Item 2. Management’s Discussion and Analysis
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of our financial condition and the results of operations as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the “Condensed Consolidated Financial Statements” and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This section and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. In some cases, forward-looking statements can be identified by words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions. Such forward-looking statements are based on current expectations, estimates and projections about our industry, our management’s beliefs and assumptions made by our management. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022, as updated by our subsequent filings under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”).
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Unless required by law, we expressly disclaim any obligation to update publicly any forward-looking statements, whether as result of new information, future events or otherwise.
Critical Accounting Policies and Estimates
The following should be read in conjunction with the critical accounting estimates presented in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022.
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. When we prepare these condensed consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Some of our accounting policies require that we make subjective judgments, including estimates that involve matters that are inherently uncertain. Our most critical estimates include those related to revenue recognition, inventory reserves for excess and obsolescence, intangible assets acquired in a business combination, goodwill, and income taxes. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition
We recognize revenue in accordance with ASU 2014-09, Revenue from Contracts with Customers (ASC 606). ASC 606 requires revenue to be recognized when promised goods or services are transferred to customers in amounts that reflect the consideration to which we expect to be entitled in exchange for those goods or services.
Revenue for TMS product deliveries and customer-funded research and development contracts is recognized over time as costs are incurred. Contract services revenue is composed of revenue recognized on contracts for the provision of services, including repairs and maintenance, training, engineering design, development and prototyping activities, and technical support services. Contract services revenue, including ISR services, is recognized over time as services are rendered. We elected the right to invoice practical expedient in which if an entity has a right to consideration from a customer in an amount that corresponds directly with the value to the customer of the entity’s performance completed to date, such as flight hours for ISR services, the entity may recognize revenue in the amount to which the entity has a right to invoice. Training services are recognized over time using an output method based on days of training completed. For performance obligations satisfied over time, revenue is generally recognized using costs incurred to date relative to total estimated costs at completion to measure progress. Incurred costs represent work performed, which correspond with, and thereby best depict, transfer of control to the customer. Contract costs include labor, materials, subcontractors’ costs, other direct costs, and indirect costs applicable on government and commercial contracts.
For performance obligations which are not satisfied over time per the aforementioned criteria above, revenue is recognized at the point in time in which each performance obligation is fully satisfied. Our small UAS, MUAS and UGV product sales revenue is composed of revenue recognized on contracts for the delivery of small UAS, MUAS and UGV systems and spare parts, respectively. Revenue is recognized at the point in time when control transfers to the customer, which generally occurs when title and risk of loss have passed to the customer.
We review cost performance, estimates-to-complete and variable consideration at least quarterly and in many cases more frequently. Adjustments to original estimates for a contract’s revenue, estimated costs at completion and estimated profit or loss are often required as work progresses under a contract, as experience is gained and as more information is obtained, even though the scope of work required under the contract may not change, or if contract modifications, including the finalization of undefinitized contract actions, occur. The impact of revisions in estimate of completion and variable consideration for all types of contracts are recognized on a cumulative catch-up basis in the period in which the revisions are made. Changes in variable consideration associated with the finalization of undefinitized contract actions could result in cumulative catch up adjustments to revenue that could be material. During the three months ended
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January 28, 2023 and January 29, 2022, changes in accounting estimates on contracts recognized over time are presented below.
For the three months ended January 28, 2023 and January 29, 2022, favorable and unfavorable cumulative catch-up adjustments included in revenue were as follows (in thousands):
Three Months Ended
January 28,
January 29,
2023
2022
Gross favorable adjustments
$
1,695
$
1,073
Gross unfavorable adjustments
(907)
(1,704)
Net favorable (unfavorable) adjustments
$
788
$
(631)
For the three months ended January 28, 2023, favorable cumulative catch-up adjustments of $1.7 million were primarily due to final cost adjustments on 11 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $0.9 million were primarily related to higher than expected costs on seven contracts, which individually were not material.
Also during the three months ended January 28, 2023, we recognized a decrease in the forward loss reserves on two MUAS ISR contracts for $2.4 million and an increase in the forward loss reserve of an MUAS products contract for $1.6 million.
For the three months ended January 29, 2022, favorable cumulative catch-up adjustments of $1.1 million were primarily due to final cost adjustments on six contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $1.7 million were primarily related to higher than expected costs on 10 contracts, which individually were not material.
For the nine months ended January 28, 2023 and January 29, 2022, favorable and unfavorable cumulative catch-up adjustments included in revenue were as follows (in thousands):
Nine Months Ended
January 28,
January 29,
2023
2022
Gross favorable adjustments
$
2,317
$
1,156
Gross unfavorable adjustments
(3,667)
(2,223)
Net unfavorable adjustments
$
(1,350)
$
(1,067)
For the nine months ended January 28, 2023, favorable cumulative catch-up adjustments of $2.3 million were primarily due to final cost adjustments on 22 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $3.7 million were primarily related to higher than expected costs on six contracts. During the nine months ended January 28, 2023, we revised our estimates of the total expected costs to complete two TMS variant contracts. The aggregate impact of these adjustments in contract estimates on revenue related to performance obligations satisfied or partially satisfied in previous periods was a decrease to revenue of approximately $2.4 million.
For the nine months ended January 29, 2022, favorable cumulative catch-up adjustments of $1.2 million were primarily due to final cost adjustments on 18 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $2.2 million were primarily related to higher than expected costs on 15 contracts, which individually were not material.
Goodwill
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Goodwill represents the excess of the cost of an acquired entity over the fair value of the acquired net assets. We test goodwill for impairment annually during the fourth quarter of our fiscal year or when events or circumstances change in a manner that indicates goodwill might be impaired. Events or circumstances that could trigger an impairment review include, but are not limited to, a significant adverse change in legal factors or in the business or political climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends or significant underperformance relative to projected future results of operations.
Our evaluation of goodwill for impairment involves the comparison of the fair value of each reporting unit to its carrying value. For the impairment test, we first assess qualitative factors, macroeconomic conditions, industry and market considerations, triggering events, cost factors, and overall financial performance, to determine whether it is necessary to perform a quantitative goodwill impairment test. Alternatively, we may bypass the qualitative assessment for some or all of its reporting units and apply the quantitative impairment test. If determined to be necessary, the quantitative impairment test shall be used to identify goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). For the quantitative impairment test we estimate the fair value by weighting the results from the income approach and the market approach. These valuation approaches consider a number of factors that include, but are not limited to, prospective financial information, growth rates, terminal value, discount rates, and comparable multiples from publicly traded companies in our industry and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of its business.
Our MUAS reporting unit is considered at an increased risk of failing future quantitative goodwill impairment tests as the estimated fair value exceeded its carrying value by approximately 10% during the most recent annual goodwill impairment test performed during the fourth quarter ended April 30, 2022. The termination of the COCO flight services at our remaining MUAS COCO services site location will be evaluated as part of the annual goodwill and intangible asset impairment test. We perform our annual impairment tests during the fourth quarter of each fiscal year. The intangibles included in the MUAS reporting unit of $56.0 million as of January 28, 2023 will also be evaluated for potential impairment during the fourth quarter.
The estimates and assumptions used to determine the fair value of our reporting units are highly subjective in nature. Actual results can be materially different from the estimates and assumptions. If actual market conditions are less favorable than those projected by the industry or by us, or if events occur or circumstances change that would reduce the estimated fair value of our indefinite-lived intangible assets below the carrying amounts, we could recognize future impairment charges, the amount of which could be material.
Fiscal Periods
Due to our fixed year end date of April 30, our first and fourth quarters each consist of approximately 13 weeks. The second and third quarters each consist of exactly 13 weeks. Our first three quarters end on a Saturday. Our 2023 fiscal year ends on April 30, 2023 and our fiscal quarters end on July 30, 2022, October 29, 2022 and January 28, 2023, respectively.
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Results of Operations
The following tables set forth our results of operations for the periods indicated (in thousands):
Three Months Ended January 28, 2023 Compared to Three Months Ended January 29, 2022
Three Months Ended
January 28,
January 29,
2023
2022
Revenue
$
134,395
$
90,093
Cost of sales
88,885
68,657
Gross margin
45,510
21,436
Selling, general and administrative
24,746
22,549
Research and development
16,157
13,013
Income (loss) from operations
4,607
(14,126)
Other (loss) income:
Interest expense, net
(2,810)
(1,510)
Other (expense) income, net
(2,587)
34
Loss before income taxes
(790)
(15,602)
Benefit from income taxes
(531)
(15,396)
Equity method investment (loss) income, net of tax
(417)
171
Net loss
$
(676)
$
(35)
We have identified four reportable segments, Small Unmanned Aircraft Systems (“Small UAS”), Tactical Missile Systems (“TMS”), Medium Unmanned Aircraft Systems (“MUAS”) and High Altitude Pseudo-Satellite Unmanned Aircraft Systems (“HAPS”). The Small UAS segment consists of our existing small UAS product lines. The TMS segment consists of our existing tactical missile systems product lines. The MUAS segment consists of our acquired Arcturus business. The HAPS segment consists of the Company’s existing development of High Altitude Pseudo-Satellite systems in conjunction with SoftBank. The category entitled “All other” includes MacCready Works, which includes the recently acquired ISG, and Telerob businesses. The following table (in thousands) sets forth our revenue, gross margin and adjusted operating income (loss) from operations generated by each reporting segment for the periods indicated. Adjusted operating income is defined as operating income before intangible amortization, amortization of purchase accounting adjustments, and acquisition related expenses. All corporate and headquarter expenses are allocated to the reportable segments.
Three Months Ended January 28, 2023
Small UAS
TMS
MUAS
HAPS
All other
Total
Revenue
$
69,376
$
24,015
$
15,405
$
8,938
$
16,661
$
134,395
Gross margin
32,937
7,841
(2,008)
2,733
4,007
45,510
Income (loss) from operations
18,548
(129)
(11,824)
1,334
(3,322)
4,607
Acquisition-related expenses
-
-
129
-
157
286
Amortization of acquired intangible assets and other purchase accounting adjustments
669
-
5,215
-
1,262
7,146
Adjusted income (loss) from operations
$
19,217
$
(129)
$
(6,480)
$
1,334
$
(1,903)
$
12,039
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Three Months Ended January 29, 2022
Small UAS
TMS
MUAS
HAPS
All other
Total
Revenue
$
24,366
$
18,603
$
21,168
$
9,543
$
16,413
$
90,093
Gross margin
8,656
5,209
335
3,173
4,063
21,436
Income (loss) from operations
(3,606)
(1,289)
(8,623)
1,574
(2,182)
(14,126)
Acquisition-related expenses
99
54
41
19
155
368
Amortization of acquired intangible assets and other purchase accounting adjustments
707
-
5,641
2
3,033
9,383
Adjusted income (loss) from operations
$
(2,800)
$
(1,235)
$
(2,941)
$
1,595
$
1,006
$
(4,375)
The Company recorded intangible amortization expense and other purchase accounting adjustments in the following categories on the accompanying unaudited condensed consolidated statements of operations:
Three Months Ended
Nine Months Ended
January 28,
January 29,
January 28,
January 29,
2023
2022
2023
2022
Cost of sales:
Product sales
$
1,026
$
2,359
$
3,060
$
6,346
Contract services
2,284
2,762
7,332
8,265
Selling, general and administrative
3,836
4,262
11,557
14,226
Total
$
7,146
$
9,383
$
21,949
$
28,837
Revenue. Revenue for the three months ended January 28, 2023 was $134.4 million, as compared to $90.1 million for the three months ended January 29, 2022, representing an increase of $44.3 million, or 49%. The increase in revenue was due to an increase in product revenue of $48.6 million, partially offset by a decrease in service revenue of $4.3 million. The increase in product revenue was primarily due to increases in small UAS and TMS product revenue, partially offset by a decrease in All other product revenue. The decrease in service revenue was primarily due to a decrease in MUAS service revenue, partially offset by increases in customer-funded research and development revenue. We expect the lower levels of MUAS service revenues to continue into fiscal 2024 due to the completion of certain MUAS site locations. Due to the higher backlog, the increase in the small UAS product revenues as compared to the prior year period is expected to continue for the fourth quarter of the fiscal year ended April 30, 2023.
Cost of Sales. Cost of sales for the three months ended January 28, 2023 was $88.9 million, as compared to $68.7 million for the three months ended January 29, 2022, representing an increase of $20.2 million, or 29%. The increase in cost of sales was a result of an increase in product cost of sales of $25.6 million, partially offset by a decrease in service costs of sales of $5.3 million. The increase in product costs of sales was primarily due to an increase in product revenue, partially offset by a favorable product mix. The decrease in service cost of sales was primarily due a decrease in service revenue. Cost of sales for the three months ended January 28, 2023 included $3.3 million of intangible amortization and other related non-cash purchase accounting expenses as compared to $5.1 million for the three months ended January 29, 2022. As a percentage of revenue, cost of sales decreased from 76% to 66%, primarily due to a favorable product mix, a decrease in intangible amortization and other related non-cash purchase accounting expenses, and an increase in revenue resulting in higher overhead cost absorption, partially offset by accelerated depreciation charges of certain deployed fixed assets related to the anticipated completion of certain MUAS site locations of $4.3 million.
Gross Margin. Gross margin for the three months ended January 28, 2023 was $45.5 million, as compared to $21.4 million for the three months ended January 29, 2022, representing an increase of $24.1 million, or 112%. The increase in gross margin was due primarily to an increase in product margin of $23.0 million and an increase in service margin of $1.0 million. The increase in product margin was primarily due to the increase in product sales and a favorable product mix. The increase in service margin was primarily due to a favorable service mix and higher overhead cost absorption. As a percentage of revenue, gross margin increased from 24% to 34%, primarily due to a favorable product mix, a decrease in intangible amortization and other related non-cash purchase accounting expenses, and an increase in revenue
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resulting in higher overhead cost absorption, partially offset by accelerated depreciation charges of certain deployed fixed assets related to the anticipated completion of certain MUAS site locations of $4.3 million. Additionally, we expect inflationary and supply chain constraint trends to continue throughout our fiscal year 2023, which are currently impacting and will continue to negatively impact our gross margin across all our segments.
Selling, General and Administrative . SG&A expense for the three months ended January 28, 2023 was $24.7 million, or 18% of revenue, as compared to SG&A expense of $22.5 million, or 25% of revenue, for the three months ended January 29, 2022. The increase in SG&A expense was primarily due to an increase in employee related expenses, partially offset by a decrease in intangible amortization and other related non-cash purchase accounting expenses.
Research and Development. R&D expense for the three months ended January 28, 2023 was $16.2 million, or 12% of revenue, as compared to R&D expense of $13.0 million, or 14% of revenue, for the three months ended January 29, 2022, primarily due to an increase in development activities regarding enhanced capabilities for our products, development of new product lines and support for our acquired businesses.
Interest Expense, net. Interest expense, net for the three months ended January 28, 2023 was $2.8 million compared to interest expense, net of $1.5 million for the three months ended January 29, 2022. The increase in interest expense, net was primarily due to an increase in interest expense resulting from higher interest rates on our debt facility, partially offset by lower average outstanding balances.
Other (Expense) Income, net. Other expense, net, for the three months ended January 28, 2023 was $(2.6) million compared to other income, net of $34 thousand for the three months ended January 29, 2022. Other expense, net for the three months ended January 28, 2023 includes unrealized losses associated with decreases in the fair market value for equity security investments.
Benefit from Income Taxes. Our effective income tax rate was 67.2% for the three months ended January 28, 2023, as compared to 98.7% for the three months ended January 29, 2022. Historically, we calculated the provision for income taxes during interim reporting periods by applying an estimate of our annual effective tax rate (“AETR”) for the full fiscal year to the pretax income or loss for the interim reporting period. For the three months ended January 28, 2023, we calculated the provision for income taxes using a discrete effective tax rate (“ETR”) method. We determined that since small changes in estimated pretax income or loss would result in significant changes in the estimated AETR, the historical method would not provide a reliable estimate for the three months ended January 28, 2023. The decrease in our effective income tax rate was in part due to the change to the ETR method. The effective income tax rate for the three months ended January 28, 2023 was primarily impacted by expected federal R&D tax credits, foreign-derived intangible income deductions and excess tax benefits on equity awards.
Equity Method Investment (Loss) Income, net of Tax. Equity method investment loss, net of tax for the three months ended January 28, 2023 was $(0.4) million as compared to equity method investment income, net of tax of $0.2 million for the three months ended January 29, 2022. In March 2022, the Company sold its 7% equity interest in HAPSMobile to SoftBank. Subsequent to the equity interest sale in HAPSMobile during the three months ended April 30, 2022, equity method investment loss, net of tax relates to activity related to investments in limited partnership funds.
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Nine Months Ended January 28, 2023 Compared to Nine Months Ended January 29, 2022
The following tables (in thousands) sets forth our revenue, gross margin and adjusted operating income (loss) from operations generated by each reporting segment for the periods indicated. Adjusted operating income is defined as operating income before intangible amortization, amortization of purchase accounting adjustments, and acquisition related expenses. All corporate and headquarter expenses are allocated to the reportable segments.
Nine Months Ended
January 28,
January 29,
2023
2022
Revenue
$
354,495
$
313,110
Cost of sales
249,381
220,496
Gross margin
105,114
92,614
Selling, general and administrative
70,302
74,496
Research and development
47,793
41,018
Loss from operations
(12,981)
(22,900)
Other loss:
Interest expense, net
(6,722)
(4,164)
Other expense, net
(2,183)
(10,360)
Loss before income taxes
(21,886)
(37,424)
Benefit from income taxes
(8,382)
(25,864)
Equity method investment (loss) income, net of tax
(2,190)
163
Net loss
$
(15,694)
$
(11,397)
Nine Months Ended January 28, 2023
Small UAS
TMS
MUAS
HAPS
All other
Total
Revenue
$
139,313
$
78,127
$
61,948
$
28,219
$
46,888
$
354,495
Gross margin
66,552
28,224
(9,965)
9,059
11,244
105,114
Income (loss) from operations
24,495
845
(36,651)
5,436
(7,106)
(12,981)
Acquisition-related expenses
-
-
470
-
720
1,190
Amortization of acquired intangible assets and other purchase accounting adjustments
2,019
-
16,057
-
3,873
21,949
Adjusted income (loss) from operations
$
26,514
$
845
$
(20,124)
$
5,436
$
(2,513)
$
10,158
Nine Months Ended January 29, 2022
Small UAS
TMS
MUAS
HAPS
All other
Total
Revenue
$
119,004
$
56,197
$
70,072
$
30,237
$
37,600
$
313,110
Gross margin
53,330
17,420
5,739
10,291
5,834
92,614
Income (loss) from operations
11,729
(1,705)
(22,004)
4,750
(15,670)
(22,900)
Acquisition-related expenses
819
468
1,533
181
1,468
4,469
Amortization of acquired intangible assets and other purchase accounting adjustments
2,121
-
17,190
5
9,521
28,837
Adjusted income (loss) from operations
$
14,669
$
(1,237)
$
(3,281)
$
4,936
$
(4,681)
$
10,406
Revenue. Revenue for the nine months ended January 28, 2023 was $354.5 million, as compared to $313.1 million for the nine months ended January 29, 2022, representing an increase of $41.4 million, or 13%. The increase in revenue was due to an increase in product revenue of $44.8 million, partially offset by a decrease in service revenue of $3.4 million. The increase in product revenue was primarily due to increases in small UAS, TMS and MUAS product revenue. The
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decrease in service revenue was primarily due to decreases in MUAS, small UAS and HAPS service revenue, partially offset by increases in revenue from customer-funded research and development efforts primarily in our All Other and TMS segments. We expect the lower levels of MUAS service revenues to continue into fiscal 2024 related to the completion of certain MUAS site locations. Due to the higher backlog, we expect the Small UAS product revenues to be significantly higher in the fourth quarter of fiscal 2023 and during the first half of fiscal 2024 as compared to the first half of fiscal 2023.
Cost of Sales. Cost of sales for the nine months ended January 28, 2023 was $249.4 million, as compared to $220.5 million for the nine months ended January 29, 2022, representing an increase of $28.9 million, or 13%. The increase in cost of sales was a result of an increase in product cost of sales of $26.4 million and an increase in service costs of sales of $2.5 million. The increase in product costs of sales was primarily due to an increase in product revenue. The increase in service cost of sales was primarily due to accelerated depreciation charges of certain deployed fixed assets related to the anticipated completion of certain MUAS site locations of $8.1 million, partially offset by a decrease in service revenue and a decrease in intangible amortization and other related non-cash purchase accounting expenses. Cost of sales for the nine months ended January 28, 2023 included $10.4 million of intangible amortization and other related non-cash purchase accounting expenses as compared to $14.6 million for the nine months ended January 29, 2022. As a percentage of revenue, cost of sales remained consistent at 70%.
Gross Margin. Gross margin for the nine months ended January 28, 2023 was $105.1 million, as compared to $92.6 million for the nine months ended January 29, 2022, representing an increase of $12.5 million, or 13%. The increase in gross margin was due to an increase in product margin of $18.4 million, partially offset by a decrease in service margin of $5.9 million. The increase in product margin was primarily due to the increase in product sales combined with a favorable product mix. The decrease in service margin was primarily due to accelerated depreciation charges of certain deployed fixed assets related to the anticipated completion of certain MUAS site locations of $8.1 million and a decrease in service revenue. As a percentage of revenue, gross margin remained consistent at 30%. Additionally, we expect inflationary and supply chain constraint trends to continue throughout our fiscal year 2023, which are currently and will continue to negatively impact our gross margin across all our segments.
Selling, General and Administrative . SG&A expense for the nine months ended January 28, 2023 was $70.3 million, or 20% of revenue, as compared to SG&A expense of $74.5 million, or 24% of revenue, for the nine months ended January 29, 2022. The decrease in SG&A expense was primarily due to a decrease in acquisition-related expenses of $3.9 million and a decrease in intangible amortization and other related non-cash purchase accounting expenses of $2.7 million, partially offset by an increase in employee related costs.
Research and Development. R&D expense for the nine months ended January 28, 2023 was $47.8 million, or 13% of revenue, as compared to R&D expense of $41.0 million, or 13% of revenue, for the nine months ended January 29, 2022, primarily due to an increase in development activities regarding enhanced capabilities for our products, development of new product lines and to support our acquired businesses.
Interest Expense, net. Interest expense, net for the nine months ended January 28, 2023 was $6.7 million compared to interest expense, net of $4.2 million for the nine months ended January 29, 2022. The increase in interest expense, net was primarily due to an increase in interest expense resulting from higher interest rates on our debt facility, partially offset by lower average outstanding balances.
Other Expense, net. Other expense, net, for the nine months ended January 28, 2023 was $2.2 million compared to other expense, net of $10.4 million for the nine months ended January 29, 2022. The decrease in other expense, net is primarily due to a legal accrual of $10.0 million for the settlement of all claims made by the buyers of our former EES business recorded during the nine months ended January 29, 2022. Other expense, net for the nine months ended January 28, 2023 includes unrealized losses associated with decreases in fair market value for equity security investments.
Benefit from Income Taxes. Our effective income tax rate was 38.3% for the nine months ended January 28, 2023, as compared to 69.1% for the nine months ended January 29, 2022. Historically, we calculate the provision for income taxes during interim reporting periods by applying an estimate of our annual effective tax rate (“AETR”) for the full fiscal year to the pretax income or loss for the interim reporting period. For the nine months ended January 28, 2023, we
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calculated the provision for income taxes using a discrete effective tax rate (“ETR”) method. We determined that since small changes in estimated pretax income or loss would result in significant changes in the estimated AETR, the historical method would not provide a reliable estimate for the nine months ended January 28, 2023. The decrease in our effective income tax rate was primarily due to the change to the ETR method. The effective income tax rate for the nine months ended January 28, 2023 was primarily impacted by expected federal R&D tax credits and foreign-derived intangible income deductions.
Equity Method Investment (Loss) Income, net of Tax. Equity method investment loss, net of tax for the nine months ended January 28, 2023 was $2.2 million as compared to equity method investment income, net of tax of $0.2 million for the nine months ended January 29, 2022. In March 2022, the Company sold its 7% equity interest in HAPSMobile to SoftBank. Subsequent to the equity interest sale in HAPSMobile during the three months ended April 30, 2022, equity method investment loss, net of tax relates to activity related to investments in limited partnership funds.
Backlog
Consistent with ASC 606, we define funded backlog as remaining performance obligations under firm orders for which funding is currently appropriated to us under a customer contract. As of January 28, 2023, our funded backlog was approximately $413.9 million, as compared to $210.8 million as of April 30, 2022.
In addition to our funded backlog, we also had unfunded backlog of $387.0 million as of January 28, 2023. Unfunded backlog does not meet the definition of a performance obligation under ASC 606. We define unfunded backlog as the total remaining potential order amounts under cost reimbursable and fixed price contracts with (i) multiple one-year options and indefinite delivery, indefinite quantity (“IDIQ”) contracts, or (ii) incremental funding. Unfunded backlog does not obligate the customer to purchase goods or services. There can be no assurance that unfunded backlog will result in any orders in any particular period, if at all. Management believes that unfunded backlog does not provide a reliable measure of future estimated revenue under our contracts. Unfunded backlog includes a $235.2 million contract with a third party that is pending export license approval prior to the funding of the contract. Unfunded backlog does not include the remaining potential value associated with a U.S. Army IDIQ-type contract for small UAS because values for each of the other domains within the contract have not been disclosed by the customer, and we cannot be certain that we will secure all task orders issued against the contract. Additionally, unfunded backlog on the U.S. Special Operations Command (“SOCOM”) Mid-Endurance Unmanned Aircraft Systems (“MEUAS”) contract reflects only those sites which have been awarded to Arcturus and does not include the remaining potential value associated with the entire SOCOM MEUAS III/IV contract.
Because of possible future changes in delivery schedules and/or cancellations of orders, backlog at any particular date is not necessarily representative of actual sales to be expected for any succeeding period, and actual sales for the year may not meet or exceed the backlog represented. Our backlog is typically subject to large variations from quarter to quarter as existing contracts expire or are renewed or new contracts are awarded. A majority of our contracts, specifically our IDIQ contracts, do not currently obligate the U.S. government to purchase any goods or services. Additionally, all U.S. government contracts included in backlog, whether or not they are funded, may be terminated at the convenience of the U.S. government.
Liquidity and Capital Resources
On September 8, 2022 we filed an S-3 shelf registration statement to offer and sell shares of our common stock, including a prospectus supplement in relation to an Open Market Sale Agreement SM , also dated September 8, 2022, with Jefferies LLC relating to the proposed offer and sale of shares of our common stock having an aggregate offering price of up to $200.0 million from time to time through Jefferies LLC as our sales agent. As of January 28, 2023, we have sold 221,971 of our shares for total gross proceeds of $21.4 million, and we have $178.6 million aggregate offering price remaining available under the registration.
On February 19, 2021 in connection with the consummation of the Arcturus acquisition, we entered into the Credit Agreement for (i) the Revolving Facility, and (ii) the Term Loan Facility, and together with the Revolving Credit Facility, the “Credit Facilities”. The Term Loan Facility requires payment of 5% of the outstanding obligations in each of
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the first four loan years, with the remaining 80.0% payable in loan year five, consisting of three quarterly payments of 1.25% each, with the remaining outstanding principal amount of the Term Loan Facility due and payable on the final maturity date. Proceeds from the Term Loan Facility were used in part to finance a portion of the cash consideration for the Arcturus acquisition. Our ability to borrow under the Revolving Facility is reduced by outstanding letters of credit of $4.7 million as of January 28, 2023. As of January 28, 2023, approximately $95.3 million was available under the Revolving Facility. Borrowings under the Revolving Facility may be used for working capital and other general corporate purposes. Refer to Note 10—Debt to our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further details. In addition, Telerob has a line of credit of €5.5 million ($6.0 million) available for issuing letters of credit of which €2.8 million ($3.0 million) was outstanding as of January 28, 2023.
We anticipate funding our normal recurring trade payables, accrued expenses, ongoing R&D costs and obligations under the Credit Facilities through our existing working capital and funds provided by operating activities including those provided by our recent acquisitions of Arcturus, ISG, Telerob and Planck. The majority of our purchase obligations are pursuant to funded contractual arrangements with our customers. We believe that our existing cash, cash equivalents, cash provided by operating activities and other financing sources will be sufficient to meet our anticipated working capital, capital expenditure requirements, future obligations related to the recent acquisitions and obligations under the Credit Facilities during the next twelve months. There can be no assurance, however, that our business will continue to generate cash flow at current levels. If we are unable to generate sufficient cash flow from operations, then we may be required to sell assets, reduce capital expenditures or draw on our Credit Facilities. We anticipate that existing sources of liquidity, Credit Facilities, and cash flows from operations will be sufficient to satisfy our cash needs for the foreseeable future.
Our primary liquidity needs are for financing working capital, investing in capital expenditures, supporting product development efforts, introducing new products and enhancing existing products, marketing acceptance and adoption of our products and services. Our future capital requirements, to a certain extent, are also subject to general conditions in or affecting the defense industry and are subject to general economic, political, financial, competitive, legislative and regulatory factors that are beyond our control. Moreover, to the extent that existing cash, cash equivalents, cash from operations, and cash from our Credit Agreement are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing, subject to the limitations specified in our Credit Facility agreement. In addition, we may also need to seek additional equity funding or debt financing if we become a party to any agreement or letter of intent for potential investments in, or acquisitions of, businesses, services or technologies.
Our working capital requirements vary by contract type. On cost-plus-fee programs, we typically bill our incurred costs and fees monthly as work progresses, and therefore working capital investment is minimal. On fixed-price contracts, we typically are paid as we deliver products, and working capital is needed to fund labor and expenses incurred during the lead time from contract award until contract deliveries begin.
To date, COVID-19 has not had a significant impact on our liquidity, cash flows or capital resources. However, the continued spread of COVID-19 has led to disruption and volatility in the global capital markets, which, depending on future developments, could impact our capital resources and liquidity in the future. In consideration of the impact of the ongoing COVID-19 pandemic, we continue to hold significant cash and cash equivalents.
During the fiscal year ended April 30, 2022, we made certain commitments outside of the ordinary course of business, including capital contribution commitments to a second limited partnership fund. Under the terms of a new limited partnership agreement, we have committed to make capital contributions to such fund totaling $20.0 million, inclusive of the expected reinvestment of distributions from our existing limited partnership fund, of which $17.2 million was remaining at January 28, 2023. The contributions are anticipated to be paid over the next five fiscal years. As of January 28, 2023, $5.0 million remains of the obligation under the legal settlement with Webasto. The final $5.0 million was paid on February 2, 2023.
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Cash Flows
The following table provides our cash flow data for the nine months ended January 28, 2023 and January 29, 2022 (in thousands):
Nine Months Ended
January 28,
January 29,
2023
2022
(Unaudited)
Net cash provided by (used in) operating activities
$
8,801
$
(23,176)
Net cash provided by (used in) investing activities
$
889
$
(37,009)
Net cash used in financing activities
$
(2,402)
$
(11,914)
Cash Provided by (Used in) Operating Activities. Net cash provided by operating activities for the nine months ended January 28, 2023 increased by $32.0 million to $8.8 million, as compared to net cash used in operating activities of $23.2 million for the nine months ended January 29, 2022. The increase in net cash provided by operating activities was primarily due to an increase in cash as a result of changes in operating assets and liabilities of $29.8 million, largely related to unbilled receivables and retentions, income taxes receivable and other liabilities, partially offset by a decrease in inventories, accounts receivable and prepaid expenses and other assets due to year over year timing differences, and an increase in non-cash expenses of $6.5 million primarily due to an increase in loss from equity investments of and stock-based compensation, partially offset by an increase in net loss of $4.3 million.
Cash Provided by (Used in) Investing Activities. Net cash provided by investing activities increased by $37.9 million to $0.9 million for the nine months ended January 28, 2023, as compared to net cash used in investing activities of $37.0 million for the nine months ended January 29, 2022. The increase in net cash provided by investing activities was primarily due to the acquisition of Telerob for $46.2 million in the prior year, a decrease in acquisition of property and equipment of $6.9 million and a decrease in equity method investments of $4.1 million, partially offset by a decrease in redemptions of available-for-sale investments of $9.9 million and equity securities investments of $5.1 million.
Cash Used in Financing Activities. Net cash used in financing activities decreased by $9.5 million to $2.4 million for the nine months ended January 28, 2023, as compared to net cash used by financing activities of $11.9 million for the nine months ended January 29, 2022. The decrease in net cash used by financing activities was primarily due to proceeds from share issuance net of issuance costs of $20.1 million and a decrease in holdback and retention payments related to business acquisitions of $6.0 million, partially offset by an increase in principal payment of the term loan of $15.0 million.
New Accounting Standards
Please refer to Note 1—Organization and Significant Accounting Policies to our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of new accounting pronouncements and accounting pronouncements adopted during the nine months ended January 28, 2023.
ITEM 3. QUANTITATIVE AND QUALITATIV E DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, we are exposed to various market risk factors, including fluctuations in interest rates, changes in general economic conditions, domestic and foreign competition, and foreign currency exchange rates.
Interest Rate Risk
It is our policy not to enter into interest rate derivative financial instruments. On February 19, 2021 in connection with the consummation of the Arcturus Acquisition, we entered into the Credit Facilities. The current outstanding balance of the Credit Facilities is $167.5 million and bears a variable interest rate. The market interest rate has increased significantly, and if market interest rates continue to increase, interest due on the Credit Facilities would increase.
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Foreign Currency Exchange Rate Risk
Since a significant part of our sales and expenses are denominated in U.S. dollars, we have not experienced significant foreign exchange gains or losses to date. We occasionally engage in forward contracts in foreign currencies to limit our exposure on non-U.S. dollar transactions. With the acquisition of Telerob, a portion of our cash balance is denominated in Euros which is Telerob’s functional currency.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.