ASTRONICS CORP 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (The following should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Form 10-K for the year ended December 31, 2021.) OVERVIEW Astronics Corporation (“Astronics” or the “Company”) is a leading supplier of advanced technologies and products to the global aerospace and defense industries. Our products and services include advanced, high-performance electrical power generation and distribution systems, seat motion solutions, lighting and safety systems, avionics products, aircraft structures, systems certification, and automated test systems. 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 (“USDOD”). 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), supply chain pressures, 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 Systems 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 USDOD, prime contractors to the USDOD, mass transit operators and prime contractors to mass transit operators. In September 2021 the Company also entered into an agreement with the U.S. Department of Transportation (“USDOT”) under the Aviation Manufacturing Jobs Protection Program (“AMJP”) for a grant of up to $14.7 million. The Company received $7.4 million under the grant in 2021, $5.2 million in the first quarter of 2022 and $2.1 million in the third quarter of 2022. The grant benefit was recognized over the six-month performance period as a reduction to cost of products sold in proportion to the compensation expense that the award is intended to defray. The Company recognized the remaining $6.0 million of the award during the nine months ended October 1, 2022. On February 13, 2019, the Company completed a divestiture of its semiconductor test business within the Test Systems segment. The total proceeds of the divestiture included two elements of contingent purchase consideration (“earnout”). In the fourth quarter of 2021, the Company agreed to an earnout payment of $10.7 million for the calendar 2020 earnout, which was recorded in 2021 as a separate line item below operating loss and was received by the Company in early January 2022. In March 2022, the Company agreed with the earnout calculation for the calendar 2021 earnout in the amount of $11.3 million. The Company recorded the gain and received the payment in the first quarter of 2022. 22 Table of Contents CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK Nine Months Ended Three Months Ended ($ in thousands) October 1, 2022 October 2, 2021 October 1, 2022 October 2, 2021 Sales $ 376,741 $ 328,856 $ 131,438 $ 111,841 Gross Profit (sales less cost of products sold) $ 50,030 $ 46,899 $ 14,388 $ 17,231 Gross Margin 13.3 % 14.3 % 10.9 % 15.4 % Selling, General and Administrative Expenses $ 76,907 $ 66,829 $ 28,702 $ 21,729 SG&A Expenses as a Percentage of Sales 20.4 % 20.3 % 21.8 % 19.4 % Net Gain on Sale of Business $ (11,284) $ — $ — $ — Interest Expense, Net of Interest Income $ 5,812 $ 5,252 $ 2,519 $ 1,795 Effective Tax Rate (28.3) % (1.4) % 13.9 % (4.9) % Net Loss $ (28,968) $ (27,182) $ (14,857) $ (7,174) A discussion by segment can be found at “Segment Results of Operations and Outlook” in this MD&A. CONSOLIDATED THIRD QUARTER RESULTS Consolidated sales were up $19.6 million from the third quarter of 2021. Aerospace sales were up $16.4 million, or 17.1%, and Test Systems sales increased $3.2 million. Consolidated cost of products sold in the third quarter of 2022 was $117.1 million, compared with $94.6 million in the prior-year period. The increase was primarily due to higher volume combined with material and labor inflation, addressing supply chain constraints to meet customer requirements and the lag in price increases implemented where possible to offset higher costs and product mix. The prior-year period benefited by a $1.1 million offset to cost of products sold from the AMJP Program grant. Selling, general and administrative (“SG&A”) expenses were $28.7 million in the third quarter of 2022 compared with $21.7 million in the prior-year period primarily due to increased wages and benefits. Third quarter 2022 reflects $4.6 million related to the settlement of a litigation claim, a customer accommodation dispute, and a lease termination settlement. The Company expects to be indemnified by other parties with respect to the litigation matter for approximately $1.5 million and will record the gain as an offset to SG&A when received, likely in the fourth quarter of 2022. Tax benefit in the quarter was $2.4 million primarily due to changes in the year-to-date and forecasted loss before income taxes. Consolidated net loss was $14.9 million, or $(0.46) per diluted share, compared with net loss of $7.2 million, or $(0.23) per diluted share, in the prior year. Bookings were $184.2 million, for a book-to-bill ratio of 1.40:1. Backlog at the end of the quarter was $547.1 million. Approximately $426.5 million, or 78%, of backlog is expected to be recognized as revenue over the next twelve months and the balance thereafter. CONSOLIDATED YEAR-TO-DATE RESULTS Consolidated sales were up $47.9 million. Aerospace sales were up $56.5 million from the first nine months of 2021. Test Systems sales decreased $8.6 million. Consolidated cost of products sold in 2022 was $326.7 million, compared with $282.0 million in the prior-year period. The increase was primarily due to higher volume as the global aerospace industry continues its recovery from the COVID-19 pandemic. The current year period benefited from $6.0 million recognized as an offset to cost of products sold related to the AMJP award, compared to a benefit from the grant of $1.1 million in the prior year. Research and development expenses increased $4.9 million due to higher innovation spend. SG&A expenses were $76.9 million in 2022 compared with $66.8 million the prior-year period primarily due to increased wages and benefits. The current-year period reflects $4.6 million related to the settlement of a litigation claim, a customer accommodation dispute, and a lease termination settlement. The Company expects to be indemnified by other parties for approximately $1.5 million related to the litigation claim and will record the gain as an offset to SG&A when received, likely in the fourth quarter of 2022. The prior-year period also benefited from a $2.2 million non-cash reduction of the fair value of a contingent consideration liability. 23 Table of Contents The effective tax rate for 2022 was (28.3)%, compared with (1.4)% in the prior year period. In the past, research and development costs were deducted as incurred. However, beginning with the 2022 tax year, these costs are required to be capitalized for tax purposes and amortized over 5 years. The 2022 tax rate was impacted by a valuation allowance applied against the associated deferred tax asset created by the new treatment, due to the Company’s cumulative losses over the last three years. This was partially offset by the removal of valuation allowances related to net operating losses, tax credit carryovers, and certain timing differences that are expected to reverse during 2022 as well as a Federal research and development credit expected for 2022. Consolidated net loss was $29.0 million, or $(0.90) per diluted share, compared with net loss of $27.2 million, or $(0.88) per diluted share, in the prior year. COVID-19 Impacts on Our Business On March 11, 2020, the World Health Organization classified the COVID-19 outbreak as a pandemic. The spread of the COVID-19 pandemic disrupted businesses on a global scale, led to significant volatility in financial markets and affected the aviation and industrial industries. Substantially all of our operations and production activities have, to-date, remained operational. However, the impacts of the pandemic have placed labor and supply chain pressures on our business and we have been impacted by customer demand variability. Although we saw stable and growing backlog during the first nine months of 2022 in our aerospace business, COVID-19 related disruptions are ongoing and continue to adversely challenge our commercial transport market. While we remain bullish about the aerospace business, we believe the recovery to pre-pandemic activity, particularly in the widebody market, will take longer than originally anticipated at the outset of the pandemic. As economic activity continues to recover, we will continue to monitor the situation, assessing further possible implications on our operations, supply chain, liquidity, cash flow and customer orders. Outlook Increasing sales is critical to satisfying our customers’ demand, and improving financial results. Revenue has been starting to ramp and we believe it will accelerate as we move forward. As previously reported, we are expecting sales of $140 million to $150 million in the fourth quarter of 2022, an increase of 10%, or $14 million, at the midpoint over the trailing third quarter. This would result in estimated 2022 sales to be up approximately 17% from last year’s revenue of $445 million. While disappointed with the lower sales level for the year than we had previously anticipated, we remain very encouraged with the demand for our products, our position in the industry and the significant opportunities in which we are engaged. Our initial look at 2023 suggests sales of $640 million to $680 million. This expectation is supported by cumulative bookings of $686 million over the last four quarters and our record backlog of $547 million. Our supply chain has been a challenge during the last year, but we now see clear signs of improvement and anticipate continued recovery over the course of 2023. Consolidated backlog at October 1, 2022 was $547.1 million. Approximately 78% of the backlog is expected to be recog nized as revenue in over the next twelve months and the balance thereafter. Planned capital expenditures for 2022 are expected to be approximately $9 million to $10 million. While core aerospace markets have strengthened as vaccination rates rise and passenger traffic accelerated, the ultimate impact of COVID-19 on our business, results of operations, financial condition and cash flows is dependent on future developments, including the duration of the pandemic, virus variants, vaccination rates and efficacy and the related length of impact on the global economy, supply chain and specifically on the markets we are active in, which are uncertain and cannot be predicted at this time. SEGMENT RESULTS OF OPERATIONS AND OUTLOOK Operating loss, as presented below, is sales less cost of products sold and other operating expenses, excluding interest expense, other corporate expenses and other non-operating sales and expenses. Cost of products sold and other operating expenses are directly identifiable to the respective segment. Operating loss is reconciled to loss before income taxes in Note 15 of the Notes to Consolidated Condensed Financial Statements included in this report. 24 Table of Contents AEROSPACE SEGMENT Nine Months Ended Three Months Ended (In thousands) October 1, 2022 October 2, 2021 October 1, 2022 October 2, 2021 Sales $ 322,871 $ 266,425 $ 112,177 $ 95,775 Less Inter-segment Sales (10) (23) — (9) Total Aerospace Sales $ 322,861 $ 266,402 $ 112,177 $ 95,766 Operating (Loss) Profit $ (7,085) $ (6,352) $ (6,859) $ 1,917 Operating Margin (2.2) % (2.4) % (6.1) % 2.0 % Aerospace Sales by Market (In thousands) Commercial Transport $ 211,721 $ 143,550 $ 78,389 $ 57,549 Military 41,336 54,847 12,463 17,064 General Aviation 48,748 41,131 14,751 12,109 Other 21,056 26,874 6,574 9,044 $ 322,861 $ 266,402 $ 112,177 $ 95,766 Aerospace Sales by Product Line (In thousands) Electrical Power & Motion $ 132,757 $ 102,742 $ 46,155 $ 38,650 Lighting & Safety 90,339 76,929 29,740 25,461 Avionics 67,453 47,355 24,172 14,491 Systems Certification 6,656 7,937 3,985 6,099 Structures 4,600 4,565 1,551 2,021 Other 21,056 26,874 6,574 9,044 $ 322,861 $ 266,402 $ 112,177 $ 95,766 (In thousands) October 1, 2022 December 31, 2021 Total Assets $ 478,385 $ 458,334 Backlog $ 464,307 $ 334,659 AEROSPACE THIRD QUARTER RESULTS Aerospace segment sales increased $16.4 million, or 17.1%, to $112.2 million. Commercial aerospace sales increased 36.2%, or $20.8 million, and drove the improvement. Sales to this market were $78.4 million compared with $57.5 million in the third quarter of 2021. Improving domestic airline travel that is driving higher fleet utilization and increased narrowbody production rates drove demand for Astronics’ products. General Aviation sales increased $2.6 million, or 21.8%, to $14.8 million due in part to higher demand in the business jet market for antenna systems and enhanced vision system products. The Company expects the strong end user demand in the business jet industry to drive higher OEM production rates in the near future, resulting in further increases in demand for its products. Military Aircraft sales decreased $4.6 million, or 27.0%, to $12.5 million. The prior-year period benefited from incremental non-recurring engineering revenue associated with development programs and higher sales of avionics products. Other revenue decreased $2.5 million to $6.6 million driven by decreased contract manufacturing programs. Aerospace segment operating loss was $6.9 million compared with operating profit of $1.9 million for the same period last year. Higher operating losses were driven by inflationary impacts on input costs and inefficiencies associated with production execution due to supply chain constraints that restricted shipment volume, as well as the settlement of a litigation claim and a customer accommodation dispute that resulted in $4.1 million of expense during the quarter. We expect to be indemnified by other parties for approximately $1.5 million related to the litigation claim and will record that gain when such proceeds are received, likely in the fourth quarter. Operating profit in the prior-year period benefited from the $1.1 million AMJP benefit. 25 Table of Contents AEROSPACE YEAR-TO-DATE RESULTS Aerospace segment sales increased $56.5 million, or 21.2%, to $322.9 million. Sales continued to be positively affected by reasons discussed above. Aerospace segment operating loss was $7.1 million compared with operating loss of $6.4 million for the same period last year. Aerospace segment experienced increased sales and the $6.0 million AMJP benefit in the 2022 period compared to an AMJP benefit of $1.1 million in the prior year, however, the operating loss was impacted by continued increases to input costs caused by inflationary impacts and supply chain constraints. Additionally, the 2022 period included $4.1 million related to the settlement of a litigation claim and a customer accommodation dispute and a $2.5 million increase of expense associated with the reinstated 401K contribution. As previously noted, we expect to be indemnified by other parties for approximately $1.5 million related to the litigation claim and will record that gain when such proceeds are received, likely in the fourth quarter. AEROSPACE OUTLOOK Aerospace bookings in the third quarter of 2022 were $165.7 million, for a book-to-bill ratio of 1.48:1. The Aerospace segment’s backlog at the end of the third quarter of 2022 was $464.3 million with approximately $375.2 million expected to be recognized as revenue over the next twelve months. TEST SYSTEMS SEGMENT Nine Months Ended Three Months Ended (In thousands) October 1, 2022 October 2, 2021 October 1, 2022 October 2, 2021 Sales $ 53,899 $ 62,811 $ 19,261 $ 16,128 Less Inter-segment Sales (19) (357) — (53) Total Test Systems Sales $ 53,880 $ 62,454 $ 19,261 $ 16,075 Operating Loss $ (4,125) $ (1,958) $ (2,312) $ (2,201) Operating Margin (7.7) % (3.1) % (12.0) % (13.7) % All Test Systems sales are to the Aerospace and Defense Market. (In thousands) October 1, 2022 December 31, 2021 Total Assets $ 108,473 $ 105,335 Backlog $ 82,807 $ 81,033 TEST SYSTEMS THIRD QUARTER RESULTS Test Systems segment sales were $19.3 million, up $3.2 million compared with the prior-year period driven by higher defense revenue. Test Systems’ operating loss was $2.3 million compared with operating loss of $2.2 million in the third quarter of 2021. Continued lower volume has driven operating losses in the third quarters of 2022 and 2021. The current year included a lease termination settlement of $0.5 million. TEST SYSTEMS YEAR-TO-DATE RESULTS Test Systems segment sales were $53.9 million, down $8.6 million compared with the prior-year period driven by lower revenue on defense and mass transit programs. Test Systems operating loss was $4.1 million compared with operating loss of $2.0 million in the prior-year period. An increased operating loss in 2022 was driven by lower volume. The current year included a lease termination settlement of $0.5 million. TEST SYSTEMS OUTLOOK Bookings for the Test Systems segment in the quarter were $18.4 million, for a book-to-bill ratio of 0.96:1 for the quarter. The Test Systems segment’s backlog at the end of the third quarter of 2022 was $82.8 million, with approximately $51.3 million expected to be recognized as revenue over the next twelve months. 26 Table of Contents Our Test business achieved a big win during the quarter when we were down-selected by the U.S. Army as the winner of a major radio test competition. A directed procurement is underway to finalize the terms of a contract, a process that is expected to be completed soon. Preliminarily, the Company expects the program could generate sales of $150 million to $200 million in the coming years. LIQUIDITY AND CAPITAL RESOURCES Operating Activities: Cash used for operating activities totaled $39.1 million for the first nine months of 2022, as compared with $18.5 million cash used for operating activities during the same period in 2021. Cash flow from operating activities decreased compared with the same period of 2021 primarily related to increases in net operating assets, primarily accounts receivable and inventory, more than offsetting cash received from income tax refunds and the AMJP program. Accounts receivable has increased with a higher volume of sales while inventory balances have increased to fulfill customer demand in upcoming quarters coupled with increased lead times on certain key components required inventory to be purchased further in advance. Investing Activities: Cash provided by investing activities was $17.7 million for the first nine months of 2022 compared with $4.6 million in cash used for investing activities in the same period of 2021. Investing cash flows in 2022 were positively impacted by the receipt of $10.7 million and $11.3 million related to the calendar 2020 and 2021 earnouts, respectively, from the sale of the semiconductor business. The Company expects capital spending in 2022 to be in the range of $9 million and $10 million. Financing Activities: Cash used for financing activities totaled $4.9 million for the first nine months of 2022, as compared with $12.3 million cash provided by financing activities during the same period in 2021. Cash used for financing activities increased compared with the same period of 2021 due to net payments on our senior credit facility of $4.0 million in the first nine months of 2022, coupled with $1.0 million in costs associated with amending our credit facility. The Company's long-term debt consists of borrowings under its Fifth Amended and Restated Credit Agreement (the “Agreement”). On March 1, 2022, the Company executed an amendment to the Agreement, which reduced the revolving credit line from $375 million to $225 million and extended the maturity date of the loans under the facility from February 16, 2023 to May 30, 2023. The definition of Adjusted EBITDA was modified to exclude income from earnout payments and asset sales. On August 9, 2022, the Company executed a further amendment to the Agreement, which reduced the revolving credit line from $225 million to $190 million until September 12, 2022 with further reductions to $180 million effective September 12, 2022 and $170 million effective October 11, 2022. The amendment extended the maturity date of the loans under the facility from May 30, 2023 to August 31, 2023. On October 21, 2022, the Company executed an additional amendment to the Agreement, under which the lenders waived enforcement of their rights against the Company arising from the Company’s failure to comply with the maximum net leverage ratio and minimum liquidity covenants, each as of September 30, 2022. The amendment increased the revolving credit line to $180 million as of October 21, 2022, with a reduction to $170 million effective November 21, 2022. Under the provisions of this amendment, the inclusion of any “going concern” language in the Company’s financial statements would constitute an event of default. A further amendment to the Agreement was executed on November 14, 2022 (the “Amended Facility”), which extended the maturity date of the loans under the facility from August 31, 2023 to November 30, 2023. Under the Amended Facility, the revolving credit line is set at $180 million, with a reduction to $170 million effective December 21, 2022. The amendment requires the Company to maintain minimum liquidity, defined as unrestricted cash plus the unused revolving credit commitments, of $10 million as of November 30, 2022 and December 31, 2022, and $15 million at the end of any month thereafter. The Amended Facility requires the Company to comply with a minimum Adjusted EBITDA covenant on a trailing twelve month basis, set at $15 million as of December 31, 2022 and March 31, 2023, and $25 million in each quarter thereafter. The amendment eliminated the net leverage ratio covenant for the remaining term of the agreement. At October 1, 2022, there was $159.0 million outstanding on the revolving credit facility and there remained $19.9 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 $180 million revolving credit line for the issuance of letters of credit, including certain existing letters of credit. At October 1, 2022, outstanding letters of credit totaled $1.1 million. Interest is payable on the unpaid principal amount of the facility at a rate equal to the Secured Overnight Financing Rate (“SOFR”, which shall be at least 1.00%), plus 5.50%. Effective January 17, 2023, interest is payable on the unpaid principal amount of the facility at a rate equal to SOFR (which shall be at least 1.00%), plus 8.50%. The Company also pays a commitment fee to the lenders in an amount 27 Table of Contents equal to 0.40% on the undrawn portion of the Amended Facility. Each amendment executed in 2022 required payment of a consent fee of 5 to 10 basis points of the commitment for each consenting lender. The Amended Facility restricts dividend payments and share repurchases through the maturity date of the Amended Facility. 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. 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. We are currently in the process of evaluating terms and conditions for a new long-term financing arrangement, which includes an asset-based lending agreement and separate term loan agreement, and expect to complete the process in the coming weeks. The extent to which we will be able to effect such refinancing, replacement or maturity extension on terms that are favorable to us or at all is dependent on a number of uncertain factors, including then-prevailing credit and other market conditions, economic conditions, particularly in the aerospace and defense markets, disruptions or volatility caused by factors such as COVID-19, regional conflicts, inflation, and supply chain disruptions. In addition, rising interest rates could limit our ability to refinance our existing credit facility when it matures or cause us to pay higher interest rates upon refinancing. As the Company’s long-term debt approaches maturity, if the Company is unable to refinance, replace or extend the maturity on its credit facility, the Company’s liquidity, results of operations, and financial condition could be materially adversely impacted. If we are unable to obtain a new long-term financing facility before we file our 2022 Form 10-K to replace our existing debt facility, borrowings outstanding under our existing credit facility will come due within 12 months of that filing date and could result in substantial doubt about our ability to continue as a going concern in the event that we are not reasonably assured to have sufficient cash balances to repay the remaining obligations at maturity. The Company expects its sales growth and improvement in inventory management will provide sufficient cash flows to fund operations. However, the Company may also evaluate various actions and alternatives to enhance its cash generation from operating activities, which could include manufacturing efficiency initiatives, working with vendors and suppliers to reduce lead times and expedite shipment of critical components, and working with customers to expedite receivable collections. 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. OFF BALANCE SHEET ARRANGEMENTS We do not have any 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. BACKLOG The Company’s backlog at October 1, 2022 was $547.1 million compared with $415.7 million at December 31, 2021 and $354.4 million at October 2, 2021. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Except as noted below, our contractual obligations and commitments have not changed materially from the disclosures in our 2021 Annual Report on Form 10-K. Purchase obligations are comprised of the Company’s commitments for goods and services in the normal course of business and amount to approximately $151.6 million payable in the coming year at October 1, 2022 and $134.0 million at December 31, 2022. As a result of amendments to our credit facility since December 31, 2021, future interest payments are expected to be $15.7 million through the expiration of the credit facility. Absent any legislative changes, the Company expects to pay approximately $5 million to $6 million in income tax payments related to the 2022 tax year. These expected tax payments are the result of the requirement to capitalize and amortize certain research and development expenses for U.S. tax purposes beginning in 2022. 28 Table of Contents MARKET RISK Interest on our revolving credit facility is payable on the unpaid principal amount of the facility at a rate equal to the SOFR (which shall be at least 1.00%), plus 5.50%. Effective January 17, 2023, interest is payable on the unpaid principal amount of the facility at a rate equal to SOFR (which shall be at least 1.00%), plus 8.50%. As SOFR is a relatively new reference rate with a limited history, there may or may not be more volatility than with other reference rates such as LIBOR, which may result in increased borrowing costs for the Company. A hypothetical increase in the SOFR of 100 basis points would impact annual income by approximately $1.6 million, before income taxes. Although the majority of our sales, expenses and cash flows are transacted in U.S. dollars, we have exposure to changes in foreign currency exchange rates related primarily to the Euro and the Canadian dollar. The Company believes that the impact of changes in foreign currency exchange rates in 2022 have not been significant. CRITICAL ACCOUNTING POLICIES Refer to Note 2 of the Notes to Consolidated Condensed Financial Statements included in this report for the Company’s critical accounting policies with respect to revenue recognition. For a complete discussion of the Company’s other critical accounting policies, refer to the Company’s annual report on Form 10-K for the year ended December 31, 2021. RECENT ACCOUNTING PRONOUNCEMENTS Refer to Note 1 of the Notes to Consolidated Condensed Financial Statements included in this report. FORWARD-LOOKING STATEMENTS Information included in this report that does not consist of historical facts, including statements accompanied by or containing words such as “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “approximate,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. Certain of these factors, risks and uncertainties are discussed in the sections of this report entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. We disclaim any obligation to update the forward-looking statements made in this report. Item 3. Quantitative and Qualitative Disclosures About Market Risk See Market Risk in Item 2, above.