44,492 | $ | 43,596 | $ | 896 | 2.1 | % | ||||||||||||||
% of revenue | 17.7 | % | 18.6 | % | 18.2 | % | 18.4 | % | ||||||||||||||||||||||
Selling and marketing expense for the three and nine months ended June 29, 2019 increased 1.2% and 2.1%, respectively, primarily driven by increased compensation from headcount additions to support sales growth, partially offset by the favorable impact of currency translation. Excluding the impact of currency translation, selling and marketing expense increased 3.2% and 3.9%, respectively.
General and Administrative Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
General and administrative | $ | 9,792 | $ | 8,160 | $ | 1,632 | 20.0 | % | $ | 28,088 | $ | 25,881 | $ | 2,207 | 8.5 | % | ||||||||||||||
% of revenue | 11.6 | % | 10.3 | % | 11.5 | % | 10.9 | % | ||||||||||||||||||||||
General and administrative expense for the three and nine months ended June 29, 2019 increased 20.0% and 8.5%, respectively, primarily driven by higher professional fees and compensation expense. Excluding the impact of currency translation, general and administrative expense increased 20.8% and 9.3%, respectively.
Research and Development Expense | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Research and development | $ | 4,588 | $ | 4,461 | $ | 127 | 2.8 | % | $ | 13,366 | $ | 13,020 | $ | 346 | 2.7 | % | ||||||||||||||
% of revenue | 5.4 | % | 5.6 | % | 5.5 | % | 5.5 | % | ||||||||||||||||||||||
R&D expense for the three and nine months ended June 29, 2019 increased 2.8% and 2.7%, respectively, primarily driven by continued investment in new product development. Excluding the impact of currency translation, R&D expense increased 4.0% and 3.7%, respectively.
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Income from Operations | ||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
June 29, 2019 | June 30, 2018 | Increased / (Decreased) | June 29, 2019 | June 30, 2018 | Increased / (Decreased) | |||||||||||||||||||||||||
$ | % | $ | % | |||||||||||||||||||||||||||
Income from operations | $ | 11,556 | $ | 12,398 | $ | (842 | ) | (6.8 | )% | $ | 33,694 | $ | 36,623 | $ | (2,929 | ) | (8.0 | )% | ||||||||||||
% of revenue | 13.7 | % | 15.7 | % | 13.8 | % | 15.5 | % | ||||||||||||||||||||||
Income from operations for the three and nine months ended June 29, 2019 declined 6.8% and 8.0%, respectively, primarily due to increased compensation expense, the unfavorable impact of currency translation and higher professional fees, partially offset by increased gross profit on higher revenue volume. Excluding the impact of currency translation, income from operations decreased 4.0% and 5.1%, respectively.
Cash Flow Comparison
The following table summarizes our cash flows from total operations:
Nine Months Ended | ||||||||
June 29, 2019 | June 30, 2018 | |||||||
Total cash provided by (used in): | ||||||||
Operating activities | $ | 49,970 | $ | 52,111 | ||||
Investing activities | (101,178 | ) | (8,885 | ) | ||||
Financing activities | 55,384 | (85,601 | ) | |||||
Effect of exchange rate changes on cash | (245 | ) | 45 | |||||
Increase (decrease) during the period | 3,931 | (42,330 | ) | |||||
Cash and cash equivalents balance, beginning of period | 71,804 | 108,733 | ||||||
Cash and cash equivalents balance, end of period | $ | 75,735 | $ | 66,403 | ||||
Operating Activities
The decrease in cash provided by operating activities was primarily due to an increase in cash used by working capital associated with timing fluctuations from accounts receivable payments received and unbilled accounts receivable accruals, accounts payable payments, advanced payments received from customers, and inventory purchases, as well as a decrease in net income due to the remeasurement of our estimated deferred tax liabilities as a result of the Tax Act in fiscal year 2018. This decrease was partially offset by a reduction in cash used by deferred income taxes due to the Tax Act in fiscal year 2018, an increase in cash provided by other assets and liabilities related to accrued project costs, and a decrease in cash used by payroll-related accruals.
Investing Activities
The increase in cash used in investing activities was primarily due to the acquisition of E2M in the first quarter of fiscal year 2019 as well as an increase in cash used to purchase property and equipment for continued strategic investments in the business.
Financing Activities
The increase in cash provided by financing activities was primarily due to borrowings under the Revolving Credit Facility used to fund the acquisition of E2M and a decrease in cash used for long-term debt payments due to required annual Excess Cash Flow payments made in fiscal year 2018.
Liquidity and Capital Resources
We had cash and cash equivalents of $75,735 as of June 29, 2019. Of this amount, $21,623 was located in North America, $28,601 in Europe and $25,511 in Asia. Repatriation of certain foreign earnings is restricted by local law. The North American cash balance was primarily invested in bank deposits. The cash balances in Europe and Asia were primarily invested in money market funds and bank deposits. In accordance with our investment policy, we place cash equivalent investments with issuers who have high-quality investment credit ratings. In addition, we limit the amount of investment exposure we have with any particular issuer. Our investment objectives are to preserve principal, maintain liquidity and achieve the best available return consistent with our primary objectives of safety and liquidity. As of June 29, 2019, we held no short-term investments.
As a result of the transition tax related to the enactment of the Tax Act, we are able to repatriate cash held in our foreign subsidiaries without such funds being subject to additional federal income tax liability. We plan to continue to repatriate certain amounts of our existing offshore cash and future earnings back to the U.S.
44
As of June 29, 2019, our capital structure was comprised of $31,634 in short-term debt, $440,767 in long-term debt and $494,539 in shareholders' equity. Long-term debt included $80,391 on our Revolving Credit Facility used to finance the acquisition of E2M. The Consolidated Balance Sheets also included $9,885 of unamortized debt issuance costs as of June 29, 2019. Total interest-bearing debt as of June 29, 2019 was $472,401. We have a credit agreement with a consortium of financial institutions (the Credit Agreement) that provides for senior secured credit facilities consisting of a Revolving Credit Facility and a Term Facility. The maturity date of the Revolving Credit Facility is July 5, 2022 and the maturity date of the loans under the Term Facility is July 5, 2023, unless a term loan lender agrees to extend the maturity date pursuant to a loan modification agreement made in accordance with the terms of the Credit Agreement. The Credit Agreement also requires mandatory prepayments on our Term Facility in certain circumstances, including the potential for an annual required prepayment of a certain percentage of our excess cash flow.
Under the Credit Agreement, we are subject to customary affirmative and negative covenants, including, among others, restrictions on our ability to incur debt, create liens, dispose of assets, make investments, loans, advances, guarantees and acquisitions, enter into transactions with affiliates and enter into any restrictive agreements and customary events of default (including payment defaults, covenant defaults, change of control defaults and bankruptcy defaults). The Credit Agreement also contains financial covenants, including the ratio of consolidated total indebtedness to adjusted consolidated earnings before interest, taxes, depreciation and amortization (Adjusted EBITDA), as defined in the Credit Agreement, as well as the ratio of Adjusted EBITDA to consolidated interest expense. These covenants restrict our ability to pay dividends and purchase outstanding shares of common stock. As of June 29, 2019, we were in compliance with these financial covenants. See Note 9 to the Consolidated Financial Statements included in Item I of Part I of this Quarterly Report on Form 10-Q for additional information on our financing arrangements.
Shareholders' equity increased by $16,607 during the nine months ended June 29, 2019 primarily due to $38,246 net income and $7,515 stock-based compensation. The increase was partially offset by $16,355 dividends declared and $6,885 other comprehensive loss. Also contributing to the decrease was a cumulative effect of accounting change reduction to our opening retained earnings balance of $6,227 related to the adoption of the new revenue recognition standard, ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).
As of June 29, 2019, we believe our current capital resources will be sufficient to fund working capital requirements, capital expenditures and operations for the foreseeable future, including at least the next twelve months. See Note 17 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for changes to our capital structure incurred subsequent to the end of the third quarter of fiscal year 2019.
Off-balance Sheet Arrangements
As of June 29, 2019, we did not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Critical Accounting Policies
The Consolidated Financial Statements have been prepared in accordance with GAAP, which requires us to make estimates and assumptions in certain circumstances that affect amounts reported, giving due consideration to materiality, that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of any contingent assets and liabilities at the date of the financial statements. We regularly review our estimates and assumptions, which are based on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For further information, see "Summary of Significant Accounting Policies" under Note 1 to the Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended September 29, 2018. For a discussion of our critical accounting policies, see "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year ended September 29, 2018.
The following critical accounting policy has been updated since our Annual Report on Form 10-K for the fiscal year ended September 29, 2018.
Revenue Recognition (Over Time)
Revenue is recognized either over time as work progresses or at a point-in-time, dependent upon contract-specific terms and the pattern of transfer of control of the product or service to the customer. Contracts with equipment revenue recognized over time use costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying the performance obligation. Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer. Equipment contract costs include materials, component parts, labor and overhead costs. For contracts
45
recognized over time, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract. Contract estimates are based on various assumptions to determine the outcome of future events that may span several years. These assumptions include labor productivity and availability, the complexity of the work to be performed, the cost and availability of materials, and internal and subcontractor performance.
As a significant change in one or more of these estimates could affect the profitability of our contracts, we review and update our contract-related estimates regularly. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the period it is identified. Our review of contract-related estimates has not resulted in adjustments that are significant to our results of operations.
Recently Issued Accounting Pronouncements
Information regarding new accounting pronouncements is included in Note 2 and Note 3 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q.
Other Matters
Dividends
Our dividend policy is to maintain a payout ratio that allows dividends to increase in conjunction with the long-term growth of earnings per share, while sustaining dividends through economic cycles. Our dividend practice is to target, over time, a payout ratio of approximately 25% of net earnings per share. We have historically paid dividends to holders of our common stock on a quarterly basis. The declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, debt repayment obligations, business development needs and regulatory considerations and are at the discretion of our Board of Directors.
Forward-looking Statements
Statements contained in this Quarterly Report on Form 10-Q including, but not limited to, the discussion under Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, that are not statements of historical fact are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act). In addition, certain statements in our future filings with the SEC, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, ROIC, Adjusted EBITDA, net income or loss, earnings or loss per share, the payment or nonpayment of dividends, our capital structure, the adequacy of our liquidity and reserves, the anticipated level of expenditures required and other statements concerning future financial performance; (ii) statements of our plans and objectives by our management or Board of Directors, including those relating to products or services, our restructuring initiatives, merger or acquisition activity and the potential impact of newly acquired businesses; (iii) statements of assumptions underlying such statements; (iv) statements regarding business relationships with vendors, customers or collaborators or statements relating to our order cancellation history, our ability to convert our backlog of undelivered orders into revenue, the timing of purchases, competitive advantages and growth in end markets; and (v) statements regarding our products and their characteristics, fluctuations in the costs of raw materials for products, our geographic footprint, performance, sales potential or effect in the hands of customers. Words such as "believes," "anticipates," "expects," "intends," "targeted," "should," "potential," "goals," "strategy," and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those described in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended September 29, 2018 and in Item 1A of Part II of this Quarterly Report on Form 10-Q. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these forward-looking statements with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. You should carefully review the disclosures and the risk factors described in our Annual Report on Form 10-K for the fiscal year ended September 29, 2018 and in other documents we file from time to time with the SEC, including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
Approximately 70% of our revenue has historically been derived from customers outside of the U.S. Our international subsidiaries have functional currencies other than our U.S. dollar reporting currency and, occasionally, transact business in currencies other than their functional currencies. These non-functional currency transactions expose us to market risk on assets, liabilities and cash flows recognized on these transactions.
The strengthening of the U.S. dollar relative to foreign currencies decreases the value of foreign currency-denominated revenue and earnings when translated into U.S. dollars resulting in an unfavorable currency translation impact on revenue and earnings. Conversely, a weakening of the U.S. dollar increases the value of foreign currency-denominated revenue and earnings resulting in a favorable currency translation impact on revenue and earnings.
A hypothetical 10% appreciation or depreciation in foreign currencies against the U.S. dollar, assuming all other variables are held constant, would result in an increase or decrease in revenue of approximately $25,701 for the nine months ended June 29, 2019.
We have operational procedures to mitigate these non-functional currency exposures. We also utilize foreign currency exchange contracts to exchange currencies at set exchange rates on future dates to offset expected gains or losses on specifically identified exposures.
Mark-to-market gains and losses on derivatives designated as cash flow hedges in our currency hedging program are recorded within accumulated other comprehensive income (loss) (AOCI) in the Consolidated Balance Sheets. Mark-to-market gains and losses are reclassified from AOCI to earnings in the same line item in the Consolidated Statements of Income and in the same period as the recognition of the underlying hedged transaction. Net gains and losses on foreign currency transactions included in the accompanying Consolidated Statements of Income were net losses of $651 and $73 during the nine months ended June 29, 2019 and June 30, 2018, respectively. See Note 8 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on our cash flow hedge currency exchange contracts.
Interest Rates
We are directly exposed to changes in market interest rates on cash, cash equivalents, short-term investments and long-term debt, and are indirectly exposed to the impact of market interest rates on overall business activity.
On floating-rate investments, increases or decreases in market interest rates will increase or decrease future interest income, respectively. On floating-rate debt, increases or decreases in market interest rates will increase or decrease future interest expense, respectively. On fixed-rate investments, increases or decreases in market interest rates do not impact future interest income but may decrease or increase the fair market value of the investments, respectively. On fixed-rate debt, increases or decreases in market interest rates do not impact future interest expense but may decrease or increase the fair market value of the debt, respectively.
As of June 29, 2019, we had cash and cash equivalents of $75,735, some of which was invested in interest-bearing bank deposits or money market funds. The interest-bearing bank deposits and money market funds have interest rates that reset every 1 to 89 days and generate interest income that will vary based on changes in short-term interest rates. A hypothetical decrease of 100 basis points in market interest rates, assuming all other variables were held constant, would decrease interest income by approximately $74 for the nine months ended June 29, 2019.
Secured floating rate credit facilities require interest payments to be calculated at a floating rate and are therefore impacted by increases or decreases in market interest rates. We have hedged a portion of our floating-rate debt to a fixed-rate such that the interest expense on this debt will not vary with changes in short-term interest rates. See Note 9 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on our interest rate swap. A hypothetical increase of 100 basis points in floating interest rates applied against our unhedged variable interest rate debt balance, assuming all other variables were held constant, would result in an approximately $2,652 increase in future annual interest expense.
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Item 4. Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), as of June 29, 2019. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 29, 2019, our disclosure controls and procedures were effective.
There were no changes in our internal control over financial reporting during the third quarter of fiscal year 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to various claims, legal actions and complaints arising in the ordinary course of business. We are not presently a party to any litigation the outcome of which we believe, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, cash flows or financial condition.
Item 1A. Risk Factors
A discussion of our risk factors can be found in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended September 29, 2018. The information below includes additional and updated risks relating to our $350,000 aggregate principal amount 5.750% senior unsecured notes due 2027 (the Notes) and other indebtedness. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks not currently known to us, or that we currently deem to be immaterial, may also adversely affect our business, financial condition or results of operations in future periods.
Our level and terms of indebtedness could adversely affect our ability to raise additional capital to fund our operations and take advantage of new business opportunities and prevent us from meeting our obligations under our debt instruments.
As of June 29, 2019, we had $468,357 outstanding under our senior secured credit facilities. Giving pro forma effect to the issuance of the Notes on July 16, 2019, as of June 29, 2019 we would have had $350,000 in aggregate principal amount of senior unsecured notes outstanding, approximately $174,000 outstanding under our Tranche B term loan facility and no amounts drawn under our revolving credit facility. See Note 17 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for changes to our capital structure incurred subsequent to the end of the third quarter of fiscal year 2019.
Our substantial debt could have important consequences to us, including:
• | increasing our vulnerability to general economic and industry conditions; |
• | requiring a substantial portion of our cash flow used in operations to be dedicated to the payment of principal and interest on our indebtedness; therefore, reducing our liquidity and our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities; |
• | exposing us to the risk of increased interest rates, and corresponding increased interest expense, because future borrowings under our senior secured credit facilities will be at variable rates of interest; |
• | reducing funds available for working capital, capital expenditures, acquisitions and other general corporate purposes due to the costs and expenses associated with such debt; |
• | limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions, and general corporate or other purposes; |
• | limiting our ability to adjust to changing marketplace conditions and placing us at a competitive disadvantage compared to our competitors who may have less debt; and |
• | potentially causing us to fail to comply with the financial and other restrictive covenants in our debt instruments, which, among other things, require us to maintain specified financial ratios, which failure could, if not cured or waived, have a material adverse effect on our ability to fulfill our obligations under our senior secured credit facilities and the Notes and on our business and prospects generally. |
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In addition, the credit agreement that governs our senior secured credit facilities and the indenture that governs the Notes impose significant operating and financial restrictions on us, including limitations on our ability to, among other things, incur additional indebtedness (including guarantee obligations); incur liens; engage in mergers, consolidations and certain other fundamental changes; dispose of assets; make advances, investments and loans; engage in sale and leaseback transactions; engage in certain transactions with affiliates; pay dividends, distributions and other payments in respect of capital stock; repurchase or retire capital stock, warrants or options; and engage in other actions that we may believe are advisable or necessary for our business. As a result of these restrictions, we will be limited as to how we conduct our business and we may be unable to raise additional debt or equity financing to compete effectively or to capitalize on available business opportunities. Further, our tranche B term loan facility is also subject to mandatory prepayments in certain circumstances and requires a prepayment of a certain percentage of our excess cash flow. Any future mandatory prepayments will reduce our cash available for other purposes and could impact our ability to reinvest in other areas of our business.
There are no assurances that we will maintain a level of liquidity sufficient to permit us to pay the principal, premium and interest on our indebtedness. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital, or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations, which could cause us to default on our debt obligations and impair our liquidity. In the event of a default under any of our indebtedness, the holders of the defaulted debt could elect to declare all the funds borrowed to be due and payable, together with accrued and unpaid interest, which in turn could result in cross-defaults under our other indebtedness. The lenders under our senior secured credit facilities could also elect to terminate their commitments thereunder and cease making further loans, and such lenders could institute foreclosure proceedings against their collateral, and we could be forced into bankruptcy or liquidation.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Our senior secured credit facilities bear, and other indebtedness we may incur in the future may bear, interest at a variable rate. As a result, at any given time interest rates on the senior secured credit facilities and any other variable rate debt could be higher or lower than current levels. If interest rates increase, our debt service obligations on our variable rate indebtedness will increase even though the amount borrowed remains the same, and therefore net income and associated cash flows, including cash available for servicing our indebtedness, will correspondingly decrease.
Increases in interest rates may directly impact the amount of interest we are required to pay and reduce earnings accordingly. In addition, recent developments in tax policy as a part of the Tax Act, such as the disallowance of tax deductions for a portion of the interest paid on outstanding indebtedness, could have a material adverse effect on our results of operations and liquidity.
Despite our current level of indebtedness, the terms of our existing indebtedness allow us, under certain circumstances, to incur substantially more debt, incur substantial ordinary course operating obligations, and enter into other transactions, which would increase our leverage and further exacerbate the risks to our financial condition described above.
We may be able to incur significant additional indebtedness in the future. Although the credit agreement that governs our senior secured credit facilities and the indenture that governs the senior unsecured notes contain restrictions on incurring additional indebtedness and entering into certain types of other transactions, these restrictions are subject to a number of qualifications and exceptions. Additional indebtedness incurred in compliance with these restrictions could be substantial. In addition, these restrictions also do not prevent us from incurring obligations, such as certain trade payables, that do not constitute indebtedness as defined under our debt instruments. To the extent we incur additional indebtedness or other obligations, the risks described herein may increase.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents repurchases of our equity securities we made during the fiscal quarter ended June 29, 2019:
Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased As Part of Publicly Announced Plans or Programs | Maximum Number of Shares that May Yet be Purchased As Part of Publicly Announced Plans or Programs | ||||||||||
March 31, 2019 – May 4, 2019 | — | $ | — | — | 438 | ||||||||
May 5, 2019 – June 1, 2019 | — | $ | — | — | 438 | ||||||||
June 2, 2019 – June 29, 2019 | — | $ | — | — | 438 | ||||||||
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We purchase common stock from time to time to mitigate dilution related to new shares issued for employee compensation such as stock options, restricted stock units, performance restricted stock units and for employee stock purchase plan activity, as well as to return to shareholders capital not immediately required to fund ongoing operations.
Share Purchase Plan
Our Board of Directors approved, and on February 11, 2011 announced, a purchase authorization of 2,000 shares. Authority over pricing and timing under the authorization has been delegated to management. The share purchase authorization has no expiration date. We made no share purchases during the third quarter of fiscal year 2019. As of June 29, 2019, there were 438 shares available for purchase under the existing authorization.
Capped Calls
In connection with the pricing of the tangible equity units (TEUs) sold in our public offering in fiscal year 2016, we purchased capped calls from third party banking institutions (Capped Calls) for $7,935. On June 13, 2018, we amended the agreements with third party banking institutions for the outstanding Capped Calls (Capped Call Agreements) to modify the timing of settlement to be only upon expiration for all outstanding Capped Calls. Per the Capped Call Agreements, the outstanding Capped Calls will automatically settle upon Capped Call Expiration in the fourth quarter of fiscal year 2019. As of June 29, 2019 the range of shares of our common stock to be received for the outstanding Capped Calls was a minimum of 0 shares to a maximum of 268 shares, subject to market conditions. See Note 12 to the Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q for additional information on our equity instruments.
Item 6. Exhibits
Exhibit Number | Description | |||
4.1 | ||||
31.1 | ||||
31.2 | ||||
32.1 | ||||
32.2 | ||||
101.INS | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document (filed herewith). | |||
101.SCH | XBRL Taxonomy Extension Schema Document (filed herewith). | |||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document (filed herewith). | |||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document (filed herewith). | |||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document (filed herewith). | |||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document (filed herewith). | |||
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SIGNATURES
Pursuant to the requirements 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.
MTS SYSTEMS CORPORATION | |||
Date: | August 5, 2019 | /s/ JEFFREY A. GRAVES | |
Jeffrey A. Graves | |||
President and Chief Executive Officer | |||
(Principal Executive Officer) | |||
Date: | August 5, 2019 | /s/ BRIAN T. ROSS | |
Brian T. Ross | |||
Executive Vice President and Chief Financial Officer | |||
(Principal Financial Officer and Principal Accounting Officer) | |||
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