ASTRONICS CORP 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Astronics Corporation, through its subsidiaries, is a leading supplier of advanced technologies and products to the global aerospace and defense and other mission-critical industries. We have two reportable segments, Aerospace and Test Systems. Our Aerospace segment has principal operating facilities in the United States, Canada and France. Our Test Systems segment has principal operating facilities in the United States and the United Kingdom. We have engineering offices in the Ukraine and India. Our Aerospace segment designs and manufactures products for the global aerospace industry. Product lines include lighting and safety systems, electrical power generation, distribution and seat motions systems, aircraft structures, avionics products, systems certification, and other products. Our primary Aerospace customers are the airframe manufacturers (“OEM”) that build aircraft for the commercial, military and general aviation markets, suppliers to those OEM’s, aircraft operators such as airlines, suppliers to the aircraft operators, and branches of the U.S. Department of Defense. Our Test Systems segment designs, develops, manufactures and maintains automated test systems that support the aerospace and defense, communications and mass transit industries as well as training and simulation devices for both commercial and military applications. In the Test Systems segment, Astronics’ products are sold to a global customer base including OEM's and prime government contractors for both electronics and military products. Our strategy is to increase our value by developing technologies and capabilities, either internally or through acquisition, and using those capabilities to provide innovative solutions to our targeted markets where our technology can be beneficial. Important factors affecting our growth and profitability are the ongoing impacts of the COVID-19 pandemic and the timing and extent of recovery (as discussed more fully below), the rate at which new aircraft are produced, government funding of military programs, our ability to have our products designed into new aircraft and the rates at which aircraft owners, including commercial airlines, refurbish or install upgrades to their aircraft. New aircraft build rates and aircraft owners spending on upgrades and refurbishments is cyclical and dependent on the strength of the global economy. Once designed into a new aircraft, the spare parts business is frequently retained by the Company. Future growth and profitability of the test business is dependent on developing and procuring new and follow-on business. The nature of our Test Systems business is such that it pursues large, often multi-year, projects. There can be significant periods of time between orders in this business which may result in large fluctuations of sales and profit levels and backlog from period to period. Test Systems segment customers include the Department of Defense, prime contractors to the Department of Defense, mass transit operators and prime contractors to mass transit operators. Each of the markets that we serve presents opportunities that we expect will provide growth for the Company over the long-term. We continue to look for opportunities in all of our markets to capitalize on our core competencies to expand our existing business and to grow through strategic acquisitions. Challenges which continue to face us include the ongoing COVID-19 pandemic and its continued impact on the aerospace industry and improving shareholder value through increasing profitability. Increasing profitability is dependent on many things, primarily sales growth, both acquired and organic, and the Company’s ability to control operating expenses and to identify means of creating improved productivity. Sales are driven by increased build rates for existing aircraft, market acceptance and economic success of new aircraft and our products, continued government funding of defense programs, the Company’s ability to obtain production contracts for parts we currently supply or have been selected to design and develop for new aircraft platforms and continually identifying and winning new business for our Test Systems segment. Reduced aircraft build rates driven by a weak economy, aircraft groundings, tight credit markets, reduced air passenger travel and an increasing supply of used aircraft on the market would likely result in reduced demand for our products, which will result in lower profits. Reduction of defense spending may result in fewer opportunities for us to compete, which could result in lower profits in the future. Many of our newer development programs are based on new and unproven technology and at the same time we are challenged to develop the technology on a schedule that is consistent with specific programs. We will continue to address these challenges by working to improve operating efficiencies and focusing on executing on the growth opportunities currently in front of us. RESTRUCTURING The COVID-19 pandemic caused a significant impact on our sales and net income for fiscal 2020 and is expected to continue to do so into fiscal 2021. This is under the assumption that the COVID-19 pandemic will continue to adversely impact customer 19 demand for all market channels, with commercial transport (both OEM and aftermarket channels) being the most adversely impacted due to the pandemic's impact on air travel worldwide. As a result, the Company executed restructuring activities in the form of workforce reduction, primarily in the second quarter of 2020, to better align capacity with expected demand. Restructuring charges of $4.9 million in severance expense associated primarily with the Aerospace segment was recorded in the year ended December 31, 2020. In the fourth quarter of 2019, in an effort to reduce the significant operating losses at our AeroSat business, we initiated a restructuring plan to reduce costs and minimize losses of our AeroSat antenna business. The plan focused the initiatives for the AeroSat business on near-term opportunities pertaining to business jet connectivity. The plan has a downsized manufacturing operation remaining in New Hampshire, with significantly reduced personnel and operating expenses. Impairments and restructuring charges recorded in 2019 as a result of the restructuring plan amounted to $28.8 million, all of which is included in the Aerospace segment. The Company incurred an impairment charge to right-of-use assets of approximately $0.7 million and $0.4 million in additional restructuring charges associated with severance at AeroSat during the year ended December 31, 2020. ACQUISITIONS On July 1, 2019, the Company acquired all of the issued and outstanding capital stock of Freedom Communication Technologies, Inc. (“Freedom”). Freedom, located in Kilgore, Texas, is a leader in wireless communication testing, primarily for the civil land mobile radio market. Freedom is included in our Test Systems segment. The total consideration for the transaction was $21.8 million, net of $0.6 million in cash acquired. On October 4, 2019, the Company acquired the stock of the primary operating subsidiaries as well as certain other assets from mass transit and defense market test solution provider, Diagnosys Test Systems Limited, for $7.0 million in cash, plus earnouts estimated at a fair value of $2.5 million at acquisition. Diagnosys Inc. and its affiliates (“Diagnosys”) is included in our Test Systems segment. Diagnosys is a developer and manufacturer of comprehensive automated test equipment providing test, support, and repair of high value electronics, electro-mechanical, pneumatic and printed circuit boards focused on the global mass transit and defense markets. The terms of the acquisition allow for a potential earnout of up to an additional $13.0 million over the three years post-acquisition based on achievement of new order levels of over $72.0 million during that period. No earnout was payable for the period from acquisition through December 31, 2020. The acquired business has operations in Westford, Massachusetts as well as Ferndown, England, and an engineering center of excellence in Bangalore, India. DIVESTITURES On February 13, 2019, the Company completed a divestiture of its semiconductor test business within the Test Systems segment. The business was not core to the future of the Test Systems segment. The total cash proceeds received upon the divestiture amounted to $103.8 million. The Company recorded a pre-tax gain on the sale of $80.1 million in the first quarter of 2019. The Company recorded income tax expense relating to the gain of $19.7 million. The transaction also includes two elements of contingent earnouts. The “First Earnout” is calculated based on a multiple of all future sales of existing and certain future derivative products to existing and future customers in each annual period from 2019 through 2022. The First Earnout may not exceed $35.0 million in total. The “Second Earnout” is calculated based on a multiple of future sales related to an existing product and program with an existing customer exceeding an annual threshold for each annual period from 2019 through 2022. The Second Earnout is not capped. For the Second Earnout, if the applicable sales in an annual period do not exceed the annual threshold, no amounts will be paid relative to such annual period; the sales in such annual period do not carry over to the next annual period. Due to the degree of uncertainty associated with estimating the future sales levels of the divested business and its underlying programs, and the lack of reliable predictive market information, the Company has elected an accounting policy to recognize such earnout proceeds, if received, as additional gain on sale when such proceeds are realized or realizable. We consider the proceeds realizable when we have received communication from the purchaser of its calculation of the earnout and the parties reach agreement on the calculation. No amounts were payable to the Company under either earnout for the year ended December 31, 2019. On February 13, 2021, the Company was notified by the purchaser that they have calculated $10.7 million as being payable to the Company under the First and Second Earnouts for the year ended December 31, 2020. There is a period by which we and the purchaser will review the earnout calculation, which is underway. Upon completion of the review and agreement of any adjustments, the Company expects to record the additional gain on the sale in the first quarter of 2021. On July 12, 2019, the Company sold intellectual property and certain assets associated with its Airfield Lighting product line for $1.0 million in cash. The Airfield Lighting product line, part of the Aerospace segment, was not core to the business and represented less than 1% of revenue. The Company recorded a pre-tax loss on the sale of approximately $1.3 million. 20 MARKETS Commercial Transport Market The commercial transport market is our largest end market with sales driven by new aircraft production and aftermarket airline retrofit programs. In the commercial transport market, while many of our key long-term fundamentals remain intact, we continue to see near-term market pressure due to COVID-19. Despite solid progress on the vaccine front, 2021 will remain very challenging for our commercial transport products with improvement expected beginning in the second half of 2021 driven by the return to production of the 737 MAX and an expectation of improved activity with our airline customers. Aircraft build rates are expected to improve modestly during 2021 from current levels as production of the 737 MAX picks up, and the aftermarket is expected to strengthen over the course of the year as aircraft utilization and load factors increase. On the other hand, wide-body production rates and usage are expected to remain depressed throughout 2021 and possibly for several years due to low international travel demand caused by the pandemic. Sales to the commercial transport market include sales of lighting and safety systems, electrical power generation, distribution and motions systems, aircraft structures, avionics products, systems certification, and other products. Sales to this market totaled approximately $262.6 million or 52.3% of our consolidated sales in 2020. As a result of the COVID-19 pandemic and its adverse impact on air travel worldwide, the commercial aerospace industry has been significantly disrupted. The significant impact of the COVID-19 pandemic on the commercial transport market channels has led to this market comprising a lower percentage of our net sales in fiscal 2020 than typical. When the commercial transport industry recovers from the disruption caused by the COVID-19 pandemic, we would expect commercial transport market sales to account for a percentage of net sales that is relatively in line with our historical results prior to the COVID-19 pandemic. Maintaining and growing sales to the commercial transport market will depend not only on market recovery from the impacts of the COVID-19 pandemic, but also on airlines’ capital spending budgets for cabin upgrades as well as the purchase of new aircraft by global airlines. This spending by the airlines is impacted by their profits, cash flow and available financing as well as competitive pressures between the airlines to improve the travel experience for their passengers. We expect that new aircraft will be equipped with more passenger and aircraft connectivity and in-seat power than previous generation aircraft which drives demand for our avionics and power products. This market has historically experienced strong growth from airlines installing in-seat passenger power systems on their existing and newly delivered aircraft. Although the 737 MAX was re-certified in the United States in November 2020 and in Europe in January 2021, and that the demand for the aircraft in the long-term has not changed, further delays in regulatory approval of the Boeing 737 MAX in one or more jurisdictions could substantially decrease sales to this market in the near or long term which could have a material adverse effect on our business, financial condition, results of operations and cash flows. The 737 MAX situation affected us not only because it has been our largest production program, but also because the grounding reduced capacity in the world’s airline fleets, challenging our aftermarket business. Our ability to maintain and grow sales to this market depends on our ability to maintain our technological advantages over our competitors and maintain our relationships with major in-flight entertainment suppliers and global airlines. Military Aerospace Market Sales to the military aerospace market include sales of lighting & safety products, avionics products, electrical power & motion products and structures products. Sales to this market totaled approximately 13.5% of our consolidated sales and amounted to $67.9 million in 2020. The military market is dependent on governmental funding which can change from year to year. Risks are that overall spending may be reduced in the future, specific programs may be eliminated or that we fail to win new business through the competitive bid process. Astronics does not have significant reliance on any one program such that cancellation of a particular program will cause material financial loss. We believe that we will continue to have opportunities similar to past years regarding this market. Business Jet Market The business jet market has also been impacted by the pandemic with new aircraft build rates significantly lower than the previous year. Most of our sales in this market are line-fit products driven by aircraft build rates although there are some aftermarket sales as well. We expect some improvement in the second half of 2021 moving into 2022 as build rates are expected to improve. Sales to the business jet market include sales of lighting & safety products, avionics products, and electrical power & motion products. Sales to this market totaled approximately 12.0% of our consolidated sales in 2020 and amounted to $60.4 million. Sales to the business jet market are driven by our ship set content on new aircraft and build rates of new aircraft. Business jet OEM build rates are impacted by global wealth creation and corporate profitability. We continue to see opportunities on new 21 aircraft currently in the design phase to employ our lighting & safety, electrical power and avionics technologies in this market. There is risk involved in the development of any new aircraft including the risk that the aircraft will not ultimately be produced or that it will be produced in lower quantities than originally expected and thus impacting our return on our engineering and development efforts. Tests Systems Products Our Test Systems segment accounted for approximately 16.8% of our consolidated sales in 2020 and amounted to $84.6 million. Sales to the aerospace & defense market were approximately $81.1 million in 2020. Sales to the semiconductor market were approximately $3.5 million from residual warranty revenue following the Company’s divestiture of its semiconductor test business on February 13, 2019. No further semiconductor revenues are expected beyond 2020. CRITICAL ACCOUNTING POLICIES Our financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles. The preparation of the Company’s financial statements requires management to make estimates, assumptions and judgments that affect the amounts reported. These estimates, assumptions and judgments are affected by management’s application of accounting policies, which are discussed in the Notes to Consolidated Financial Statements, Note 1 of Item 8, Financial Statements and Supplementary Data of this report. The critical accounting policies have been reviewed with the Audit Committee of our Board of Directors. Revenue Recognition Revenue is recognized when, or as, the Company transfers control of promised products or services to a customer in an amount that reflects the consideration the Company expects to be entitled in exchange for transferring those products or services. Sales shown on the Company's Consolidated Statements of Operations are from contracts with customers. Payment terms and conditions vary by contract, although terms generally include a requirement of payment within a range from 30 to 90 days after the performance obligation has been satisfied; or in certain cases, up-front deposits. In circumstances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined that the Company's contracts generally do not include a significant financing component. Taxes collected from customers, which are subsequently remitted to governmental authorities, are excluded from sales. The Company recognizes an asset for the incremental, material costs of obtaining a contract with a customer if the Company expects the benefit of those costs to be longer than one year and the costs are expected to be recovered. These incremental costs include, but are not limited to, sales commissions incurred to obtain a contract with a customer. As of December 31, 2020, the Company does not have material incremental costs on any open contracts with an original expected duration of greater than one year. The Company recognizes an asset for certain, material costs to fulfill a contract if it is determined that the costs relate directly to a contract or an anticipated contract that can be specifically identified, generate or enhance resources that will be used in satisfying performance obligations in the future, and are expected to be recovered. Such costs are amortized on a systematic basis that is consistent with the transfer to the customer of the goods to which the asset relates. Start-up costs are expensed as incurred. Capitalized fulfillment costs are included in Inventories in the accompanying Consolidated Balance Sheets. Should future orders not materialize or it is determined the costs are no longer probable of recovery, the capitalized costs are written off. As of December 31, 2020 and 2019, the Company did not have material capitalized fulfillment costs. 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. The majority 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 which are, therefore, not distinct. Thus, the contract's transaction price is the revenue recognized when or as that performance obligation is satisfied. Promised goods or services that are immaterial in the context of the contract are not separately assessed as performance obligations. Some of our contracts have multiple performance obligations, most commonly due to the contract covering multiple phases of the product lifecycle (development, production, maintenance and support). For contracts with multiple performance obligations, the contract’s transaction price is allocated to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is the expected cost plus margin approach, under which expected costs are forecast to satisfy a performance obligation and then an appropriate margin is added for that distinct good or service. Shipping and handling activities that occur after the customer has obtained control of the good are considered fulfillment activities, not performance obligations. 22 Some of our contracts offer price discounts or free units after a specified volume has been purchased. The Company evaluates these options to determine whether they provide a material right to the customer, representing a separate performance obligation. If the option provides a material right to the customer, revenue is allocated to these rights and recognized when those future goods or services are transferred, or when the option expires. Contract modifications are routine in the performance of our contracts. Contracts are often modified to account for changes in contract specifications or requirements. In most instances, contract modifications are for goods or services that are distinct, and, therefore, are accounted for as new contracts. The effect of modifications has been reflected when identifying the satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price. The majority of the Company’s revenue from contracts with customers is recognized at a point in time, when the customer obtains control of the promised product, which is generally upon delivery and acceptance by the customer. These contracts may provide credits or incentives, which may be accounted for as variable consideration. Variable consideration is estimated at the most likely amount to predict the consideration to which the Company will be entitled, and only to the extent it is probable that a subsequent change in estimate will not result in a significant revenue reversal when estimating the amount of revenue to recognize. Variable consideration is treated as a change to the sales transaction price and based on an assessment of all information (i.e., historical, current and forecasted) that is reasonably available to the Company, and estimated at contract inception and updated at the end of each reporting period as additional information becomes available. Most of our contracts do not contain rights to return product; where this right does exist, it is evaluated as possible variable consideration. For contracts that are subject to the requirement to accrue anticipated losses, the company recognizes the entire anticipated loss in the period that the loss becomes probable. For contracts with customers in which the Company promises to provide a product to the customer that has no alternative use to the Company and the Company has enforceable rights to payment for progress completed to date inclusive of profit, the Company satisfies the performance obligation and recognizes revenue over time, using costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying our performance obligations. Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer. Contract costs include labor, material and overhead. The Company also recognizes revenue from service contracts (including service-type warranties) over time. The Company recognizes revenue over time during the term of the agreement as the customer is simultaneously receiving and consuming the benefits provided throughout the Company’s performance. The Company typically recognizes revenue on a straight-line basis throughout the contract period. Reviews for Impairment of Long-Lived Assets Goodwill Impairment Testing Our goodwill is the result of the excess of purchase price over net assets acquired from acquisitions. As of December 31, 2020, we had approximately $58.3 million of goodwill. As of December 31, 2019, we had approximately $145.0 million of goodwill. We identify our reporting units by assessing whether the components of our operating segments constitute businesses for which discrete financial information is available and segment management regularly reviews the operating results of those components. The Test Systems operating segment is its own reporting unit while the other reporting units are one level below our Aerospace operating segment. Companies may perform a qualitative assessment as the initial step in the annual goodwill impairment testing process for all or selected reporting units under certain circumstances. Companies are also allowed to bypass the qualitative analysis and perform a quantitative analysis if desired. Economic uncertainties and the length of time from the calculation of a baseline fair value are factors that we would consider in determining whether to perform a quantitative test. The Company tests goodwill at the reporting unit level on an annual basis or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Quantitative testing first requires a comparison of the fair value of each reporting unit to the carrying value. We use the discounted cash flow method to estimate the fair value of each of our reporting units. The discounted cash flow method incorporates various assumptions, the most significant being projected sales growth rates, operating profit margins and cash flows, the terminal growth rate and the discount rate. Management projects sales growth rates, operating margins and cash flows based on each reporting unit’s current business, expected developments and operational strategies. If the carrying value of the reporting unit exceeds its fair value, goodwill is considered impaired and any loss must be measured. Goodwill impairment 23 is measured as the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying value of goodwill. As a result of the qualitative factors related to the COVID-19 pandemic that surfaced during the first quarter of 2020, we performed interim quantitative assessments for the eight reporting units which had goodwill as of March 28, 2020, and an additional quantitative assessment for our PECO reporting unit as of June 27, 2020 driven by reductions from previously forecasted aircraft build rates. Based on our quantitative assessments, the Company recorded goodwill impairment charges associated with four Aerospace reporting units, totaling $86.3 million within the Impairment Loss line in the December 31, 2020 Consolidated Statements of Operations. The Company’s five reporting units remaining with goodwill as of the first day of our fourth quarter were subject to the annual goodwill impairment test. Based on our quantitative assessments of our reporting units performed during our annual goodwill impairment test, we concluded that no additional goodwill impairment was required. In 2019, we performed quantitative assessments for the reporting units which had goodwill as of the first day of the fourth quarter. Based on our quantitative assessment, the Company recorded a full goodwill impairment charge of approximately $1.6 million in the December 31, 2019 Consolidated Statements of Operations associated with the AeroSat reporting unit. The impairment loss was incurred in the Aerospace segment and is reported within the Impairment Loss line of the Consolidated Statements of Operations. CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK (In thousands, except percentages) 2020 2019 (1) 2018 Sales $ 502,587 $ 772,702 $ 803,256 Gross Margin 19.3 % 20.2 % 22.5 % SG&A Expenses as a Percentage of Sales 22.0 % 18.6 % 14.6 % Impairment Loss $ 87,016 $ 11,083 $ — Net Gain on Sale of Businesses $ — $ 78,801 $ — Interest Expense $ 6,741 $ 6,141 $ 9,710 Effective Tax Rate (3.0) % 23.8 % 10.5 % Net (Loss) Income $ (115,781) $ 52,017 $ 46,803 (1) Financial results reflect the divestiture of the Test Systems’ semiconductor business on February 13, 2019, and the acquisitions of Freedom acquired in July 2019, and Diagnosys acquired in October 2019 (collectively, the “Acquired Businesses”). A discussion by segment can be found at “Segment Results of Operations and Outlook” in this MD&A. CONSOLIDATED OVERVIEW OF OPERATIONS 2020 Compared With 2019 Consolidated sales were down $270.1 million to $502.6 million compared to the prior year. Aerospace sales were down $274.6 million. Test System sales increased $4.5 million. Consolidated cost of products sold decreased $210.8 million to $405.7 million in 2020 from $616.6 million in the prior year. The decrease was primarily due to lower sales volume in 2020 due to the combination of the impacts of the COVID-19 pandemic on aerospace markets and the continued 737 MAX grounding. The Company rapidly adjusted to the changed environment by aggressively adjusting its cost structure to changed demand, initiating workforce reduction activities and cost conservation activities including suspension of certain benefit programs and wage adjustments and reduction or elimination of discretionary spending. The lower volume and the impact of these measures resulted in a significant reduction in cost of products sold in 2020 compared with the prior year. Consolidated cost of products sold in 2019 included charges recorded for tariff expense of $5.9 million and $15.4 million of charges associated with the restructuring and impairment charges of our AeroSat antenna business which required classification within cost of products sold. Selling, general and administrative (“SG&A”) expenses were $110.5 million compared with $143.4 million for the prior year period. The decrease in 2020 was due to the cost conservation activities referred to above, though these savings were partially offset by associated severance charges of $5.3 million. The prior year period included charges for a long-term patent dispute of 24 $19.6 million and impairment and restructuring charges related to the antenna business classified within SG&A expense of $2.4 million. Further, non-cash impairment charges of $87.0 million in the Aerospace segment were recognized in the current year due to reduced expectations of future operating results due to the COVID-19 pandemic, which has significantly impacted the global economy, and particularly the aerospace industry. During the first quarter, the Company recognized full impairments of the goodwill of Astronics Connectivity Systems and Certification (“CSC”), PGA and Custom Control Concepts (“CCC”) reporting units, and a partial impairment of the goodwill of the PECO reporting unit. During the second quarter of 2020, an additional partial impairment of the PECO reporting unit goodwill was recorded. The Company recorded in the prior-year period a gain of $80.1 million upon the sale of the semiconductor business on February 13, 2019, partially offset by a $1.3 million loss on the sale of the airfield lighting product line on July 12, 2019. Consolidated net loss was $115.8 million, or $(3.76) per diluted share, compared with net income of $52.0 million, or $1.60 per diluted share in the prior year. The after-tax impact of the impairment loss in 2020 was $81.4 million, or $(2.64) per diluted share. The $80.1 million pre-tax gain on the sale of the semiconductor test business in contributed $60.4 million to net income after taxes in 2019. Other expense, net of other income includes charges of $3.5 million and $5.0 million related to impairments of equity investments in 2020 and 2019, respectively. The effective tax rate for 2020 was (3.0)%, compared with 23.8% in 2019. The effective tax rate in 2020 was impacted by a $21.5 million valuation allowance against federal deferred tax assets as well as permanently non-deductible goodwill impairments. See Note 11 of the consolidated financial statements at Item 8 of this report for additional information regarding the valuation allowance recorded in 2020. 2019 Compared With 2018 Consolidated sales for the full year of 2019 decreased $30.6 million to $772.7 million, primarily because of the divested semiconductor business which had sales of $9.7 million in 2019 and $84.3 million in 2018. Consolidated cost of products sold decreased $6.0 million to $616.6 million in 2019 from $622.6 million in the prior year. The decline was due to lower sales, primarily due to the divestiture of the semiconductor business, partially offset with incremental tariff expense of $5.9 million and $15.4 million of charges associated with the restructuring and impairment charges of our AeroSat antenna business which required classification within cost of products sold. SG&A expenses were $143.4 million, or 18.6% or sales, compared with $117.0 million, or 14.6% of sales, for the prior year period. The $26.3 million increase was due to increased legal reserves for the long-term patent dispute of $19.6 million and impairment and restructuring charges related to the antenna business classified within SG&A expense of $2.4 million. The Company recorded a gain of $80.1 million upon the sale of the semiconductor business on February 13, 2019, offset by a $1.3 million loss on the sale of the airfield lighting product line on July 12, 2019. Other expense, net of other income in 2019 includes a $5.0 million impairment of an equity investment. Income Taxes Our effective tax rates for 2020, 2019 and 2018 were (3.0)%, 23.8% and 10.5%, respectively. Our tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amount of income we earn in those jurisdictions, which we expect to be fairly consistent in the near term. It is also affected by discrete items that may occur in any given year, but are not consistent from year to year. Our tax rate is also affected by the recognition of valuation allowances against deferred tax assets if, based on the available evidence, it is not more likely than not (defined as a likelihood of more than 50%) that all or a portion of such assets will not be realized. In addition to state income taxes, the following items had the most significant impact on the difference between our statutory U.S. federal income tax rate (21% in 2020, 2019 and 2018) and our effective tax rate: 2020: 1. Recognition of approximately $21.5 million of valuation allowance against federal deferred tax assets. See Note 11 of the consolidated financial statements at Item 8 of this report for additional information. 2. Permanently non-deductible goodwill impairment 25 3. Recognition of approximately $1.8 million of 2020 U.S. R&D tax credits. 2019: 1. Recognition of approximately $3.1 million of 2019 U.S. R&D tax credits. 2018: 1. Recognition of approximately $3.2 million of 2018 U.S. R&D tax credits. 2. Benefit of approximately $3.5 million from revised state filing position. Impact of COVID-19 and Operational Adjustments As previously discussed, we face risks related to outbreaks of infectious diseases, including the ongoing COVID-19 pandemic. The challenges posed by the COVID-19 pandemic on the global economy, and more profoundly on the aerospace industry, increased significantly as 2020 progressed, and are expected to continue into 2021. COVID-19 has caused disruption and volatility in the global capital markets, and has authored an economic slowdown. In response to COVID-19, national and local governments around the world have instituted certain measures, including travel bans, prohibitions on group events and gatherings, shutdowns of certain businesses, curfews, shelter-in-place orders and recommendations to practice social distancing. Although our operations have been deemed essential and we follow the COVID-19 guidelines from the Centers for Disease Control (“CDC”) concerning the health and safety of our personnel, these measures have resulted in attenuating activity and, in some cases, required temporary closures of certain of our facilities, among other impacts. The duration of these measures is unknown, may be extended and additional measures may be imposed. In response to the global COVID-19 pandemic, we implemented actions to maintain the health of our employees as well as our financial health and liquidity. These actions included: • Implementing social distancing measures, the use of masks, restricting visitors and unnecessary travel, and working from home whenever possible; • Workforce reduction activities to align capacity with expected demand, reducing headcount by approximately 20% to approximately 2,200 employees currently; • Eliminated consultants and temporary labor where possible; • Implemented significant cost conservation measures; • Suspending cash bonus plans and wage adjustments; • Amended our revolving credit facility on May 4, 2020, as further described in the “Liquidity and Capital Resources” section below; • Suspending share repurchases; • Reducing capital spending to $7.5 million from an initial plan of $20 to $25 million; and • Restrictions on marketing, trade shows, travel and discretionary spending. These reductions collectively are substantial, lowering our cost structure by an estimated $55 million to $60 million for the year, beginning in the second quarter. 2021 Outlook We will not provide fiscal 2021 guidance at this time, given the number of uncontrollable variables. However, we do expect that customer demand in the first half of 2021 will be similar to that of the second half of 2020. The year is expected to start slowly, however, with first quarter sales of about $100 million, strengthening as the year goes on. Given our forecast expectations, and the structure of our revised lending agreement, combined with the earnout from the sale of the semiconductor business, we expect to have sufficient liquidity to operate through the COVID-19 pandemic and its economic impacts. We expect to remain compliant with our debt covenants at least through 2021 based on our current outlook, and expect to manage the Company to generate cash in 2021, which will be used to reduce debt. At December 31, 2020, our consolidated backlog was $283.4 million. At December 31, 2019, our backlog was $359.6 million. Backlog in the Aerospace segment was $191.1 million at December 31, 2020, of which $162.8 million is expected to be recognized as revenue in 2021. Backlog in the Test Systems segment was $92.3 million at December 31, 2020. The Test Systems segment expects to recognize as revenue $54.1 million of backlog in 2021. Cash taxes related to 2021 are expected to be insignificant. 26 Capital equipment spending in 2021 is expected to be in the range of $10 million to $11 million, up from $7.5 million in 2020 due to investments in customer programs. SEGMENT RESULTS OF OPERATIONS AND OUTLOOK Operating profit, as presented below, is sales less cost of products sold and other operating expenses excluding interest expense, corporate expenses and other non-operating sales and expenses. Cost of products sold and operating expenses are directly attributable to the respective segment. Operating profit is reconciled to earnings before income taxes in Note 20 of Item 8, Financial Statements and Supplementary Data, of this report. AEROSPACE SEGMENT (In thousands, except percentages) 2020 2019 2018 Sales $ 417,988 $ 692,609 $ 675,625 Operating (Loss) Profit $ (89,833) $ 16,657 $ 69,761 Operating Margin (21.5) % 2.4 % 10.3 % 2020 2019 Total Assets $ 484,885 $ 629,371 Backlog $ 191,081 $ 275,754 Sales by Market 2020 2019 2018 Commercial Transport $ 262,636 $ 523,921 $ 536,269 Military 67,944 76,542 68,138 Business Jet 60,437 67,541 43,090 Other 26,971 24,605 28,128 Total $ 417,988 $ 692,609 $ 675,625 Sales by Product Line 2020 2019 2018 Electrical Power & Motion $ 179,245 $ 338,237 $ 303,180 Lighting & Safety 118,928 185,462 174,383 Avionics 76,113 106,787 131,849 Systems Certification 6,899 14,401 13,951 Structures 9,832 23,117 24,134 Other 26,971 24,605 28,128 Total $ 417,988 $ 692,609 $ 675,625 2020 Compared With 2019 Aerospace segment sales decreased by $274.6 million, or (39.7)%, to $418.0 million, when compared with the prior-year period. Sales were negatively affected by the grounding of the 737 MAX, overall lower build rates for commercial transport and general aviation aircraft and a weak commercial aircraft aftermarket as the airlines reduced spending and OEM’s reduced production due to the global COVID-19 pandemic. Electrical Power & Motion sales decreased $159.0 million compared with the prior-year period. Additionally, Lighting & Safety sales decreased $66.5 million and Avionics sales decreased by $30.7 million. Aerospace operating loss for 2020 was $89.8 million compared with operating income of $16.7 million in the same period of 2019. Aerospace operating profit was impacted by impairment charges of $87.0 million, of which $86.3 million was related to goodwill. Restructuring-related severance charges of $5.3 million and leverage lost on reduced sales also significantly impacted operating results. 2019 Compared With 2018 Aerospace segment sales increased by $17.0 million, or 2.5%, to $692.6 million, when compared with the prior-year period. 27 Electrical Power & Motion sales increased $35.1 million, or 11.6%, due primarily to increased sales of in-seat power and motion products. Lighting & Safety sales increased $11.1 million due to higher sales of products to the military market. Avionics sales decreased by $25.1 million due to lower demand for inflight entertainment and connectivity products and lower antenna sales. Sales of Other products were down $3.5 million. Aerospace operating profit for 2019 was $16.7 million, or 2.4% of sales, compared with $69.8 million, or 10.3% of sales, in the same period of 2018. Aerospace operating profit was impacted by the legal reserve for the patent dispute of $19.6 million for the full year incremental tariff expense of $5.9 million and antenna business impairment and restructuring charges of $28.8 million. 2021 Outlook for Aerospace – The Aerospace segment’s backlog at December 31, 2020 was $191.1 million, compared to $275.8 million at December 31, 2019. Approximately $162.8 million of the backlog at December 31, 2020 is expected to be shipped over the next 12 months. TEST SYSTEMS SEGMENT (In thousands, except percentages) 2020 2019 2018 Sales $ 84,599 $ 80,093 $ 127,631 Operating Profit $ 5,549 $ 4,494 $ 10,718 Operating Margin 6.6 % 5.6 % 8.4 % 2020 2019 Total Assets $ 105,079 $ 110,994 Backlog $ 92,337 $ 83,837 Sales by Market 2020 2019 2018 Semiconductor $ 3,483 $ 9,692 $ 84,254 Aerospace & Defense 81,116 70,401 43,377 Total $ 84,599 $ 80,093 $ 127,631 2020 Compared With 2019 Test Systems Segment sales were $84.6 million, up $4.5 million compared with the prior year. The Acquired Businesses contributed an incremental $6.2 million in sales. Sales related to the Semiconductor business, which was sold in early 2019, decreased $6.2 million. Test Systems operating profit was $5.5 million, or 6.6% of sales, compared with operating profit of $4.5 million, or 5.6% of sales, in 2019. Operating profit in the prior-year period was impacted by restructuring-related severance charges of $2.0 million. 2019 Compared With 2018 Test Segment sales decreased from $127.6 million to $80.1 million for 2019, primarily due to the divestiture of the semiconductor test business, which contributed sales of $84.3 million in 2018 and $9.7 million in 2019. Operating profit was $4.5 million, or 5.6% of sales, compared with $10.7 million, or 8.4% of sales, in 2018. 2021 Outlook for Test Systems – Backlog in the Test Systems segment was $92.3 million at December 31, 2020, compared to $83.8 million at December 31, 2019. The Test Systems segment expects to recognize as revenue $54.1 million of backlog in 2021. We do not have material off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition. 28 CONTRACTUAL OBLIGATIONS The following table represents contractual obligations as of December 31, 2020: Payments Due by Period (In thousands) Total 2021 2022-2023 2024-2025 After 2025 Long-term Debt $ 173,000 $ — $ 173,000 $ — $ — Interest on Long-term Debt 13,390 6,330 7,060 — — Purchase Obligations 86,402 76,230 10,172 — — Supplemental Retirement Plan and Post Retirement Obligations 32,841 404 743 1,408 30,286 Lease Obligations 26,616 7,816 9,709 5,661 3,430 Other Long-term Liabilities 3,770 2,236 760 765 9 Total Contractual Obligations $ 336,019 $ 93,016 $ 201,444 $ 7,834 $ 33,725 Notes to Contractual Obligations Table Long-term Debt — See Item 8, Financial Statements and Supplementary Data, Note 8, Long-Term Debt. in this report. Interest on Long-term Debt — Future interest payments have been calculated using the applicable interest rate of each debt facility based on actual borrowings as of December 31, 2020. Actual future borrowings and rates may differ from these estimates. Purchase Obligations — Purchase obligations are comprised of the Company’s commitments for goods and services in the normal course of business. Lease Obligations — Financing and operating lease obligations are primarily related to the Company's facility leases and interest. Other Long-term Liabilities — Table excludes the $16.7 million accrual recorded as management's best estimate of damages related to Lufthansa’s indirect sales claim in Germany, as discussed in Item 8, Financial Statements and Supplementary Data, Note 19, Legal Proceedings in this report. LIQUIDITY AND CAPITAL RESOURCES (In thousands) 2020 2019 2018 Net Cash Flows from: Operating Activities $ 37,335 $ 42,689 $ 54,881 Investing Activities $ (5,797) $ 64,630 $ (19,667) Financing Activities $ (24,576) $ (92,182) $ (36,134) Our cash flow from operations and available borrowing capacity provide us with the financial resources needed to run our operations and reinvest in our business. Our ability to maintain sufficient liquidity is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on our liquidity, our ability to obtain financing, and our operations in the future. Operating Activities Cash provided by operating activities was $37.3 million in 2020 compared with $42.7 million in 2019. The decrease of $5.4 million in 2020 was primarily due to lower net income adjusted for non-cash expenses and income in 2020 compared with 2019, due to the impacts of the COVID-19 pandemic on our business, partially offset by a change in net operating assets, driven largely by receivable collections. Cash provided by operating activities was $42.7 million in 2019 compared with $54.9 million in 2018. The decrease of $12.2 million in 2019 was primarily due to the net non-cash effect on net income of the net gain from the sale of businesses, the legal reserve and the antenna business impairment and restructuring charges, partially offset by a change in net operating assets. 29 Our cash flows from operations are primarily dependent on our net income adjusted for non-cash expenses and the timing of collections of receivables, level of inventory and payments to suppliers and employees. Sales and operating results of our Aerospace segment are influenced by the impact in 2020 of the COVID-19 pandemic on the aerospace industry, in particular, build rates of new aircraft, which are subject to general economic conditions, airline passenger travel and spending for government and military programs. Our Test Systems segment sales depends in part on capital expenditures of the aerospace & defense industry which, in turn, depend on current and future demand for those products. A reduction in demand for our customers’ products would adversely affect our operating results and cash flows. We maintain a revolving credit facility to fund our short and long-term capital requirements including working capital, acquisitions and share repurchase efforts. Investing Activities Cash used for investing activities in 2020 was $5.8 million, primarily the result of purchases of property, plant and equipment (“PP&E”) of $7.5 million, partially offset by proceeds from sales of PP&E. Cash provided by investing activities in 2019 was $64.6 million, primarily the result of the $103.8 million in proceeds from the divestiture of the semiconductor business offset by purchases of property, plant and equipment (“PP&E”) of $12.1 million. Cash provided by investing activities in 2019 was also offset by net cash used for the purchases of Freedom and Diagnosys for $21.8 million and $7.0 million, respectively. Cash used for investing activities in 2018 was $19.7 million, primarily related to purchases of PP&E of $16.3 million. Our expectation for 2021 is that we will invest between $10 million and $11 million for PP&E. Future requirements for PP&E depend on numerous factors, including expansion of existing product lines and introduction of new products. Management believes that our cash flow from operations and current borrowing arrangements will provide for these capital expenditures. We expect to continue to evaluate acquisition opportunities in the future. Financing Activities The Company's Fifth Amended and Restated Credit Agreement (the “Agreement”) provided for a $500 million revolving credit line with the option to increase the line by up to $150 million. The maturity date of the loans under the Agreement is February 16, 2023. The maximum leverage ratio of funded debt to Adjusted EBITDA (as defined in the Agreement) was 3.75 to 1, increasing to 4.50 to 1 for up to four fiscal quarters following the closing of an acquisition permitted under the Agreement, subject to limitations. The Company paid interest on the unpaid principal amount of the facility at a rate equal to one-, three- or six-month LIBOR plus between 1.00% and 1.50% based upon the Company’s leverage ratio. The Company also paid a commitment fee to the Lenders in an amount equal to between 0.10% and 0.20% on the undrawn portion of the credit facility, based upon the Company’s leverage ratio. The COVID-19 pandemic has significantly impacted the global economy, and particularly the aerospace industry, resulting in reduced expectations of the Company’s future operating results. As a result, the Company was projected to exceed its maximum leverage ratio in the fourth quarter of 2020. Accordingly, on May 4, 2020, the Company executed an amendment to the Agreement (the “Amended Facility”), which reduced the revolving credit line from $500 million to $375 million. The Amended Facility suspends the application of the maximum net leverage ratio up through and including the second quarter of 2021 (the “suspension period”). The maximum net leverage ratio will be 6.00 to 1 for the third quarter of 2021, 5.50 to 1 for the fourth quarter of 2021, 4.50 to 1 for the first quarter of 2022, and return to 3.75 to 1 for each quarter thereafter. Through the third quarter of 2021, the Amended Facility requires the Company to maintain minimum liquidity, defined as unrestricted cash plus the unused revolving credit commitments, of $180.0 million at all times. Through the second quarter of 2021, the Company is required to maintain a minimum interest coverage ratio of 1.75x on a quarterly basis, except for the first quarter of 2021, which is set at 1.50x. The interest coverage ratio at December 31, 2020 was 6.34x. The Company was in compliance with its financial covenants at December 31, 2020. During the suspension period, the Company will pay interest on the unpaid principal amount of the Amended Facility at a rate equal to one-, three- or six-month LIBOR (which shall be at least 1.00%) plus 2.25%. The Company will also pay a commitment fee to the lenders in an amount equal to 0.35% on the undrawn portion of the Amended Facility. After the suspension period, the Company will pay interest on the unpaid principal amount of the Amended Facility at a rate equal to one-, three- or six-month LIBOR (which shall be at least 1.00%) plus between 1.00% to 2.25% based upon the Company’s leverage ratio. The Company will also pay a commitment fee to the lenders in an amount equal to 0.10% to 0.35% on the undrawn portion of the Amended Facility, based upon the Company’s leverage ratio. The Amended Facility provided for the payment of a consent fee of 15 basis points of the commitment for each consenting lender. The Amended Facility also temporarily restricts certain activities, including acquisitions and share repurchases, and requires mandatory prepayments during the suspension period when the Company’s cash balance exceeds $100 million. In the first quarter of 2020, before executing the Amended Facility, we incurred approximately $150 million in new incremental 30 borrowings as a precautionary response to macroeconomic conditions caused by the COVID-19 pandemic. Subsequent to the execution of the Amended Facility, the Company made prepayments approximating $165.0 million. The Company’s obligations under the Amended Facility are jointly and severally guaranteed by each domestic subsidiary of the Company other than non-material subsidiaries. The obligations are secured by a first priority lien on substantially all of the Company’s and the guarantors’ assets. At December 31, 2020, there was $173.0 million outstanding on the revolving credit facility and there remains $200.9 million available subject to the minimum liquidity covenant discussed above, net of outstanding letters of credit. The credit facility allocates up to $20 million of the $375 million revolving credit line for the issuance of letters of credit, including certain existing letters of credit. At December 31, 2020, outstanding letters of credit totaled $1.1 million. The primary financing activities in 2020 were related to net payments on our senior credit facility of $15.0 million and repurchase of approximately 282,000 shares at an aggregate cost of $7.7 million. The primary financing activities in 2019 related to a repurchase of approximately 1,851,000 shares at an aggregate cost of $50.8 million under our share purchase program, coupled with net payments on our senior credit facility of $39.0 million. In the event of voluntary or involuntary bankruptcy of the Company or any subsidiary, all unpaid principal and other amounts owing under the Amended Facility automatically become due and payable. Other events of default, such as failure to make payments as they become due and breach of financial and other covenants, change of control, judgments over a certain amount, and cross default under other agreements give the agent the option to declare all such amounts immediately due and payable. The Company’s cash needs for working capital, debt service, capital equipment, and acquisition opportunities during 2021 is expected to be met by cash flows from operations and cash balances and, if necessary, utilization of the revolving credit facility. DIVIDENDS Management believes that it should retain the capital generated from operating activities for investment in advancing technologies, acquisitions and debt retirement. Accordingly, there are no plans to institute a cash dividend program. BACKLOG At December 31, 2020, our consolidated backlog was $283.4 million. At December 31, 2019, our backlog was $359.6 million. Backlog in the Aerospace segment was $191.1 million at December 31, 2020, of which $162.8 million is expected to be recognized as revenue in 2021. Backlog in the Test Systems segment was $92.3 million at December 31, 2020, of which $54.1 million is expected to be recognized as revenue of in 2021. RELATED-PARTY TRANSACTIONS Information regarding certain relationships and related transactions is incorporated herein by reference to the information included in the Company’s 2021 Proxy Statement which will be filed with the Commission within 120 days after the end of the Company’s 2020 fiscal year. RECENT ACCOUNTING PRONOUNCEMENTS See Note 1 of the consolidated financial statements at Item 8 of this report.