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 2022 and 2021 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 ended July 1, 2022 is referred to as “fiscal 2022” or “2022”; our fiscal year ended July 2, 2021 is referred to as “fiscal 2021” or “2021”; and our fiscal year ended July 3, 2020 is referred to as “fiscal 2020” or “2020.” Our fiscal year ends on the Friday nearest to June 30. Fiscal 2022 and fiscal 2021 presented included 52 weeks while fiscal 2020 included 53 weeks. This one week difference between fiscal 2022 and 2021 to fiscal 2020 impacts the comparison of both revenue and expenses.
Overview
Aviat sells radios, routers, software and services. We have more than 3,000 customers and significant relationships with global service providers and private network operators. Our manufacturing base in North America consists of a combination of contract manufacturing and assembly and test operated in Austin, Texas by Aviat. Our technology is underpinned by more than 200 patents. We compete on the basis of total cost of ownership, microwave radio expertise and solutions for mission critical communications. We have a global presence.
The COVID-19 pandemic related disruptions to our business, operations, customers and suppliers lessened over the course of fiscal 2022. While supply chain lead-times remain extended and difficult to manage, the impact on our ability to fulfill orders for the year ended July 1, 2022 was minimal. Depending on the progression of pandemic-related factors such as supply constraints, potential for temporary manufacturing restrictions and our ability to perform field services during shelter in place orders, we could experience constraints and delays in fulfilling customer orders in future periods. We are monitoring, assessing and adapting to the situation to mitigate impacts on our business, supply chain and customer demand. We expect the potential for these challenges to continue until business and economic activities return to more normal levels.
Our first priority remains the health and safety of our employees and their families. Employees whose tasks can be done offsite have been instructed to work from home. Our manufacturing sites remain operational, and we are maintaining social distancing and have enhanced cleaning protocols and usage of personal protective equipment, where appropriate.
Operations Review
The market for mobile backhaul continued to be our primary addressable market segment globally in fiscal 2022. In North America, we supported 5G and 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 3G deployments, 5G 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 in “Overview” 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 (3) Latin America and Asia Pacific. Revenue by region for fiscal 2022, 2021 and 2020 and the related changes are shown in the table below:
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Fiscal Year $ Change % Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
North America $ 199,801 $ 183,071 $ 151,709 $ 16,730 $ 31,362 9.1 % 20.7 %
Africa and the Middle East 47,527 44,023 37,595 3,504 6,428 8.0 % 17.1 %
Europe 12,973 8,826 11,157 4,147 (2,331) 47.0 % (20.9) %
Latin America and Asia Pacific 42,658 38,991 38,181 3,667 810 9.4 % 2.1 %
Total Revenue $ 302,959 $ 274,911 $ 238,642 $ 28,048 $ 36,269 10.2 % 15.2 %
We achieved revenue growth of 10.2% in fiscal 2022. We have progressed in the U.S. rural broadband and wireless internet service provider areas and there is evidence of investment to support 5G deployments with our U.S. service provider customers.
Our revenue from North America increased by $16.7 million, or 9.1%, in fiscal 2022 compared with fiscal 2021. The increase in North America revenue during fiscal 2022 was due to revenue growth with private network customers and rural broadband customers. Revenue from North America increased $31.4 million, or 20.7%, in fiscal 2021 compared with fiscal 2020. The increase in North America revenue during fiscal 2021 was due to stronger order flow from private network customers, as well as increased sales to mobile operators.
Our revenue from Africa and the Middle East increased by $3.5 million, or 8.0%, in fiscal 2022 compared with fiscal 2021. The increase in revenue was primarily due to increased sales to mobile operators in the region. Revenue from Africa and the Middle East increased $6.4 million, or 17.1%, in fiscal 2021 compared with fiscal 2020. The increase in revenue was primarily due to increased sales to mobile operators in the region.
Revenue from Europe increased by $4.1 million, or 47.0%, in fiscal 2022 compared with fiscal 2021. The increase in revenue was due to higher sales to private network customers. Revenue in Europe decreased $2.3 million, or 20.9%, in fiscal 2021 compared with fiscal 2020. The decrease was due to lower sales to mobile operator customers.
Revenue in Latin America and Asia Pacific increased by $3.7 million, or 9.4%, in fiscal 2022 compared with fiscal 2021. The increase in revenue was primarily due to higher sales to mobile operator customers in Asia Pacific offset in part by decreased revenue in Latin America. Revenue from Latin America and Asia-Pacific increased $0.8 million, or 2.1%, in fiscal 2021 compared with fiscal 2020. The increase in revenue was primarily due to higher sales to mobile operator customers in Asia Pacific offset in part by decreased revenue in Latin America.
Fiscal Year $ Change % Change
(In thousands, except percentages)
2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
Product sales
$ 208,100 $ 185,787 $ 153,793 $ 22,313 $ 31,994 12.0 % 20.8 %
Services
94,859 89,124 84,849 5,735 4,275 6.4 % 5.0 %
Total Revenue
$ 302,959 $ 274,911 $ 238,642 $ 28,048 $ 36,269 10.2 % 15.2 %
Our revenue from product sales increased by $22.3 million, or 12.0%, in fiscal 2022 compared with fiscal 2021. Product volume increased with customers in all regions. Our services revenue increased by $5.7 million, or 6.4%, in fiscal 2022 compared with fiscal 2021 from increased sales in all regions, except for Asia Pacific.
Our revenue from product sales increased $32.0 million, or 20.8%, in fiscal 2021 compared with fiscal 2020. Product volume increased with customers in North America and Middle East Africa, offset in part by small declines in the other international markets. Our services revenue increased by $4.3 million, or 5.0%, in fiscal 2021 compared with fiscal 2020 from increased sales in North America.
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Gross Margin
Fiscal Year $ Change % Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
Revenue $ 302,959 $ 274,911 $ 238,642 $ 28,048 $ 36,269 10.2 % 15.2 %
Cost of revenue 193,724 172,296 153,946 21,428 18,350 12.4 % 11.9 %
Gross margin $ 109,235 $ 102,615 $ 84,696 $ 6,620 $ 17,919 6.5 % 21.2 %
% of revenue 36.1 % 37.3 % 35.5 %
Product margin % 36.4 % 39.1 % 38.0 %
Service margin % 35.4 % 33.5 % 30.9 %
Gross margin for fiscal 2022 increased by $6.6 million, or 6.5%, compared with fiscal 2021. Gross margin as a percentage of revenue for fiscal 2022 decreased to 36.1%, compared with 37.3% in fiscal 2021, primarily due to inflationary pressures during the year.
Gross margin for fiscal 2021 increased $17.9 million, or 21.2%, compared with fiscal 2020. Gross margin as a percentage of revenue for fiscal 2021 increased to 37.3%, compared with 35.5% in fiscal 2020, primarily due to higher volume of Private Network business, increased sales through Aviat Store which serves primarily the Rural Broadband, and wins with our multiband products and software sales.
Research and Development Expenses
Fiscal Year $ Change % Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
Research and development expenses
$ 22,596 $ 21,810 $ 19,284 $ 786 $ 2,526 3.6 % 13.1 %
% of revenue 7.5 % 7.9 % 8.1 %
Our research and development (“R&D”) expenses increased by $0.8 million, or 3.6%, in fiscal 2022 compared with fiscal 2021. The increase was due to additional investments to support new product offerings and redesigns to mitigate supply chain constraints.
Our R&D expenses increased $2.5 million, or 13.1%, in fiscal 2021 compared with fiscal 2020. The increase was due to additional investments to support new product offerings.
Selling and Administrative Expenses
Fiscal Year $ Change % Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
Selling and administrative expenses
$ 57,656 $ 56,324 $ 57,985 $ 1,332 $ (1,661) 2.4 % (2.9) %
% of revenue 19.0 % 20.5 % 24.3 %
Our selling and administrative expenses increased by $1.3 million, or 2.4%, in fiscal 2022 compared with fiscal 2021. The increase was primarily due to higher corporate expenses.
Our selling and administrative expenses decreased $1.7 million, or 2.9%, in fiscal 2021 compared with fiscal 2020. The decrease was primarily due to lower travel expenses and restructuring savings offset in part by increases in sales-related expenses.
Restructuring Charges
During the fourth quarter of Q4 2022, our Board of Directors approved a restructuring plan (the “Q4 2022 Plan”) to restructure specific groups to optimize skill sets and execute on strategic deliverables. The Q4 2022 Plan was anticipated to be implemented through early fiscal year 2023, with a certain number of positions being consolidated. We recorded $0.4 million restructuring charges for this plan in Fiscal Year 2022.
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During the third quarter of fiscal 2021, our Board of Directors approved restructuring plans (the “Fiscal 2021 Plan”) to continue to reduce our operating costs and improve profitability. We recorded restructuring charges of $2.4 million related to the Fiscal 2021 Plan in fiscal 2021. Payments related to the accrued restructuring balances for this plan are expected to be fully paid in fiscal 2023.
During the fourth quarter of fiscal 2020, our Board of Directors approved a restructuring plan (the “Q4 2020 Plan”) to continue to reduce our operating costs and improve profitability to optimize our business model and increase efficiencies. 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 were fully paid in fiscal 2022.
During the third quarter of fiscal 2020, our Board of Directors approved a restructuring plan (the “Q3 2020 Plan”) 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 were fully paid in fiscal 2021.
Our restructuring charges by plan for fiscal 2022, 2021 and 2020 are summarized in the table below:
Fiscal Year $ Change % Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
Q4 2022 Plan $ 434 $ — $ — $ 434 $ — N/A N/A
Fiscal 2021 Plan 271 2,414 — (2,143) 2,414 (88.8) % N/A
Prior Years Plans (231) (143) 4,049 (88) (4,192) 61.5 % (103.5) %
Prior Year Plan: Facilities and Other (236) — — (236) — N/A N/A
Restructuring charges $ 238 $ 2,271 $ 4,049 $ (2,033) $ (1,778) (89.5) % (43.9) %
Restructuring charges for fiscal 2022 included employee and severance and benefits of $0.4 million under the Q4 2022 Plan and $0.3 million under the Fiscal 2021 Plan and reductions of Prior Years Plans estimated accruals of $0.5 million. Restructuring charges for fiscal 2021 included employee severance and benefits of $2.4 million, the Fiscal 2021 Plan and a reduction in the previously estimated accrual of $0.1 million in Prior Years Plans. Restructuring charges for fiscal 2020 included employee severance and benefits costs of $1.9 million for the Q4 2020 Plan and $2.2 million for the Prior Years Plans.
Our successfully executed restructuring initiatives have enabled us to restructure specific groups to optimize skill sets and align structure to execute on strategic deliverables, in addition to aligning cost structure with core of the business.
Other Income (Expense), Net
Fiscal Year $ Change % Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020 2022/2021 2021/2020
Other income, net 1,690 230 331 1,460 (101) 635 % (31) %
Our other income, net increased by $1.5 million, in fiscal 2022 compared with fiscal 2021, primarily due to gains in marketable securities partially offset by movement in foreign exchange.
Income Taxes
Fiscal Year $ Change
(In thousands, except percentages) 2022 2021 2020 2022/2021 2021/2020
Income before income taxes
$ 30,435 $ 22,440 $ 3,709 $ 7,995 $ 18,731
Provision for (benefit from) income taxes 9,275 (87,699) 3,452 96,974 (91,151)
As % of income before income taxes
30.5 % (390.8) % 93.1 %
Our provision for (benefit from) income taxes was $9.3 million of expense for fiscal 2022, $87.7 million of benefit for fiscal 2021 and $3.5 million of expense for fiscal 2020. Our tax expense for fiscal 2022 was primarily due to tax expense related to U.S. and profitable foreign subsidiaries.
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Our tax benefit for fiscal 2021 was primarily due to the release of $92.2 million in valuation allowance on our U.S. federal and state deferred tax assets, offset by tax expenses related to profitable foreign subsidiaries and an increase in our reserve for uncertain tax positions.
Liquidity, Capital Resources and Financial Strategies
As of July 1, 2022, our cash and cash equivalents and marketable securities totaled $47.8 million. Approximately $5.9 million, or 12.3%, was held in the United States. The remaining balance of $41.9 million, or 87.7%, was held by entities outside the United States. This amount includes $14.0 million moved in advance of the Redline acquisition closure. Of the amount of cash and cash equivalents held by our foreign subsidiaries at July 1, 2022, $29.2 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 used in or 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 $2.8 million for fiscal 2022, $17.3 million and $17.5 million, respectively, were provided by operating activities for fiscal 2021 and fiscal 2020.
For fiscal 2022 compared to fiscal 2021, cash provided by operating activities decreased by $14.5 million. The net contribution of non-cash items to cash provided by operating activities increased by $97.4 million and the net contribution of changes in operating assets and liabilities to cash provided by operating activities decreased by $22.9 million in fiscal 2022 as compared to fiscal 2021.
The $97.4 million increase in the net contribution of non-cash items to cash provided by operating activities was primarily attributable to a $98.6 million net change in deferred tax assets.
Net changes in operating assets and liabilities resulted in a decrease of $22.9 million additional cash used by operating activities for fiscal 2022 compared to fiscal 2021. 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 2022 were primarily due to the timing of liabilities incurred and vendor payments. The change in inventories and in customer service inventories during fiscal 2022 were primarily driven by forecasted demand and to secure component parts in shortage. The decrease in customer advance payments and unearned revenue during fiscal 2022 was due to the timing of payment from customers and revenue recognition. We used $1.6 million in cash during fiscal 2022 on expenses related to restructuring liabilities.
For fiscal 2021 compared to fiscal 2020, cash provided by operating activities increased by $0.2 million. The net contribution of non-cash items to cash provided by operating activities decreased by $92.3 million and the net changes in operating assets and liabilities to cash provided by operating activities decreased by $17.7 million in fiscal 2021 as compared to fiscal 2020.
The $92.3 million decrease in the net contribution of non-cash items to cash provided by operating activities was primarily attributable to a $90.4 million net change in deferred tax assets offset by proceeds from sale of asset held for sale.
Investing Activities
Net cash used in investing activities was $7.8 million for fiscal year 2022, $2.8 million for fiscal 2021 and $4.6 million for fiscal 2020, which consisted of purchases of marketable securities and capital expenditures net of cash received from sale of a real estate asset.
For fiscal 2023, 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.
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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 $4.9 million for fiscal year 2022, which was attributable to $5.4 million for repurchase of common stock relating to treasury shares, $0.5 million payments for taxes related to net settlement of equity awards, offset by $1.0 million proceeds from the issuance of common stock from employee stock plans. Net cash used by financing activities was $8.0 million for fiscal 2021 and $2.5 million for fiscal 2020.
As of July 1, 2022, our principal sources of liquidity consisted of the $47.8 million in cash and cash equivalents and marketable securities, $21.7 million of available credit under our $25.0 million credit facility with Silicon Valley Bank (“SVB Credit Facility”) which matures on June 28, 2024, 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 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.
On May 17, 2021 we entered into Amendment No. 4 to Third Amended and Restated Loan and Security Agreement, which extended the expiration date to June 28, 2024. While we intend to continue to renew the SVB Credit Facility in the future, 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.
On April 13, 2021, we filed a registration statement on Form S-3 with the SEC using a “shelf” registration process. If and when we utilize the shelf registration, we will be able to, from time to time, offer and sell, either individually or in combination, in one or more offerings, up to a total dollar amount of $200 million of any combination of the securities described in the shelf registration statement. Each time we offer securities under this shelf registration, we will provide a prospectus supplement that will contain more specific information about the terms of that offering.
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.
Available Credit Facility, Borrowings and Repayment of Debt
On May 17, 2021, we entered into Amendment No. 4 to Third Amended and Restated Loan and Security Agreement to extend the maturity date to June 28, 2024. The SVB Credit Facility provides for a $25.0 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 1, 2022, available credit under the SVB Credit Facility was $21.7 million reflecting the calculated borrowing base of $25.0 million less outstanding letters of credit of $3.3 million. We did not borrow against the SVB Credit Facility during fiscal 2022 and there was no borrowing outstanding as of July 1, 2022.
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.
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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 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 1, 2022, we were in compliance with the quarterly financial covenants, as amended, contained in the SVB Credit Facility.
During fiscal 2022, we terminated our uncommitted short-term line of credit from a bank in New Zealand.
Restructuring Payments
We had liabilities for restructuring activities totaling $1.4 million as of July 1, 2022, 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.
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 consolidated balance sheets. 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 1, 2022, we had multiple forward contracts in one foreign currency outstanding as follows:
Notional Contract Amount Notional Contract Amount
Currency (Local Currency) (USD)
(In thousands)
Euro 1,500 $ 1,681
Net foreign exchange (loss) gain recorded in our consolidated statements of operations during fiscal 2022, 2021 and 2020 were $(1.1) million, $(1.0) million, and $0.4 million, respectively.
A 10% adverse change in currency exchange rates for our foreign currency derivatives held as of July 1, 2022 would have no impact as we held no foreign currency derivatives as of July 1, 2022.
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 1, 2022 and July 2, 2021, the cumulative translation adjustment decreased our stockholders’ equity by $16.0 million and $14.3 million, respectively.
Interest Rate Risk
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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 $47.8 million in total cash and cash equivalents and marketable securities as of July 1, 2022. Cash equivalents and short-term investments totaled $9.0 million as of July 1, 2022 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 consolidated 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 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 1, 2022, had weighted-average days to maturity of 36 days, and an average yield of 6.43% 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 2022, we had no demand borrowings outstanding under our credit facility. The interest would have been 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 2022, our weighted average interest rate would have been 5.25%.
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.
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 for estimated costs to complete overtime services;
• inventory valuation and provision for excess and obsolete inventory losses; 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
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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.
Under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, 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.
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. Certain judgment is required when estimating total contract costs and progress to completion on the over-time arrangements, as well as whether a loss is expected to be incurred on the contract. The cost estimation process for these contracts is based on the knowledge and experience of the Company’s project managers, engineers, and financial professionals. Changes in job performance and job conditions are factors that influence estimates of the total costs to complete those contracts and the Company’s revenue recognition. If circumstances arise that change the original estimates of revenues, costs, or extent of progress toward completion, revisions to the estimates are made in a timely manner. 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 to determine whether the latest estimates of revenues, costs, and profits require updating. In rare circumstances if these estimates indicate that the contract will be unprofitable, the entire estimated loss for the remainder of the contract is recorded immediately.
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 statements 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
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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.
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. Certain 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 consolidated 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.
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.