KEY TRONIC CORPORATION Overview
Key Tronic is a leading contract manufacturer offering value-added design and manufacturing services from its facilities inthe United States ,Mexico ,China andVietnam . We provide full engineering services, materials management, worldwide manufacturing facilities, assembly services, in-house testing, worldwide distribution and unparalleled customer service. It's customers include some of the world's leading original equipment manufacturers. Our combined capabilities and vertical integration are proving to be a desirable offering to our expanded customer base. Our international production capability provides our customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in all of our operating facilities to give us the production capacity, capabilities and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Part II Item 1A, Risk Factors included as part of this filing. Our mission is to provide our customers with superior manufacturing and engineering services at the lowest total cost for the highest quality products, and create long-term mutually beneficial business relationships by employing our "Trust, Commitment, Results" philosophy. Executive Summary During the fourth quarter of fiscal year 2021, we won new programs involving consumer products, exercise equipment, and residential building products. We reported net sales of$518.7 million for fiscal year 2021, the highest annual revenue in the Company's fifty-two year history, and up 15% from$449.5 million for fiscal year 2020. While demand has remained strong from both new and existing customers, revenue for the fourth quarter and for the full year of fiscal year 2021 continued to be significantly constrained by issues related to the worldwide pandemic, the supply chain, and transportation and logistics. Moving into fiscal 2022, the COVID-19 crisis, component shortages and logistic delays continue to present multiple business challenges, but we continue to see the favorable trend of contract manufacturing returning toNorth America . With our recent investments in new capacity, we're increasingly well-prepared for long term growth. For the first quarter of fiscal year 2022, the Company expects to report revenue in the range of$125 million to$135 million . Despite growing customer demand and backlog, we expect that delays in the supply of key components for the Company's business will continue to significantly limit production and adversely impact operating efficiencies. We have continued to diversify our customer base by adding additional programs and customers. Our current customer relationships involve a variety of products, including consumer electronics, electronic storage devices, plastics, household products, gaming devices, specialty printers, telecommunications, industrial equipment, military supplies, computer accessories, medical, educational, irrigation, automotive, transportation management, robotics, RFID, power supply, off-road vehicle equipment, fitness equipment, HVAC controls, consumer products, home building products, material handling systems, lighting equipment, consumer security products, smart security, architectural LED lighting, power meters and smart grid, wireless power solutions, sanitizer dispensing, automotive controllers, oil and gas drilling, wireless security and personal healthcare protective equipment. Gross profit as a percent of net sales was 8.1 percent in fiscal year 2021 compared to 7.8 percent for the prior fiscal year. The increase in gross profit as a percentage of net sales was primarily related to streamlining efforts in the Company'sJuarez facilities partially offset by supply chain constraints, a temporary four-day closure of ourMexico facilities during a late winter storm that caused power disruptions in the region, and continued but lessening expenses related to COVID-19. The level of gross margin is impacted by product mix, timing of the startup of new programs, facility utilization, and pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter and year to year. Operating income as a percentage of net sales for fiscal year 2021 was 1.8 percent compared to 1.5 percent for fiscal year 2020. The increase in operating income as a percentage of net sales was primarily driven by the increase in gross profit. Net income for fiscal year 2021 was$4.3 million or$0.39 per share, as compared to$4.8 million or$0.44 per share for fiscal year 2020. Earnings for the fourth quarter of fiscal 2021 continued to be adversely impacted by supply chain and transportation and logistics issues causing both factory downtime and overtime expenses. Earnings for the fourth quarter of fiscal 2021 were also constrained by legal and other professional service expenses related to the previously disclosed internal investigation of approximately$1.0 million during quarter, and we expect some additional expenses to occur prospectively. Additionally, the Company recorded approximately$0.5 million in non-cash tax expense related to expired stock appreciation rights during the fourth quarter of fiscal year 2021. 21
--------------------------------------------------------------------------------
We maintained a strong balance sheet with a current ratio of 2.4 and a debt to equity ratio of 0.81. Total cash used in operating activities as defined on our cash flow statement was$15.1 million during fiscal year 2021. We maintained sufficient liquidity for our expected future operations. We believe cash flow from operations, our borrowing capacity, and equipment financing should provide adequate capital for planned growth over the long term. RESULTS OF OPERATIONS Comparison of the Fiscal Year EndedJuly 3, 2021 with the Fiscal Year EndedJune 27, 2020 The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report. Fiscal Year Ended % of % of % point July 3, 2021 net sales June 27, 2020 net sales $ change change Net sales$ 518,698 100.0%$ 449,480 100.0%$ 69,218 - Cost of sales 476,659 91.9 414,231 92.2 62,428 (0.3) Gross profit 42,039 8.1 35,249 7.8 6,790 0.3 Operating expenses: Research, development and engineering 9,790 1.9 7,391 1.6 2,399
0.3
Selling, general and administrative 22,723 4.4 21,030 4.7 1,693 (0.3) Total operating expenses 32,513 6.3 28,421 6.3 4,092 - Operating income 9,526 1.8 6,828 1.5 2,698 0.3 Interest expense, net 3,613 0.7 2,509 0.6 1,104 0.1 Income before income taxes 5,913 1.1 4,319 1.0 1,594 0.1 Income tax provision (benefit) 1,572 0.3 (439) (0.1) 2,011 0.4 Net income$ 4,341 0.8%$ 4,758 1.1%$ (417) (0.3) Effective income tax rate 26.6 % (10.2) % Net Sales The increase in net sales of$69.2 million from prior year period was primarily driven by an increase in new program wins and demand for current programs. However, partially offsetting the increase in revenue during fiscal year 2021, the Company's revenue was constrained by tightening worldwide supply chain and transportation and logistics issues which delayed the arrival of key components, causing factory downtime. The following table shows the revenue by industry sectors as a percentage of revenue for fiscal years 2021 and 2020: Fiscal Year Ended July 3, 2021 June 27, 2020 Consumer 51% 44% Industrial 38% 42% Communication 5 4 Gaming 3 5 Transportation 1 2 Printers 1 2 Computer and Peripheral 1 1 Total 100% 100% We provide services to customers in a number of industries and produce a variety of products for our customers in each industry.Key Tronic does not target any particular industry, but rather seeks to find programs that strategically fit our vertical manufacturing capabilities. As we continue to diversify our customer base and win new customers, we expect to continue to see a change in the industry concentrations of our revenue. Sales to foreign locations represented 28.2 percent and 24.6 percent of our total net sales in fiscal years 2021 and 2020, respectively. 22
--------------------------------------------------------------------------------
Cost of Sales Total cost of sales as a percentage of net sales was 91.9 percent and 92.2 percent in fiscal years 2021 and 2020, respectively. We provide a reserve for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. We also consider our customers' ability to pay for inventory whether or not there is a lead-time assurance agreement for a specific program. The amounts charged to expense for these inventories were approximately$753,000 and$136,000 in fiscal years 2021 and 2020, respectively. We provide warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. Warranty expense is related to workmanship claims on keyboards and other products. The amounts charged to expense are determined based on an estimate of warranty exposure. The net warranty expense was approximately$145,000 and$121,000 in fiscal years 2021 and 2020, respectively. Gross Profit Gross profit as a percentage of net sales was 8.1 percent and 7.8 percent in fiscal years 2021, and 2020, respectively. The 0.3 percentage point increase in gross profit as a percentage of net sales during fiscal year 2021 as compared to fiscal year 2020 is primarily related to streamlining efforts in the Company'sJuarez facilities and material cost reductions, partially offset by supply chain constraints, a temporary four-day closure of ourMexico facilities during a late winter storm that caused power disruptions in the region, and continued but lessening expenses related to COVID-19. Changes in gross profit margins reflect the impact of a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing and shortages, end market demand for customers' products, fluctuations in and timing of customer orders, and competition within the contract manufacturing industry. These and other factors can cause variations in operating results. There can be no assurance that gross margins will not decrease in future periods. We took early pay discounts to suppliers that totaled approximately$32,000 and$0.1 million in fiscal years 2021 and 2020, respectively. Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. Research, Development and Engineering Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology and facilities costs. Total RD&E expenses were$9.8 million in fiscal year 2021 and$7.4 million in fiscal year 2020, respectively. The Company invested more in its RD&E in fiscal year 2021 for development and design of customer programs. The Company anticipates higher RD&E costs in the future as the Company continues to offer these services. Total RD&E expenses as a percent of net sales was 1.9 percent in fiscal year 2021 and 1.6 in fiscal year 2020. Selling, General and Administrative Selling, general and administrative expenses (SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales commissions, travel expenses, provision for doubtful accounts, facilities costs, and professional services. Total SG&A expenses were$22.7 million and$21.0 million in fiscal years 2021 and 2020, respectively. Total SG&A expenses as a percent of net sales were 4.4 percent and 4.7 percent in fiscal years 2021 and 2020, respectively. This 0.3 percentage point decrease in SG&A as a percentage of net sales is primarily related to an increase in sales year over year and a decrease in travel related expenses due to the COVID-19 pandemic. 23
--------------------------------------------------------------------------------
Interest Expense We had net interest expense of$3.6 million and$2.5 million in fiscal years 2021 and 2020, respectively. The increase in interest expense is primarily related to an increase in the average balance outstanding on our line of credit and increased interest rates. Income Tax Benefit We had an income tax expense of approximately$1.6 million during fiscal year 2021 and an income tax benefit of approximately$(0.4) million during fiscal year 2020. The income tax expense (benefit) recognized during both fiscal years 2021 and 2020 was primarily a function ofU.S. and foreign taxes recognized at statutory rates, the net benefit associated with federal research and development tax credits, the non-cash tax impact of expired stock appreciation rights in fiscal year 2021, and the recognition of previously unrecognized tax benefits for federal research and development tax credits in fiscal year 2020. We continually review our requirements for liquidity domestically to fund current operations, revenue growth and to look for potential future acquisitions. We anticipate repatriating a portion of our unremitted foreign earnings. The estimated taxes associated with these expected repatriations are included in the income tax calculation. For further information on taxes please review footnote 6 of the "Notes to Consolidated Financial Statements." International Subsidiaries We offer customers a complete global manufacturing solution. Our facilities provide our customers the opportunity to have their products manufactured in the facility that best serves specific cost, product manufacturing and distribution needs. The locations of active foreign subsidiaries are as follows: •Key Tronic Juarez,SA de CV owns five facilities and leases three facilities inJuarez, Mexico . These facilities include an SMT facility, an assembly and molding facility, a sheet metal fabrication facility, and assembly and warehouse facilities. This subsidiary is primarily used to support ourU.S. operations. •Key Tronic Computer Peripherals (Shanghai ) Co., Ltd. leases two facilities with SMT, assembly, global purchasing and warehouse capabilities inShanghai, China , which began operations in 1999. Its primary function is to provide contract manufacturing services for export. •Key Tronic Vietnam leases one facility inDa Nang, Vietnam . This facility includes SMT, assembly, and warehouse capabilities. Its primary function is to provide contract manufacturing services for export. Foreign sales (based on shipping instructions) from our worldwide operations, including domestic exports, were$146.5 million and$110.7 million in fiscal years 2021 and 2020, respectively. Products and manufacturing services provided by our subsidiary operations are often shipped to customers directly by the parent company. RESULTS OF OPERATIONS Comparison of the Fiscal Year EndedJune 27, 2020 with the Fiscal Year EndedJune 29, 2019 To review the results of operations comparison of the fiscal year endedJune 27, 2020 with the fiscal year endedJune 29, 2019 , please refer to our Form 10-K filedSeptember 11, 2020 with theSecurities and Exchange Commission or follow the link below.
https://www.sec.gov/ix?doc=/Archives/edgar/data/719733/000071973320000061/ktcc-20200627.htm
Capital Resources and Liquidity Operating Cash Flow Net cash used in operating activities for fiscal year 2021 was$15.1 million compared to net cash used in operating activities of$31.0 million and net cash provided by operating activities of$0.9 million in fiscal years 2020 and 2019, respectively. The$15.1 million of net cash used in operating activities during fiscal year 2021 is primarily related to$4.3 million of net income adjusted for$6.9 million of depreciation and amortization,$24.3 million increase in accounts receivable, a$23.1 million increase in inventory, a$1.0 million increase in contract assets, a$2.3 million decrease in other assets, partially offset by a$12.6 million increase in accounts payable, an$5.6 million increase in other liabilities, and a$1.0 million increase in accrued compensation and vacation. The$31.0 million of net cash used in operating activities during fiscal year 2020 was primarily related to$4.8 million of net income adjusted for$5.6 million of depreciation and amortization,$28.3 million increase in accounts receivable, a$14.7 million increase in inventory, a$7.7 million increase in other assets, a$1.6 million increase in contract assets, partially offset by a$6.6 million increase in accounts payable and a$3.7 million increase in accrued compensation and vacation. 24
--------------------------------------------------------------------------------
The$0.9 million of net cash provided by operating activities during fiscal year 2019 was primarily related to$8.0 million of net loss,$12.4 million impairment of goodwill and intangibles,$7.3 million of depreciation and amortization,$6.7 million of cash received from arbitration settlement, a$3.3 million decrease in accounts receivable, partially offset by a$10.3 million increase in contract assets, a$4.5 million increase in other assets, a$2.6 million increase in accounts payable and a$1.4 million decrease in inventory. Accounts receivable fluctuates based on the timing of shipments, terms offered and collections. In addition, accounts receivable will fluctuate based upon the amount of accounts receivable sold under our Trade Accounts Receivable Purchase Program. The Company did not sell any accounts receivables during the twelve months endedJuly 3, 2021 . During fiscal years 2020 and 2019, we factored receivables of$41.4 million and$81.0 million , respectively, from accounts receivable sold to financial institutions, which are not included on our Consolidated Balance Sheets. The Company no longer had factored receivables at year end fiscal 2021 or 2020. We purchase inventory based on customer forecasts and orders, and when those forecasts and orders change, the amount of inventory may also fluctuate. Accounts payable fluctuates with changes in inventory levels, volume of inventory purchases, negotiated supplier terms, and taking advantage of early pay discounts. Investing Cash Flow Cash flows used in investing activities were$10.6 million for fiscal year 2021. Cash flows used in investing activities were$3.6 million and$1.9 million in fiscal year 2020 and 2019, respectively. Our primary use of cash in investing activities during fiscal years 2021, 2020 and 2019, was purchasing equipment to support increased production levels for new programs. During fiscal years 2020 and 2019, our primary source of cash provided by investing activities came from receipts of the deferred purchase price on factored receivables. Operating and finance leases under accounting guidance that became effective in fiscal year 2020, and capital leases prior to that date are often utilized when potential technical obsolescence and funding requirement advantages outweigh the benefits of equipment ownership. Capital expenditures and periodic lease payments are expected to be financed with internally generated funds and available borrowing capacities. During fiscal years 2021, 2020 and 2019, we did not receive any cash resulting from the sale and leaseback of equipment under operating leases. Financing Cash Flow Cash flows provided by financing activities were$28.6 million ,$34.5 million , and$1.2 million in fiscal years 2021, 2020, and 2019. Our primary financing activities during fiscal year 2021, were repayments on our term loans of$11.7 million as well as borrowings and repayments under our revolving line of credit facility. Our primary financing activities during fiscal year 2020 was repayments on our term loans of$7.1 million as well as borrowings and repayments under our revolving line of credit facility. Our primary financing activities during fiscal year 2019 was repayments on our term loans of$5.9 million as well as borrowings and repayments under our revolving line of credit facility. As ofJuly 3, 2021 , the Company had an outstanding balance on the line of credit of$90.9 million . We had availability to borrow an additional$2.1 million under the asset-based revolving credit facility and we were in compliance with our loan covenants. Our cash requirements are affected by the level of current operations and new programs. We believe that projected cash from operations, funds available under the asset-based revolving credit facility and fixed asset financing will be sufficient to meet our working and fixed capital requirements for the foreseeable future. As ofJuly 3, 2021 , we had approximately$2.0 million of cash held by foreign subsidiaries. Under the Tax Cuts and Jobs Act, future cash repatriations from these foreign subsidiaries are no longer subject toU.S. income taxes, but may be subject to foreign withholding taxes. See additional discussion in Footnote 6, Income Taxes. The total amount of foreign withholding taxes required to be paid for the amount of foreign subsidiary cash on hand as ofJuly 3, 2021 , would approximate$47,000 . The Company also has approximately$23.6 million of foreign earnings that have not been repatriated to theU.S. Of that amount, the Company estimates that$7.5 million is to be repatriated in the future, requiring foreign withholding taxes of$0.8 million that is currently accrued in our deferred tax liabilities. The remaining$16.1 million is considered to be permanently reinvested inMexico ,China andVietnam . If these amounts were required to be repatriated, we estimate it would create an additional$0.8 million in foreign withholding taxes payable. 25
--------------------------------------------------------------------------------
Contractual Obligations and Commitments
In the normal course of business, we enter into contracts which obligate us to
make payments in the future. The table below sets forth our significant future
obligations by fiscal year:
Payments Due by Fiscal Year (in thousands)
Total 2022 2023 2024 2025 2026 Thereafter
Term loans (1) $ 10,049 $ 2,143 $ 2,190 $ 2,239 $ 2,290 $ 1,187 $ -
Bank of America revolving
loan (2) $ 90,886 $ - $ - $ - $ - $ 90,886 $ -
Operating leases (3) $ 18,308 $ 4,225 $ 3,140 $ 2,526 $ 2,427 $ 1,865 $ 4,125
Purchase orders (4) $ 116,067
(1)The terms of the Bank of America term loans are discussed in the consolidated
financial statements at Note 4, "Long-Term Debt." The equipment financing
facility relating to the Company's existing U.S. manufacturing equipment is
payable in equal monthly payments of approximately $94,000 which commenced on
September 14, 2020 and will continue through the maturity of the equipment
financing facility on August 14, 2025 . The equipment financing facility relating
to the Company's existing Mexico manufacturing equipment is payable in equal
monthly payments of approximately $100,000 which commenced on May 24, 2021 and
will continue through the maturity of the equipment term loan on April 24, 2026 .
(2)The terms of the Bank of America asset-based revolving credit facility are
discussed in the consolidated financial statements at Note 4, "Long-Term Debt."
As of July 3, 2021 , we were in compliance with our loan covenants.
(3)We maintain vertically integrated manufacturing operations in the United
States , Mexico , China and Vietnam . We lease some of our administrative and
manufacturing facilities and equipment. A complete discussion of properties can
be found in Part 1, Item 2 at "Properties." Leases have proven to be an
acceptable method for us to acquire new or replacement equipment and to maintain
facilities with a minimum impact on our short term cash flows for operations. In
addition, such operations are heavily dependent upon technically superior
manufacturing equipment including molding machines in various tonnages, Surface
Mount Technology (SMT) lines, sheet metal fabrication and stamping machines,
clean rooms, and automated insertion, and test equipment for the various
products we are capable of producing.
(4)As of July 3, 2021 , we had open purchase order commitments for materials and
other supplies of approximately $116.1 million . Included in the open purchase
orders are various blanket orders for annual requirements. Actual needs under
these blanket purchase orders fluctuate with our manufacturing levels and as
such cannot be broken out between fiscal years. In addition, we have contracts
with many of our customers that minimize our exposure to losses for material
purchased within lead-times necessary to meet customer forecasts. Purchase
orders generally can be cancelled without penalty within specified ranges that
are determined in negotiations with our suppliers. These agreements depend in
part on the type of materials purchased as well as the circumstances surrounding
any requested cancellations.
In addition to the cash requirements presented above, we have various other
accruals which are not included in the table above. For example, we owe our
suppliers approximately $92.8 million for accounts payable and shipments in
transit at the end of the fiscal year. We generally pay our suppliers in a range
from 30 to 120 days depending on terms offered. These payments are financed by
operating cash flows and our revolving line of credit.
We believe that cash flows generated from operations, factoring, leasing
facilities, and funds available under the revolving credit facility will satisfy
cash requirements for a period in excess of 12 months and into the foreseeable
future.
26
--------------------------------------------------------------------------------
Critical Accounting Policies and Estimates
Preparation of our consolidated financial statements requires management to make
estimates and assumptions that affect the reported amount of assets,
liabilities, revenues and expenses. Note 1 to our consolidated financial
statements describes the significant accounting policies used in the preparation
of our consolidated financial statements. Management believes the most complex
and sensitive judgments, because of their significance to our consolidated
financial statements, result primarily from the need to make estimates about
effects of matters that are inherently uncertain. The most significant areas
involving management judgments are described below. Actual results in these
areas could differ from management's estimates.
Revenue
The Company specializes in services ranging from product manufacturing to
engineering and tooling services. The first step in its process for revenue
recognition is to identify the contract with a customer. A contract is defined
as an agreement between two or more parties that creates enforceable rights and
obligations. A contract can be written, oral, or implied. The Company generally
enters into manufacturing service agreements ("MSA") with its customers that
outlines the terms of the business relationship between the customer and the
Company. This includes matters such as warranty, indemnification, transfer of
title and risk of loss, liability for excess and obsolete inventory, pricing,
payment terms, etc. The Company will also bid on a program-by-program basis for
customers in which an executed MSA may not be in place. In these instances, as
well as when we have an MSA in place, we receive customer purchase orders for
specific quantities and timing of products. As a result, the Company considers
its contract with a customer to be the combination of the MSA and the purchase
order. The transaction price is fixed and set forth in each purchase order. In
the Company's normal course of business, there are no variable pricing
components, or material amounts refunded to customers in the form of refunds or
rebates.
The Company assesses whether control of the product or services promised under
the contract is transferred to the customer at a point in time (shipment) or
over time (as we manufacture the product). The Company is first required to
evaluate whether its contracts meet the criteria for 'over-time' or
'point-in-time' recognition. The Company has determined that for the majority of
its contracts the Company is manufacturing products for which there is no
alternative use due to the unique nature of the customer-specific product, IP
and other contract restrictions. Further, the Company has an enforceable right
to payment including a reasonable profit for performance completed to date with
respect to these contracts. As a result, revenue is recognized under these
contracts 'over-time' based on the input cost-to-cost method as it better
depicts the transfer of control. This input method is based on the ratio of
costs incurred to date as compared to the total estimated costs at completion of
the performance obligation. For all other contracts that do not meet these
criteria, such as manufacturing contracts for which the terms do not provide an
enforceable right to payment for performance completed to date, the Company
recognizes revenue when it has transferred control of the related manufactured
products which generally occurs upon shipment to the customer. Revenue from
engineering services is recognized over time as the services are performed.
Inactive, Obsolete, and Surplus Inventory Reserve
Inventories are stated at the lower of cost or net realizable value. Inventory
valuation is determined using the first-in, first-out (FIFO) method. We reserve
for inventories that we deem inactive, obsolete or surplus. This reserve is
calculated based upon the demand for the products that we produce. Demand is
determined by expected sales, customer purchase orders, or customer forecasts.
If expected sales do not materialize, then we would have inventory in excess of
our reserves and would have to charge the excess against future earnings. In the
case where we have purchased material based upon a customer's forecast or
purchase orders, we are usually covered by lead-time assurance agreements or
purchase orders with each customer. These contracts state that the financial
liability for material purchased within agreed upon lead-time and based upon the
customer's forecasts, lies with the customer. If we purchase material outside
the lead-time assurance agreement and the customer's forecasts do not
materialize or if we have no lead-time assurance agreement for a specific
program, we would have the financial liability and may have to charge inactive,
obsolete or surplus inventory against earnings. We also reserve for inventory
related to specific customers covered by lead-time assurance agreements when
those customers are experiencing financial difficulties or reimbursement is not
reasonably assured.
Allowance for Doubtful Accounts
We value our accounts receivable net of an allowance for doubtful accounts. As
of July 3, 2021 , the allowance for doubtful accounts was approximately $275,000 .
As of June 27, 2020 , the allowance for doubtful accounts was approximately
$609,000 . This allowance is based on estimates of the portion of accounts
receivable that may not be collected in the future. The estimates used are based
primarily on specific identification of potentially uncollectible accounts. Such
accounts are identified using publicly available information in conjunction with
evaluations of current payment activity. However, if any of our customers were
to develop unexpected and immediate financial problems that would prevent
payment of open invoices, we could incur additional and possibly material
expenses that would negatively impact earnings.
27
--------------------------------------------------------------------------------
Accrued Warranty An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. We review the adequacy of this accrual quarterly based on historical analysis and anticipated product returns and rework costs. Our warranty period for keyboards is generally longer than that for other products. We only warrant materials and workmanship on products, and we do not warrant design defects for customers. Income Taxes Income tax expense includesU.S. and international income taxes and a provisional estimate forU.S. taxes on undistributed earnings of foreign subsidiaries. We do not record foreign withholding taxes on undistributed earnings of international subsidiaries that are deemed to be permanently reinvested. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. The deferred income taxes are classified as long-term assets or liabilities. The most significant areas involving management judgments include deferred income tax assets and liabilities, uncertain tax positions, and research and development tax credits. Our estimates of the realization of the deferred tax assets related to our tax credits are based upon our estimates of future taxable income which may change. Stock-Based Compensation Stock-based compensation is accounted for according toFinancial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718, Compensation-Stock Compensation. ASC 718 requires us to expense the fair value of employee stock options, stock appreciation rights and other forms of stock-based compensation. Under the fair value recognition provisions of ASC 718, share-based compensation cost is estimated at the grant date based upon the fair value of the award and is recognized as expense ratably over the requisite service period of the award (generally the vesting period). Determining the appropriate fair value model and calculating the fair value of share-based awards requires judgment, including estimating the expected life of the share-based award, the expected stock price volatility over the expected life of the share-based award and forfeitures. To determine the fair value of stock based awards on the date of grant we use the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock price volatility, option life, risk-free interest rate and dividend yield. The risk-free interest rate is a less-subjective assumption as it is based on factual data derived from public sources. We use a dividend yield of zero as we have never paid cash dividends and have no intention to pay cash dividends in the foreseeable future. The expected stock price volatility and option life assumptions require a greater level of judgment. Our expected stock-price volatility assumption is based upon the historical volatility of our stock which is obtained from public data sources. The expected life represents the weighted average period of time that share-based awards are expected to be outstanding, giving consideration to vesting schedules and historical exercise patterns. We determine the expected life assumption based upon the exercise and post-vesting behavior that has been exhibited historically, adjusted for specific factors that may influence future exercise patterns. If expected volatility or expected life were to increase, that would result in an increase in the fair value of our stock options which would result in higher compensation charges, while a decrease in volatility or the expected life would result in a lower fair value of our stock option awards resulting in lower compensation charges. We estimate forfeitures for all of our awards based upon historical experience of stock-based pre-vesting forfeitures. We believe that our estimates are based upon outcomes that are reasonably likely to occur. If actual forfeitures are higher than our estimates it would result in lower compensation expense and to the extent the actual forfeitures are lower than our estimate we would record higher compensation expense. Impairment of Long-Lived Assets Long-lived assets, such as property, plant, and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Derivatives and Hedging Activity Derivatives are recognized on the balance sheet at their estimated fair value. On the date a derivative contract is entered into, the Company designates the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a "cash flow" hedge). The Company does not enter into derivatives for speculative purposes. Changes in the fair value of a derivative that qualifies as a cash flow hedge are recorded in "Accumulated Other Comprehensive Income," until earnings are affected by the variability of cash flows. See Note 10 of the Company's consolidated financial statements for additional information. 28
--------------------------------------------------------------------------------
Long-Term Incentive Compensation Accrual Long-term incentive compensation is recognized as expense ratably over the requisite service period of the award which is generally three years. The Board of Directors approve target performance measures for the three year period for each of the Company's officers and non-employee Directors. Performance measures are based on a combination of sales growth targets and return on invested capital targets. No cash awards will be made to participants if actual Company performance does not exceed the minimum target performance measures. The calculation used to determine the necessary accrual uses a combination of actual results and projected results. We believe that our estimates are based upon outcomes that are reasonably likely to occur. These estimates and assumptions are based on historical results as well as future expectations. Actual results could vary from our estimates and assumptions. Impairment ofGoodwill In accordance with ASC 350,Goodwill and Other Intangible Assets, goodwill is not amortized but is required to be reviewed for impairment at least annually or when events or circumstances indicate that carrying value may exceed fair value. The Company is permitted the option to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the fair value of any reporting unit is less than its corresponding carrying value. If, after assessing the totality of events and circumstances, the Company concludes that it is not more likely than not that the fair value of any reporting unit is less than its corresponding carrying value then the Company is not required to take further action. However, if the Company concludes otherwise, then it is required to perform a quantitative impairment test, including computing the fair value of the reporting unit and comparing that value to its carrying value. The Company utilized a weighting of the income approach and a market approach in the impairment test. We also considered valuation factors including the Company's market capitalization, future discounted cash flows and an estimated control premium based upon a review of comparable market transactions. Our consideration of discounted future cash flows included assumptions regarding growth rates and margins based on our historical trends. In addition, we applied a market discount rate calculated based upon an analysis of companies similar in size. If our future cash flows do not meet our projections or there is an event that impacts our market capitalization, the assumptions used in our goodwill analysis could be negatively impacted.Goodwill impairment would be measured as the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying value of goodwill. In the event that goodwill is impaired, an impairment charge to earnings would become necessary. The Company also has the option to bypass the qualitative assessment for goodwill in any period and proceed directly to performing the quantitative impairment test. Refer to footnote 14 for discussion of the write-off of goodwill and other intangibles that occurred during fiscal year 2019, as a result of certain triggering events being present. New and Future Accounting Pronouncements See Note 1 to our consolidated financial statements. 29
--------------------------------------------------------------------------------
© Edgar Online, source
