Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview of Business; Operating Environment and Key Factors Impacting Fiscal 2020 and 2019 Results
The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand our results of operations and financial condition. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes. In the discussion below, our fiscal year ending July 2, 2021 is referred to as “fiscal 2021” or “2021”; our fiscal year ended July 3, 2020 is referred to as “fiscal 2020” or “2020”; our fiscal year ended June 28, 2019 is referred to as “fiscal 2019” or “2019”; and our fiscal year ended June 29, 2018 is referred to as “fiscal 2018” or “2018.” Our fiscal year ends on the Friday nearest to June 30. Fiscal 2020 presented included 53 weeks while fiscal 2019 and fiscal 2018 each included 52 weeks. This one extra week has impacted both our fiscal 2020 revenue and expenses.
Overview
We anticipate modest growth in revenue in fiscal 2021. We have a healthy backlog entering fiscal 2021 for North America private network projects and we anticipate continuing our strong momentum across these verticals. We have made inroads into the U.S. rural broadband and wireless internet service provider areas and there is further evidence now of investment to support 5G deployments with our U.S. service provider customers. Internationally, we are continuing a more conservative view of our revenue opportunity based on a variety of factors that have led to an overall capital spending decline and increased competitive intensity, especially from vendors based in China.
Operations Review
The market for mobile backhaul continued to be our primary addressable market segment globally in fiscal 2020. In North America, we supported long-term evolution (LTE) deployments of our mobile operator customers, public safety network deployments for state and local governments, and private network implementations for utilities and other customers. In international markets, our business continued to rely on a combination of customers increasing their capacity to handle subscriber growth, the ongoing build-out of some large 3G deployments, and LTE deployments. Our position continues to be to support our customers for 5G and LTE readiness and ensure that our technology roadmap is well aligned with evolving market requirements. We continue to find that our strength in turnkey and after-sale support services is a differentiating factor that wins business for us and enables us to expand our business with existing customers in all markets. However, as disclosed above and in the “Risk Factors” section in Item 1A of this Annual Report on Form 10-K, a number of factors could prevent us from achieving our objectives, including ongoing pricing pressures attributable to competition and macroeconomic conditions in the geographic markets that we service.
Revenue
We manage our sales activities primarily on a geographic basis in North America and three international geographic regions: (1) Africa and the Middle East, (2) Europe and Russia and (3) Latin America and Asia Pacific. Revenue by region for fiscal 2020, 2019 and 2018 and the related changes are shown in the table below:
Fiscal Year $ Change % Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
North America $ 151,709 $ 132,884 $ 131,078 $ 18,825 $ 1,806 14.2 % 1.4 %
Africa and the Middle East 37,595 48,305 58,459 (10,710) (10,154) (22.2) % (17.4) %
Europe and Russia 11,157 16,933 18,205 (5,776) (1,272) (34.1) % (7.0) %
Latin America and Asia Pacific 38,181 45,736 34,764 (7,555) 10,972 (16.5) % 31.6 %
Total Revenue $ 238,642 $ 243,858 $ 242,506 $ (5,216) $ 1,352 (2.1) % 0.6 %
During fiscal 2020 and 2019, we recognized revenue based on Accounting Standards Codification (“ASC”) 606 but revenue for fiscal 2018 was recognized based on ASC 605. Therefore, the periods are not directly comparable. See “Critical Accounting Estimates—Revenue Recognition” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information on our revenue recognition.
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Our revenue from North America increased by $18.8 million, or 14.2%, in fiscal 2020 compared with fiscal 2019. The increase in North America revenue during fiscal 2020 was due to revenue growth with private network customers, as well as increased sales to mobile operators. Revenue from North America increased $1.8 million, or 1.4%, in fiscal 2019 compared with fiscal 2018. The increase in North America revenue during fiscal 2019 was due to stronger order flow from private network customers.
Our revenue from Africa and the Middle East decreased by $10.7 million, or 22.2%, in fiscal 2020 compared with fiscal 2019. The decrease in revenue was primarily due to decreased sales to our large mobile operator customers in the region. Revenue from Africa and the Middle East decreased $10.2 million, or 17.4%, in fiscal 2019 compared with fiscal 2018. The decrease in revenue was primarily due to decreased sales to our large mobile operator customers in the region and completion of a one-time large Middle East project in fiscal 2018.
Revenue from Europe and Russia decreased by $5.8 million, or 34.1%, in fiscal 2020 compared with fiscal 2019. The decrease was due to lower sales to mobile operator customers, offset in part by increased sales to private network customers in the region. Revenue in Europe and Russia decreased $1.3 million, or 7.0%, in fiscal 2019 compared with fiscal 2018. The decrease during fiscal 2019 was due to lower sales to mobile and private network customers in the region.
Revenue from Latin America and Asia Pacific decreased by $7.6 million, or 16.5%, in fiscal 2020 compared with fiscal 2019. The decrease was primarily due to lower sales volume from certain mobile operator customers in Asia Pacific offset in part by increased revenue in Latin America. Revenue from Latin America and Asia-Pacific increased $11.0 million, or 31.6%, in fiscal 2019 compared with fiscal 2018. The increase was primarily due to higher sales volume from certain mobile operator customers in Asia Pacific.
Fiscal Year $ Change % Change
(In thousands, except percentages)
2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
Product sales
$ 153,793 $ 156,724 $ 151,685 $ (2,931) $ 5,039 (1.9) % 3.3 %
Services
84,849 87,134 90,821 (2,285) (3,687) (2.6) % (4.1) %
Total Revenue
$ 238,642 $ 243,858 $ 242,506 $ (5,216) $ 1,352 (2.1) % 0.6 %
Our revenue from product sales decreased by $2.9 million, or 1.9%, in fiscal 2020 compared with fiscal 2019. Product volume decreased with customers in international markets and was offset in part by increased product sales in North America. Our services revenue decreased by $2.3 million, or 2.6%, in fiscal 2020 compared with fiscal 2019. Decreased sales in international markets were offset in part by increased sales in North America.
Our revenue from product sales increased $5.0 million, or 3.3%, in fiscal 2019 compared with fiscal 2018. Product volume increased primarily with mobile operators in Asia Pacific and a small increase in North America offsetting volume reductions in the other regions compared with fiscal 2018. Our services revenue decreased by $3.7 million, or 4.1%, in fiscal 2019 compared with fiscal 2018. Decreased sales in Africa and the Middle East were offset in part by increased sales in other regions.
Gross Margin
Fiscal Year $ Change % Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
Revenue $ 238,642 $ 243,858 $ 242,506 $ (5,216) $ 1,352 (2.1) % 0.6 %
Cost of revenue 153,946 164,588 162,003 (10,642) 2,585 (6.5) % 1.6 %
Gross margin $ 84,696 $ 79,270 $ 80,503 $ 5,426 $ (1,233) 6.8 % (1.5) %
% of revenue 35.5 % 32.5 % 33.2 %
Product margin % 38.0 % 33.9 % 34.0 %
Service margin % 30.9 % 29.9 % 31.9 %
Gross margin for fiscal 2020 increased by $5.4 million, or 6.8%, compared with fiscal 2019. Gross margin as a percentage of revenue for fiscal 2020 increased to 35.5%, compared with 32.5% in fiscal 2019, primarily due to higher
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margin rates for product sales and implementation of cost savings initiatives. The increased volume of product sales in North America, which generally has a higher gross margin compared to international, contributed most of the overall gross margin improvement in fiscal 2020.
Gross margin for fiscal 2019 decreased $1.2 million, or 1.5%, compared with fiscal 2018. Gross margin as a percentage of revenue for fiscal 2019 decreased to 32.5%, compared with 33.2% in fiscal 2018, primarily due to lower margin rates for services. Service margin as a percentage of service revenue declined in fiscal 2019 compared to fiscal 2018, primarily due to decreased margins in North America, the Middle East and Africa.
Research and Development Expenses
Fiscal Year $ Change % Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
Research and development expenses
$ 19,284 $ 21,111 $ 19,750 $ (1,827) $ 1,361 (8.7) % 6.9 %
% of revenue 8.1 % 8.7 % 8.1 %
Our research and development (“R&D”) expenses decreased by $1.8 million, or 8.7%, in fiscal 2020 compared with fiscal 2019. The decrease was primarily due to consolidation of product development, lower variable compensation and costs reduction initiatives associated with COVID-19, offset in part by expenses associated with one extra week in our fiscal 2020 calendar.
Our R&D expenses increased $1.4 million, or 6.9%, in fiscal 2019 compared with fiscal 2018. The increase was primarily due to increased development activity on new product lines.
Selling and Administrative Expenses
Fiscal Year $ Change % Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
Selling and administrative expenses
$ 57,985 $ 56,055 $ 58,157 $ 1,930 $ (2,102) 3.4 % (3.6) %
% of revenue 24.3 % 23.0 % 24.0 %
Our selling and administrative expenses increased by $1.9 million, or 3.4%, in fiscal 2020 compared with fiscal 2019. The increase was primarily due to higher variable compensation and expenses associated with one extra week in our fiscal 2020 calendar, partially offset by cost reductions initiatives associated with COVID-19.
Our selling and administrative expenses decreased $2.1 million, or 3.6%, in fiscal 2019 compared with fiscal 2018. The decrease was primarily due to lower variable compensation.
Restructuring Charges
During the fourth quarter of fiscal 2020, our Board of Directors approved a restructuring plan (the “Q4 2020 Plan”) in order to continue to reduce our operating costs and improve profitability to optimize our business model and increase efficiencies. The Q4 2020 Plan is being implemented starting with our fourth fiscal quarter of 2020 through the second fiscal quarter of 2021. We recorded restructuring charges of $1.9 million related to the Q4 2020 Plan in fiscal 2020. Payments related to the accrued restructuring liability balance for this plan are expected to be fully paid in fiscal 2021.
During the third quarter of fiscal 2020, our Board of Directors approved a restructuring plan (the “Q3 2020 Plan”) in order to reduce our operating costs and improve profitability to optimize our business model and increase efficiencies. We recorded restructuring charges of $0.6 million related to the Q3 2020 Plan in fiscal 2020. Payments related to the accrued restructuring liability balance for this plan are expected to be fully paid in fiscal 2021.
During the fourth quarter of fiscal 2019, our Board of Directors approved a restructuring plan (the “Fiscal 2020 Plan”) to primarily consolidate product development, right size our resources to support our International business and
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other support functions. Payments related to the accrued restructuring liability balance for this plan are expected to be fully paid in fiscal 2021.
During the fourth quarter of fiscal 2018, our Board of Directors approved a restructuring plan (the “Fiscal 2018-2019 Plan”) to consolidate back-office support functions and align resources by geography to lower our expense structure. We completed the restructuring activities under the Fiscal 2018-2019 Plan at the end of fiscal 2019. The remaining payments related to the accrued restructuring liability balance for this plan are expected to be fully paid in fiscal 2021.
Our restructuring charges by plan for fiscal 2020, 2019 and 2018 are summarized in the table below:
Fiscal Year $ Change % Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
Q4 2020 Plan $ 1,879 $ — $ — $ 1,879 $ — N/A N/A
Q3 2020 Plan $ 595 $ — $ — $ 595 $ — N/A N/A
Fiscal 2020 Plan $ 1,725 $ — $ — $ 1,725 $ — N/A N/A
Fiscal 2018-2019 Plan $ (150) $ 736 $ 1,532 $ (886) $ (796) (120.4) % N/A
Fiscal 2016-2017 Plan — — (5) — 5 N/A (100.0) %
Other prior years plans — — (248) — 248 N/A (100.0) %
Total $ 4,049 $ 736 $ 1,279 $ 3,313 $ (543) 450.1 % (42.5) %
Restructuring charges in fiscal 2020 of $4.0 million relate to employee severance and benefits for the Q4 2020 Plan, Q3 2020 Plan and the Fiscal 2020 Plan. Restructuring charges for fiscal 2019 included $0.7 million of employee severance and benefits costs related to the Fiscal 2018-2019 Plan. Restructuring charges for fiscal 2018 included $1.5 million of employee severance and benefits costs primarily related to the Fiscal 2018-2019 Plan and a reduction in the previously estimated accrual of $0.3 million of an older plan.
Interest Income, Interest Expense and Other Income (Expense), Net
Fiscal Year $ Change % Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018 2020/2019 2019/2018
Interest income $ 385 $ 267 $ 198 $ 118 $ 69 44 % 35 %
Interest expense (54) (102) (29) 48 (73) (47) % 252 %
Other income (expense), net — 17 (220) (17) 237 N/A N/A
Interest income reflected interest earned on our cash equivalents which were comprised of money market funds and bank certificates of deposit.
Interest expense was primarily related to interest associated with borrowings under our Silicon Valley Bank (“SVB”) credit facility and discounts on customer letters of credit.
Other expense in fiscal 2018 included $0.2 million related to the foreign exchange loss on a dividend declared by our Nigeria entity (a partnership for U.S. tax purposes) to our Aviat U.S. entity.
Income Taxes
Fiscal Year $ Change
(In thousands, except percentages) 2020 2019 2018 2020/2019 2019/2018
Income before income taxes
$ 3,709 $ 1,550 $ 1,266 $ 2,159 $ 284
Provision for (benefit from) income taxes 3,452 (8,188) (1,036) 11,640 (7,152)
As % of income before income taxes
93.1 % (528.3) % (81.8) %
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Our provision for (benefit from) income taxes was $3.5 million of expense for fiscal 2020, $8.2 million of benefit for fiscal 2019 and $1.0 million of benefit for fiscal 2018. The tax expense for fiscal 2020 was primarily due to tax expense related to profitable foreign subsidiaries and an increase in our reserve for uncertain tax positions.
Our tax benefit for fiscal 2019 was primarily due to the release of certain U.S. federal and state valuation allowances of $7.5 million and a refundable foreign withholding tax credit, partially offset by losses in tax jurisdictions in which we cannot recognize tax benefits. During the first quarter of fiscal 2019, we received notification from the Department of Federal Revenue of Brazil that our withholding tax refund request had been approved. We recorded a net discrete income tax benefit of $1.6 million for the release of valuation allowance previously recorded as a deferred tax asset for the withholding tax credits. This consisted of an income tax benefit of $1.9 million for the refundable withholding tax credit, less tax expense of $0.3 million from recognizing an ASC 740-10 reserve previously recorded as a reduction to the withholding tax credits. We expect to receive the refundable withholding tax credit during our fiscal year 2021.
Liquidity, Capital Resources and Financial Strategies
As of July 3, 2020, our cash and cash equivalents and short-term investments totaled $41.6 million. Approximately $25.2 million, or 60.5%, was held in the United States. The remaining balance of $16.4 million, or 39.5%, was held by entities outside the United States. Of the amount of cash and cash equivalents held by our foreign subsidiaries at July 3, 2020, $16.0 million was held in jurisdictions where our undistributed earnings are indefinitely reinvested, and if repatriated, would be subject to foreign withholding taxes.
Operating Activities
Cash provided by operating activities is presented as net income adjusted for certain non-cash items and changes in assets and liabilities. Net cash provided by operating activities was $17.5 million for fiscal 2020, $2.9 million for fiscal 2019 and $8.2 million for fiscal 2018.
For fiscal 2020 compared to fiscal 2019, cash provided by operating activities increased by $14.5 million. The net contribution of non-cash items to cash provided by operating activities increased by $9.3 million and the net contribution of changes in operating assets and liabilities to cash provided by operating activities increased by $10.3 million in fiscal 2020 as compared to fiscal 2019.
The $9.3 million increase in the net contribution of non-cash items to cash provided by operating activities was primarily attributable to a $8.6 million net change in deferred tax assets.
Changes in operating assets and liabilities resulted in an increase of $10.3 million to cash provided by operating activities for fiscal 2020 compared to fiscal 2019. Accounts receivable and unbilled costs fluctuate from period to period, depending on the amount and timing of sales and billing activities and cash collections. The fluctuations in accounts payable and accrued expenses during fiscal 2020 were primarily due to the timing of liabilities incurred and vendor payments. The change in inventories and in customer service inventories during fiscal 2020 were primarily driven by forecasted demand and to secure component parts in shortage. The increase in customer advance payments and unearned revenue during fiscal 2020 was due to the timing of payment from customers and revenue recognition. We used $2.6 million in cash during fiscal 2020 on expenses related to restructuring liabilities.
For fiscal 2019 compared to fiscal 2018, cash provided by operating activities declined by $5.3 million. The net contribution of non-cash items to cash provided by operating activities decreased by $7.2 million and the net contribution of changes in operating assets and liabilities to cash provided by operating activities decreased by $5.5 million in fiscal 2019 as compared to fiscal 2018.
The $7.2 million decrease in the net contribution of non-cash items to cash provided by operating activities was primarily attributable to a $5.6 million net change in deferred tax assets, a $0.7 million decrease in depreciation and amortization and a $0.6 million decrease in share based compensation.
Investing Activities
Net cash used in investing activities was $4.6 million for fiscal year 2020, $5.2 million for fiscal 2019 and $6.3 million for fiscal 2018, which consisted primarily of capital expenditures.
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For fiscal 2021, we expect to spend between $5.0 million to $6.0 million for capital expenditures, primarily on equipment for development and manufacturing of new products and IT infrastructure.
Financing Activities
Financing cash flows consist primarily of proceeds and repayments of short-term debt, repurchase of stock and proceeds from the sale of shares of common stock through employee equity plans. Net cash used in financing activities was $2.5 million for fiscal year 2020, which was primarily attributable to $1.8 million for the repurchases of our common stock and a $0.8 million payment for taxes related to the net settlement of equity awards. Net cash used by financing activities was $3.0 million for fiscal 2019 and net cash provided by financing activities was $12,000 for fiscal 2018.
As of July 3, 2020, our principal sources of liquidity consisted of the $41.6 million in cash and cash equivalents, $13.3 million of available credit under our $23.8 million credit facility with Silicon Valley Bank (“SVB Credit Facility”) which matures on June 28, 2021, and future collections of receivables from customers. We regularly require letters of credit from certain customers and, from time to time, these letters of credit are discounted without recourse shortly after shipment occurs in order to meet immediate liquidity requirements and to reduce our credit and sovereign risk. Historically, our primary sources of liquidity have been cash flows from operations and credit facilities.
We believe that our existing cash and cash equivalents, the available line of credit under the SVB Credit Facility and future cash collections from customers will be sufficient to provide for our anticipated requirements for working capital and capital expenditures for at least the next 12 months. On May 4, 2020, we entered into Amendment No. 3 to Third Amended and Restated Loan and Security Agreement which extended the expiration date to June 28, 2021. While we intend to continue to renew the SVB Credit Facility annually, there can be no assurance that the SVB Credit Facility will be renewed. In addition, there can be no assurance that our business will generate cash flow from operations, that we will be in compliance with the quarterly financial covenants contained in the SVB Credit Facility, or that we will have a sufficient borrowing base under such facility. If we are not in compliance with the financial covenants or do not have sufficient eligible accounts receivable to support our borrowing base, the availability of our credit facility is not certain or may be diminished. Over the longer term, if we are unable to maintain cash balances or generate sufficient cash flow from operations to service our obligations that may arise in the future, we may be required to sell assets, reduce capital expenditures, or obtain financing. If we need to obtain additional financing, we cannot be assured that it will be available on favorable terms, or at all. Our ability to make scheduled principal payments or pay interest on or refinance any future indebtedness depends on our future performance and financial results, which, to a certain extent, are subject to general conditions in or affecting the microwave communications market and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.
Available Credit Facility, Borrowings and Repayment of Debt
On May 4, 2020, we entered into Amendment No. 3 to Third Amended and Restated Loan and Security Agreement with Silicon Valley Bank. The SVB Credit Facility provides for a $23.8 million accounts receivable formula-based revolving credit facility that can be borrowed by the U.S. company, with a $25.0 million sub-limit that can be borrowed by our U.S. and Singapore entities. Loans may be advanced under the SVB Credit Facility based on a borrowing base equal to a specified percentage of the value of eligible accounts of all borrowers under the SVB Credit Facility. The borrowing base is subject to certain eligibility criteria. Availability under the accounts receivable formula-based revolving credit facility can also be utilized to issue letters of credit with a $12.0 million sub-limit. We may prepay loans under the SVB Credit Facility in whole or in part at any time without premium or penalty. As of July 3, 2020, available credit under the SVB Credit Facility was $13.3 million reflecting the calculated borrowing base of $23.8 million less existing borrowings of $9.0 million and outstanding letters of credit of $1.5 million.
The SVB Credit Facility carries an interest rate, at our option, computed (i) at the prime rate reported in the Wall Street Journal plus a spread of 0.50% to 1.50%, with such spread determined based on our adjusted quick ratio; or (ii) if we satisfy a minimum adjusted quick ratio, a LIBOR rate determined in accordance with the SVB Credit Facility, plus a spread of 2.75%. Any outstanding Singapore subsidiary-borrowed loans shall bear interest at an additional 2.00% above the applicable prime or LIBOR rate. During fiscal 2020, the weighted-average interest rate on our outstanding loan was 3.97%. As of July 3, 2020 and June 28, 2019, our outstanding debt balance under the SVB Credit Facility was $9.0 million, and the interest rate was 3.75% and 6.00%, respectively.
The SVB Credit Facility contains monthly and quarterly financial covenants for minimum adjusted quick ratio and minimum profitability (EBITDA) requirements, respectively. In the event our adjusted quick ratio falls below a certain level, cash received in our accounts with SVB may be directly applied to reduce outstanding obligations under the SVB
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Credit Facility. The SVB Credit Facility also imposes certain restrictions on our ability to dispose of assets, enter into a transaction resulting in a change in control, merge or consolidate, make acquisitions, incur indebtedness, grant liens, make investments, make certain restricted payments and enter into transactions with affiliates under certain circumstances. Certain of our assets, including accounts receivable, inventory, and equipment, are pledged as collateral for the SVB Credit Facility. Upon an event of default, outstanding obligations would be immediately due and payable. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default at a per annum rate of interest equal to 5.00% above the applicable interest rate.
As of July 3, 2020, we were in compliance with the quarterly financial covenants, as amended, contained in the SVB Credit Facility. The $9.0 million borrowing was classified as a current liability as of July 3, 2020 and June 28, 2019. We repaid the $9.0 million in July 2020.
Due to the current economic uncertainty stemming from the impact of the COVID-19 pandemic, on April 21, 2020, we entered into a Paycheck Protection Program Note (the “Note”) with Silicon Valley Bank as the lender (“Lender”) in an aggregate principal amount of $5.9 million pursuant to the Paycheck Protection Program under the CARES Act (the “PPP Loan”). On April 22, 2020, we received proceeds of $5.9 million from the PPP Loan. At the time when we applied for the PPP Loan, we had qualified to receive the funds pursuant to the then-published qualification requirements. On April 23, 2020, the SBA, in consultation with the Department of Treasury, issued new guidance regarding qualification requirements for public companies. Based on our assessment of the new guidance, on May 5, 2020, we repaid the principal and interest on the PPP Loan.
We also obtained an uncommitted short-term line of credit of $0.3 million from a bank in New Zealand to support the operations of our subsidiary located there in fiscal 2015. This line of credit provides for $0.2 million in short-term advances at various interest rates, all of which was available as of July 3, 2020. The line of credit also provides for the issuance of standby letters of credit and company credit cards, of which $0.1 million was outstanding as of July 3, 2020. This facility may be terminated upon notice, is reviewed annually for renewal or modification, and is supported by a corporate guarantee.
Restructuring Payments
We had liabilities for restructuring activities totaling $2.7 million as of July 3, 2020, which was classified as current liability and expected to be paid in cash over the next 12 months. We expect to fund these future payments with available cash and cash provided by operations.
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Contractual Obligations
The following table summarizes our contractual obligations and commitments as of July 3, 2020:
Obligations Due by Fiscal Year
(In thousands) Total < 1 year 1 - 3 years 3 - 5 years > 5 years Other
Borrowings under credit facility $ 9,000 $ 9,000 $ — $ — $ — $ —
Purchase obligations (1)(4)
22,088 21,851 165 72 — —
Other purchase obligations (3)(4)
1,626 1,626 — — — —
Operating lease commitments 4,933 1,711 970 472 1,780 —
Reserve for uncertain tax positions (2)
5,759 — — — — 5,759
Total contractual cash obligations $ 43,406 $ 34,188 $ 1,135 $ 544 $ 1,780 $ 5,759
___________________________
(1) From time to time in the normal course of business we may enter into purchasing agreements with our suppliers that require us to accept delivery of, and remit full payment for, finished products that we have ordered, finished products that we requested be held as safety stock, and work in process started on our behalf in the event we cancel or terminate the purchasing agreement. Because these agreements do not specify fixed or minimum quantities, do not specify minimum or variable price provisions, and do not specify the approximate timing of the transaction, and we have no present intention to cancel or terminate any of these agreements, we currently do not believe that we have any future liability under these agreements.
(2) Liabilities for uncertain tax positions of $5.8 million were included in long-term liabilities in the consolidated balance sheets. At this time, we are unable to make a reasonably reliable estimate of the timing of payments related to this amount due to uncertainties in the timing of tax audit outcomes.
(3) Contractual obligation related to software as a service and software maintenance support.
(4) These items are not recorded on our consolidated balance sheets.
Commercial Commitments
We have entered into commercial commitments in the normal course of business including surety bonds, standby letters of credit and other arrangements with financial institutions and insurers primarily relating to the guarantee of future performance on certain tenders and contracts to provide products and services to customers. As of July 3, 2020, we had commercial commitments on outstanding surety bonds and standby letters of credit as follows:
Expiration of Commitments by Fiscal Year
(In thousands) Total 2021 2022 2023 After 2023
Standby letters of credit used for:
Bids $ 35 $ 35 $ — $ — $ —
Payment guarantees 781 781 — — —
Performance 686 555 131 — —
1,502 1,371 131 — —
Surety bonds used for:
Performance 53,389 51,907 1,482 — —
Payment guarantees 98 — — — 98
Tax bonds 2,247 8 2,239 — —
55,734 51,915 3,721 — 98
Total commercial commitments $ 57,236 $ 53,286 $ 3,852 $ — $ 98
Historically, we have not paid out any significant amount of our performance guarantees. As such, the outstanding commercial commitments have not been recorded in our consolidated balance sheets.
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Off-Balance Sheet Arrangements
In accordance with the definition under SEC rules (Item 303(a)(4)(ii) of Regulation S-K), any of the following qualify as off-balance sheet arrangements:
• any obligation under certain guarantee contracts;
• a retained or contingent interest in assets transferred to an unconsolidated entity or similar entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;
• any obligation, including a contingent obligation, under certain derivative instruments; and
• any obligation, including a contingent obligation, arising out of a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or engages in leasing, hedging or research and development services with us.
Currently we are not participating in transactions that generate relationships with unconsolidated entities or financial partnerships, including variable interest entities, and we do not have any material retained or contingent interest in assets as defined above. As of July 3, 2020, we did not have material financial guarantees or other contractual commitments that are reasonably likely to adversely affect liquidity. In addition, we are not currently a party to any related party transactions that materially affect our results of operations, cash flows or financial condition.
Financial Risk Management
In the normal course of doing business, we are exposed to the risks associated with foreign currency exchange rates and changes in interest rates. We employ established policies and procedures governing the use of financial instruments to manage our exposure to such risks.
Exchange Rate Risk
We conduct business globally in numerous currencies and are therefore exposed to foreign currency risks. We use derivative instruments to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. We do not hold or issue derivatives for trading purposes or make speculative investments in foreign currencies.
We also enter into foreign exchange forward contracts to mitigate the change in fair value of specific non-functional currency assets and liabilities on the balance sheet. All balance sheet hedges are marked to market through earnings every period. Changes in the fair value of these derivatives are largely offset by re-measurement of the underlying assets and liabilities.
As of July 3, 2020, we had three foreign currency forward contracts outstanding as follows:
Currency Notional Contract Amount
(Local Currency) Notional
Contract
Amount
(USD)
(In thousands)
New Zealand dollar 1,000 $ 643
British pound 600 742
Singapore dollar 300 216
Total of all currency forward contracts $ 1,601
Net foreign exchange gain (loss) recorded in our consolidated statements of operations during fiscal 2020, 2019 and 2018 was as follows:
Fiscal Year
(In thousands) 2020 2019 2018
Amount included in costs of revenues $ 419 $ (664) $ 402
Amount included in other (expense) income, net — — (188)
Total foreign exchange gain (loss), net $ 419 $ (664) $ 214
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A 10% adverse change in currency exchange rates for our foreign currency derivatives held as of July 3, 2020 would have an impact of approximately $0.2 million on the fair value of such instruments.
Certain of our international business are transacted in non-U.S. dollar currency. As discussed above, we utilize foreign currency hedging instruments to minimize the currency risk of international transactions. The impact of translating the assets and liabilities of foreign operations to U.S. dollars is included as a component of stockholders’ equity. As of July 3, 2020 and June 28, 2019, the cumulative translation adjustment decreased our stockholders’ equity by $15.2 million and $12.7 million, respectively.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our cash equivalents, short-term investments and borrowings under our credit facility.
Exposure on Cash Equivalents and Short-term Investments
We had $41.6 million in total cash and cash equivalents and short-term investments as of July 3, 2020. Cash equivalents and short-term investments totaled $21.4 million as of July 3, 2020 and were comprised of money market funds and certificates of deposit. Cash equivalents and short-term investments have been recorded at fair value on our balance sheets.
We do not use derivative financial instruments in our short-term investment portfolio. We invest in high-credit quality issues and, by policy, limit the amount of credit exposure to any one issuer and country. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. The portfolio is also diversified by maturity to ensure that funds are readily available as needed to meet our liquidity needs. This policy reduces the potential need to sell securities in order to meet liquidity needs and therefore the potential effect of changing market rates on the value of securities sold.
The primary objective of our short-term investment activities is to preserve principal while maximizing yields, without significantly increasing risk. Our cash equivalents and short-term investments earn interest at fixed rates; therefore, changes in interest rates will not generate a gain or loss on these investments unless they are sold prior to maturity. Actual gains and losses due to the sale of our investments prior to maturity have been immaterial. The investments held as of July 3, 2020, had weighted-average days to maturity of 40 days, and an average yield of 5.72% per annum. A 10% change in interest rates on our cash equivalents and short-term investments is not expected to have a material impact on our financial position, results of operations or cash flows.
Exposure on Borrowings
During fiscal 2020, we had $9.0 million of demand borrowings outstanding under our credit facility that incurred interest at the prime rate plus a spread of 0.50% to 1.50%, with such spread determined based on our adjusted quick ratio. During fiscal 2020, our weighted average interest rate was 3.97% and we recorded total interest expense of less than $0.1 million on these borrowings.
A 10% change in interest rates on the current borrowings or on future borrowings is not expected to have a material impact on our financial position, results of operations or cash flows since interest on our borrowings is not material to our overall financial position.
Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us.
These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected.
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The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
• revenue recognition and valuation of accounts receivable;
• inventory valuation and provision for excess and obsolete inventory losses;
• impairment of long-lived assets; and
• income taxes valuation.
In some cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP and does not require management’s judgment in its application. There are also areas in which management’s judgment in selecting among available alternatives would not produce a materially different result. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board.
The following is not intended to be a comprehensive list of all of our accounting policies or estimates. Our significant accounting policies are more fully described in “Note 1. The Company and Summary of Significant Accounting Policies” in the notes to consolidated financial statements. In preparing our financial statements and accounting for the underlying transactions and balances, we apply those accounting policies. We consider the estimates discussed below as critical to an understanding of our financial statements because their application places the most significant demands on our judgment, with financial reporting results relying on estimates about the effect of matters that are inherently uncertain.
Besides estimates that meet the “critical” accounting estimate criteria, we make many other accounting estimates in preparing our financial statements and related disclosures. All estimates, whether or not deemed critical, affect reported amounts of assets, liabilities, revenue and expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience and other information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information becomes known, including for estimates that we do not deem “critical.”
Revenue Recognition
Effective June 30, 2018, we adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, using the modified retrospective method applied to those contracts that were not completed as of June 29, 2018. Results for the reporting periods after June 29, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historical accounting under ASC 605.
We recognize revenue by applying the following five-step approach: (1) identification of the contract with a customer; (2) identification of the performance obligations in the contract; (3) determination of the transaction price; (4) allocation of the transaction price to the performance obligations in the contract; and (5) recognition of revenue when, or as, we satisfy a performance obligation.
Contracts and customers purchase orders are used to determine the existence of an arrangement.
Revenue from product sales, recognized at a point-in-time, is generated predominately from the sales of products manufactured by third-party manufacturers to whom we have outsourced our manufacturing processes. Printed circuit assemblies, mechanical housings, and packaged modules are manufactured by contract manufacturing partners, with periodic business reviews of material levels and obsolescence. Product assembly, product testing, complete system integration, and system testing may either be performed within our own facilities or at the locations of our third-party manufacturers.
Revenue from services includes certain network planning and design, engineering, installation and commissioning, extended warranty, customer support, consulting, training, and education. Maintenance and support services are generally offered to our customers and recognized over a specified period of time and from sales and subsequent renewals of maintenance and support contracts. The network planning and design, engineering and installation related services noted are recognized based on an over-time recognition model using the cost-input method.
Revenues related to certain contracts for customized network solutions are recognized over time using the cost input method. In using this input method, we generally apply the cost-to-cost method of accounting where sales and
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profits are recorded based on the ratio of costs incurred to estimated total costs at completion. Recognition of profit on these contracts requires estimates of the total contract value, the total cost at completion, and the measurement of progress towards completion. Significant judgment is required when estimating total contract costs and progress to completion on the arrangements, as well as whether a loss is expected to be incurred on the contract. If circumstances arise that change the original estimates of revenues, costs, or extent of progress toward completion, revisions to the estimates are made. These revisions may result in increases or decreases in estimated revenues or costs, and such revisions are reflected in income in the period in which the circumstances that gave rise to the revision become known to us. We perform ongoing profitability analysis of our service contracts accounted for under this method in order to determine whether the latest estimates of revenues, costs, and profits require updating. If at any time these estimates indicate that the contract will be unprofitable, the entire estimated loss for the remainder of the contract is recorded immediately. We establish billing terms at the time project deliverables and milestones are agreed. Revenues recognized in excess of the amounts invoiced to clients are classified as unbilled receivables on the unaudited condensed consolidated balance sheet.
In addition, shipping documents and customer acceptances, when applicable, are used to verify delivery and transfer of control. We typically satisfy our performance obligations upon shipment or delivery of product depending on the contractual terms. Payment terms to customers generally range from net 30 to 120 days from invoice, which are considered to be standard payment terms. We assess our ability to collect from our customers based primarily on the creditworthiness and past payment history of the customer.
While our customers do not have the right of return, we reserve for estimated product returns as an offset to revenue based primarily on historical trends. Actual product returns may be different than what was estimated. These factors and unanticipated changes in economic and industry condition could make actual results differ from our return estimates.
We present transactional taxes such as sales and use tax collected from customers and remitted to government authorities on a net basis.
Bill-and-Hold Sales
Certain customer arrangements consist of bill-and-hold characteristics under which transfer of control has been met (including the passing of title and significant risk and reward of ownership to the customers). Therefore, the customers can direct the use of the bill-and-hold inventory while we retain physical possession of the product until it is installed at a customer site at a point in time in the future.
Termination Rights
The contract term is determined on the basis of the period over which the parties to the contract have present enforceable rights and obligations. Certain customer contracts include a termination for convenience clause that allows the customer to terminate services without penalty, upon advance notification. We concluded that the duration of support contracts does not extend beyond the non-cancellable portion of the contract.
Variable Consideration
The consideration associated with customer contracts is generally fixed. Variable consideration includes discounts, rebates, refunds, credits, incentives, penalties, or other similar items. The amount of consideration that can vary is not a substantial portion of total consideration.
Variable consideration estimates are re-assessed at each reporting period until a final outcome is determined. The changes to the original transaction price due to a change in estimated variable consideration will be applied on a retrospective basis, with the adjustment recorded in the period in which the change occurs. Changes to variable consideration will be tracked and material changes disclosed.
Stand-alone Selling Price
Stand-alone selling price is the price at which an entity would sell a good or service on a stand-alone (or separate) basis at contract inception. Under the model, the observable price of a good or service sold separately provides the best evidence of stand-alone selling price. However, in certain situations, stand-alone selling prices will not be readily observable and the entity must estimate the stand-alone selling price.
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When allocating on a relative stand-alone selling price basis, any discount provided in the contract is allocated proportionately to all of the performance obligations in the contract.
The majority of products and services that we offer have readily observable selling prices. For products and services that do not, we estimate stand-alone selling price using the market assessment approach based on expected selling price and adjust those prices as necessary to reflect our costs and margins. As part of our stand-alone selling price policy, we review product pricing on a periodic basis to identify any significant changes and revise our expected selling price assumptions as appropriate.
Shipping and Handling
Shipping and handling costs are included as a component of costs of product sales in our consolidated statements of operations because they are also included in revenue that we bill our customers.
Costs to Obtain a Contract
We have assessed the treatment of costs to obtain or fulfill a contract with a customer. Under ASC 606, we capitalize sales commissions related to multi-year service contracts and amortize the asset over the period of benefit, which is the estimated service period. Sales commissions paid on contract renewals, including service contract renewals, is commensurate with the sales commissions paid on the initial contracts.
We elected the practical expedient to expense sales commissions as incurred when the amortization period of the related asset is one year or less. These costs are recorded as sales and marketing expense and included in our consolidated balance sheet as accrued expenses until paid. Our amortization expense was not material for the fiscal year ended July 3, 2020.
Inventory Valuation and Provisions for Excess and Obsolete Losses
Our inventories have been valued at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. We balance the need to maintain prudent inventory levels to ensure competitive delivery performance with the risk of excess or obsolete inventory due to changing technology and customer requirements, and new product introductions. The manufacturing of our products is handled primarily by contract manufacturers. Our contract manufacturers procure components and manufacture our products based on our forecast of product demand. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand, the stage of the product life cycle, anticipated end of product life and production requirements. Several factors may influence the sale and use of our inventories, including decisions to exit a product line, technological change, new product development and competing product offerings. These factors could result in a change in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case the provision required for excess and obsolete inventory may be overstated or understated. In the future, if we determine that our inventory is overvalued, we would be required to recognize such costs in cost of product sales and services in our consolidated statement of operations at the time of such determination. In the case of goods which have been written down below cost at the close of a fiscal quarter, such reduced amount is considered the new lower cost basis for subsequent accounting purposes, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. We did not make any material changes in the valuation methodology during the past three fiscal years.
Our customer service inventories are stated at the lower of cost and net realizable value. We carry service parts because we generally provide product warranty for 12 to 36 months and earn revenue by providing enhanced and extended warranty and repair service during and beyond this warranty period. Customer service inventories consist of both component parts, which are primarily used to repair defective units, and finished units, which are provided for customer use permanently or on a temporary basis while the defective unit is being repaired. We record adjustments to reduce the carrying value of customer service inventories to their net realizable value. Factors influencing these adjustments include product life cycles, end of service life plans and volume of enhanced or extended warranty service contracts. Estimates of net realizable value involve significant estimates and judgments about the future, and revisions would be required if these factors differ from our estimates.
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Impairment of Long-Lived Assets
We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying amount of the assets. If impairment exists, the impairment loss is measured and recorded based on discounted estimated future cash flows. In estimating future cash flows, assets are grouped at the lowest levels for which there are identifiable cash flows that are largely independent of cash flows from other asset groups.
Our estimate of future cash flows is based upon, among other things, certain assumptions about expected future operating performance, growth rates and other factors. The actual cash flows realized from these assets may vary significantly from our estimates due to increased competition, changes in technology, fluctuations in demand, consolidation of our customers, reductions in average selling prices and other factors. Assumptions underlying future cash flow estimates are therefore subject to significant risks and uncertainties.
Income Taxes Valuation
We record the estimated future tax effects of temporary differences between the tax basis of assets and liabilities of amounts reported in our consolidated balance sheets, as well as operating loss and tax credit carryforwards. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the opening and closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences may result in an increase or decrease to our tax provision in a subsequent period in which such determination is made.
We record deferred taxes by applying enacted statutory tax rates to the respective jurisdictions and follow specific and detailed guidelines in each tax jurisdiction regarding the recoverability of any tax assets recorded on the balance sheets and provide necessary valuation allowances as required. Future realization of deferred tax assets ultimately depends on meeting certain criteria in ASC 740, Income Taxes . One of the major criteria is the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. We regularly review our deferred tax assets for recoverability based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. Our judgments regarding future profitability may change due to many factors, including future market conditions and our ability to successfully execute our business plans and/or tax planning strategies. Should there be a change in our ability to recover our deferred tax assets, our tax provision would increase or decrease in the period in which the assessment is changed.
Realization of deferred tax assets is dependent upon future earnings in applicable tax jurisdictions. Prior to fiscal 2019, due to our U.S. operating losses in previous years and continuing U.S. earnings volatility which did not allow sustainable profitability, we had established and maintained a full valuation allowance for our U.S. deferred tax assets. While there had been a trend of positive evidence that had been strengthening in prior to fiscal 2019, it was not sufficiently persuasive to outweigh the negative evidence in future periods. During the third quarter of fiscal 2019, we generated our third consecutive profitable year from a U.S. pre-tax book income perspective. Accordingly, we determined that it was more likely than not that we would realize a portion of our U.S. deferred tax assets, primarily relating to certain net operating loss carryforwards and current temporary differences. The positive evidence as of March 29, 2019, which outweighed the negative evidence to release a portion of the valuation allowance, included our fiscal 2019 and three-year cumulative U.S. profitability driven by continued demand for our products in North America that have historically resulted in higher margins than international sales, reductions in operating expenses resulting from our previous restructurings, and our forecasted U.S. operating profits in future periods. The negative evidence primarily relates to certain net operating loss carryforwards and credits that are expected to expire prior to utilization. We believed that our positive evidence was strong and continues to be strong in fiscal 2020. The improved financial performance as it relates to U.S. profitability in recent years is an objectively verifiable piece of positive evidence and is the result of a number of factors which have been present to a greater or lesser extent in prior years but had only gathered sufficient weight to deliver objectively verifiable, consistent U.S. pre-tax book profits in fiscal 2019. In performing our analysis, we used the most updated plans and estimates that we currently use to manage the underlying business and calculated the utilization of our deferred tax assets. Accordingly, during fiscal 2019, we released $7.5 million of U.S. valuation
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allowance as a discrete item on certain deferred tax assets. The remaining valuation allowance relates to deferred tax assets, for which we believe it is not more likely than not to be realized in future periods. We performed this analysis in fiscal 2020, which resulted in no additional U.S. valuation allowance release.
The accounting estimates related to the liability for uncertain tax position require us to make judgments regarding the sustainability of each uncertain tax position based on its technical merits. It is inherently difficult and subjective to estimate our reserves for the uncertain tax positions. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will be same as these estimates. These estimates are updated quarterly based on factors such as change in facts or circumstances, changes in tax law, new audit activity, and effectively settled issues.
Impact of Recently Issued Accounting Pronouncements
See “Note 1. The Company and Summary of Significant Accounting Policies” in the notes to consolidated financial statements for a full description of recently issued accounting pronouncements, including the respective expected dates of adoption and effects on our consolidated financial position and results of operations.