KEY TRONIC CORP 10-K

Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Shareholders and the Board of Directors of Key Tronic Corporation Opinion on the Financial Statements We have audited the accompanying consolidated balance sheet of Key Tronic Corporation (the “Company”) as of July 2, 2022, the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the year then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of July 2, 2022, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of July 2, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated September 13, 2022 expressed an unqualified opinion on the Company’s internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. As described in Notes 1 and 13 to the consolidated financial statements, the Company reported revenue of $531.8 million for the year ended July 2, 2022, of which $515.8 million related to revenue recognized over time. The Company has determined that for the majority of its contracts the Company is manufacturing products for which there is no alternative use due to the unique nature of the customer-specific product, intellectual property, and other contract restrictions. The Company has an enforceable right to payment including a reasonable profit for performance completed to date with respect to these contracts. As a result, revenue is recognized under these contracts over-time based on the input cost-to-cost method as it better depicts the transfer of control. This input method is based on the ratio of costs incurred to date as compared to the total estimated costs at completion of the performance obligation. We identified revenue recognized over time on contracts for manufacturing products as a critical audit matter. Management’s calculation includes reports with varying elements, to estimate costs incurred to date for various performance obligations. Auditing management’s estimates used in the calculation of revenue recognized over time involved especially challenging and subjective auditor judgment. 27 The primary procedures we performed to address this critical audit matter included: • Testing the design, implementation, and operating effectiveness of controls relating to revenue recognized over time, including controls over the quarterly calculation of in-process contracts, and the related contract assets. • Evaluating the methodology of estimating costs incurred to date on in-process contracts and testing the completeness and accuracy of the system generated reports used to estimate costs incurred by recalculating the expected costs on in-process contracts, vouching to source documents, tracing in-process orders to subsequent sales and shipping documentation within a reasonable period after year-end, identifying and testing significant assumptions used in the revenue calculation, and performing data validation procedures. • Comparing margins realized to trending historic margins, and comparing total revenue recognized to independent expectations of total revenues disaggregated by revenue stream. • Performing cutoff procedures to test that revenue transactions were recorded in the appropriate period. /s/ Moss Adams LLP Seattle, Washington September 14, 2022 We have served as the Company’s auditor since 2021. 28 Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors Key Tronic Corporation Spokane Valley, Washington Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Key Tronic Corporation (the “Company”) as of July 3, 2021, the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the two years in the period ended July 3, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at July 3, 2021, and the results of its operations and its cash flows for each of the two years in the period ended July 3, 2021 , in conformity with accounting principles generally accepted in the United States of America. Change in Accounting Principles As discussed in Note 1 to the consolidated financial statements, the Company changed its accounting method for accounting for leases in fiscal year 2020 due to the adoption of Topic 842: Leases, using a modified retrospective approach. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ BDO USA, LLP We have served as the Company's auditor from 2003 through 2021. Spokane, Washington September 16, 2021 29 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) July 2, 2022 July 3, 2021 ASSETS Current assets: Cash and cash equivalents $ 1,707 $ 3,473 Trade receivables, net of allowance for doubtful accounts of $12 and $275 135,876 110,324 Contract assets 21,974 24,781 Inventories, net 155,741 137,329 Other 24,710 23,345 Total current assets 340,008 299,252 Property, plant and equipment, net 26,012 35,735 Operating lease right-of-use assets, net 16,731 15,745 Other assets: Deferred income tax asset 10,055 9,656 Other 14,117 1,458 Total other assets 24,172 11,114 Total assets $ 406,923 $ 361,846 LIABILITIES AND SHAREHOLDERS ’ EQUITY Current liabilities: Accounts payable $ 121,393 $ 92,823 Accrued compensation and vacation 11,836 11,471 Current portion of debt, net 7,402 2,143 Other 23,036 20,268 Total current liabilities 163,667 126,705 Long-term liabilities: Term loans 5,716 7,906 Revolving loan 94,577 90,362 Operating lease liabilities 12,023 11,428 Deferred income tax liability 64 — Other long-term obligations 5,998 1,740 Total long-term liabilities 118,378 111,436 Total liabilities 282,045 238,141 Commitments and contingencies (Note 4 and 8) Shareholders’ equity: Common stock, no par value—shares authorized 25,000; issued and outstanding 10,762 and 10,762 shares, respectively 47,474 47,181 Retained earnings 77,829 74,452 Accumulated other comprehensive (loss) income ( 425 ) 2,072 Total shareholders’ equity 124,878 123,705 Total liabilities and shareholders’ equity $ 406,923 $ 361,846 See accompanying notes to consolidated financial statements. 30 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 Net sales $ 531,815 $ 518,698 $ 449,480 Cost of sales 488,601 476,659 414,231 Gross profit 43,214 42,039 35,249 Research, development and engineering expenses 9,821 9,790 7,391 Selling, general and administrative expenses 24,598 22,723 21,030 Total operating expenses 34,419 32,513 28,421 Operating income 8,795 9,526 6,828 Interest expense, net 5,104 3,613 2,509 Income before income taxes 3,691 5,913 4,319 Income tax provision (benefit) 314 1,572 ( 439 ) Net income $ 3,377 $ 4,341 $ 4,758 Net income per share — Basic $ 0.31 $ 0.40 $ 0.44 Weighted average shares outstanding — Basic 10,762 10,760 10,760 Net income per share — Diluted $ 0.31 $ 0.39 $ 0.44 Weighted average shares outstanding — Diluted 11,063 11,046 10,816 See accompanying notes to consolidated financial statements. 31 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands) Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 Comprehensive income: Net income $ 3,377 $ 4,341 $ 4,758 Other comprehensive income: Unrealized gain (loss) on hedging instruments, net of tax ( 2,497 ) 3,572 ( 3,926 ) Comprehensive income $ 880 $ 7,913 $ 832 Other comprehensive income for fiscal years 2022, 2021, and 2020 is reflected net of tax provision (benefit) of approximately $( 0.8 ) million, $ 1.2 million and $( 1.1 ) million, respectively. See accompanying notes to consolidated financial statements. 32 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 Operating activities: Net income $ 3,377 $ 4,341 $ 4,758 Adjustments to reconcile net income to cash used in operating activities: Depreciation and amortization 7,562 6,856 5,591 Amortization of interest rate swap 301 276 — Amortization of deferred loan costs 143 95 30 Excess tax benefit from exercise of stock options — ( 43 ) — Inventory write-down to net realizable value 950 753 136 Provision for warranty 446 145 121 Provision for doubtful accounts 67 117 551 (Gain) loss on disposal of assets ( 12 ) — 207 Share-based compensation expense 293 192 266 Deferred income taxes 481 ( 942 ) ( 958 ) Changes in operating assets and liabilities Trade receivables ( 25,619 ) ( 24,318 ) ( 28,254 ) Contract assets 2,807 ( 1,028 ) ( 1,592 ) Inventories ( 19,362 ) ( 23,062 ) ( 14,725 ) Other assets ( 1,651 ) 2,317 ( 7,728 ) Accounts payable 28,569 12,618 6,632 Accrued compensation and vacation 365 1,043 3,669 Other liabilities ( 3,624 ) 5,588 292 Cash used in operating activities ( 4,907 ) ( 15,052 ) ( 31,004 ) Investing activities: Purchases of property and equipment ( 6,813 ) ( 10,602 ) ( 8,623 ) Proceeds from sale of fixed assets 14 — 696 Prepayments on finance lease obligations ( 1,252 ) — — Cash receipts from deferred purchase price of factored receivables — — 4,350 Cash used in investing activities ( 8,051 ) ( 10,602 ) ( 3,577 ) Financing activities: Payment of financing costs ( 118 ) ( 617 ) ( 84 ) Proceeds from issuance of long term debt 11,594 11,000 5,000 Interest rate swap termination fee — ( 925 ) — Repayments of long term debt ( 2,143 ) ( 11,720 ) ( 7,121 ) Borrowings under revolving credit agreement 581,893 414,943 177,343 Repayments of revolving credit agreement ( 577,703 ) ( 384,150 ) ( 140,605 ) Principal payments on finance leases ( 2,331 ) — — Excess tax benefit from exercise of stock options — 43 — Cash provided by financing activities 11,192 28,574 34,533 Net increase (decrease) in cash and cash equivalents ( 1,766 ) 2,920 ( 48 ) Cash and cash equivalents, beginning of period 3,473 553 601 Cash and cash equivalents, end of period $ 1,707 $ 3,473 $ 553 Supplemental cash flow information: Interest payments $ 5,110 $ 3,777 $ 2,483 Income tax payments, net of refunds $ 1,315 $ 2,014 $ 683 Recognition of operating lease liabilities and right-of-use assets $ 5,247 $ 3,103 $ — Recognition of financing lease liabilities and right-of-use assets $ 13,096 $ — $ — See accompanying notes to consolidated financial statements. 33 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (In thousands) Shares Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Shareholders’ Equity Balances, June 29, 2019 10,760 $ 46,680 $ 65,353 $ 2,426 $ 114,459 Net income — — 4,758 — 4,758 Unrealized loss on hedging instruments, net of tax — — — ( 3,926 ) ( 3,926 ) Share-based compensation — 266 — — 266 Balances, June 27, 2020 10,760 $ 46,946 $ 70,111 $ ( 1,500 ) $ 115,557 Net income — — 4,341 — 4,341 Unrealized gain on hedging instruments, net of tax — — — 3,572 3,572 Exercise of stock appreciation rights 2 — — — — Excess tax benefit from exercise of stock options 43 43 Share-based compensation — 192 — — 192 Balances, July 3, 2021 10,762 $ 47,181 $ 74,452 $ 2,072 $ 123,705 Net income — — 3,377 — 3,377 Unrealized loss on hedging instruments, net of tax — — — ( 2,497 ) ( 2,497 ) Share-based compensation — 293 — — 293 Balances, July 2, 2022 10,762 $ 47,474 $ 77,829 $ ( 425 ) $ 124,878 See accompanying notes to consolidated financial statements. 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES Business Key Tronic Corporation and subsidiaries (the Company) is engaged in contract manufacturing for original equipment manufacturers (OEMs) and also manufactures keyboards and other input devices. The Company’s headquarters are located in Spokane Valley, Washington with manufacturing operations in Oakdale, Minnesota; Fayetteville, Arkansas; Corinth, Mississippi; and foreign manufacturing operations in Juarez, Mexico; Shanghai, China; and Da Nang, Vietnam. Due to the COVID-19 pandemic, the Company has seen extreme shifts in demand from its customer base, supply chain and logistics risks. The possibility of future temporary closures, as well as adverse fluctuations in customer demand, freight and expedite costs, precautionary safety expenses and labor shortages, collectability of accounts, and future supply chain disruptions during the rapidly changing COVID-19 environment can materially impact operating results. Additionally, continued adverse macroeconomic conditions and significant currency exchange fluctuations can also materially impact operating results. Correction of an Immaterial Error The Company made an out-of-period tax adjustment in fiscal year 2021 in the amount of $0.4 million decreasing the deferred tax asset related to unexercised stock appreciation rights (SARs), to reflect the fact that certain of the unexercised SARs had expired over several different periods prior to fiscal year 2021. Principles of Consolidation The consolidated financial statements include the Company and its wholly owned subsidiaries in the United States, Mexico, China and Vietnam. Intercompany balances and transactions have been eliminated during consolidation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates include the allowance for doubtful receivables, calculating inventory impairments related to obsolete and non-saleable inventories to value at net realizable value, deferred tax assets and liabilities, uncertain tax positions, impairment of long-lived assets, medical self-funded insurance liability, long-term incentive compensation accrual, the provision for warranty costs, and the fair value of stock appreciation rights granted under the Company’s share-based compensation plan. Due to uncertainties with respect to the assumptions and estimates, actual results could differ from those estimates. Cash and Cash Equivalents The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value. The Company may have cash and cash equivalents at financial institutions that are in excess of federally insured limits from time to time. Allowance for Doubtful Accounts The Company evaluates the collectability of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount that management reasonably estimates will be collected. A specific allowance is recorded against receivables considered to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the allowance, the Company considers several factors including the aging of the receivables, the current business environment and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. Inventories Inventories are stated at the lower of cost or net realizable value. Inventory valuation is determined using the first-in, first-out (FIFO) method. Customer orders are based upon forecasted quantities of product manufactured for shipment over defined periods. Raw material inventories are purchased to fulfill these customer requirements. Within these arrangements, customer demands for products frequently change, sometimes creating excess and obsolete inventories. The Company regularly reviews raw material inventories by customer for both excess and obsolete quantities. Wherever possible, the Company attempts to recover its full cost of excess and obsolete inventories from customers or, in some cases, through other markets. When it is determined that the Company’s carrying cost of such excess and obsolete inventories cannot be recovered in full, a charge is taken against income for the difference between the carrying cost and the estimated realizable amount. We also reserve for inventory related to specific customers covered by lead-time assurance agreements when those customers are experiencing financial difficulties or reimbursement is not reasonably assured. 35 Property, Plant and Equipment Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives of the assets. Repairs and maintenance costs are expensed as incurred. Leases Lease assets and liabilities are initially recognized based on the present value of lease payments over the lease term calculated using the Company’s incremental borrowing rate, unless the implicit rate is readily determinable. Our incremental borrowing rate represents the rate of interest that we would have to pay to borrow on a collateralized basis over a similar term in a similar economic environment. Lease assets also include any lease prepayments. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the consolidated statements of income. For further information, please refer to Footnote “Leases” of the “Notes to Consolidated Financial Statements.” Impairment of Long-lived Assets The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. Accrued Warranty An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. Self-funded Insurance The Company self-funds its domestic employee health plans. The Company contracts with a separate administrative service company to supervise and administer the programs and act as its representative. The Company reduces its risk under this self-funded platform by purchasing stop-loss insurance coverage for high dollar individual claims. In addition, if the aggregate annual claims amount to more than 125 percent of expected claims for the plan year this insurance will also pay those claims amounts exceeding that level. The Company estimates its exposure for claims incurred but not paid at the end of each reporting period and uses historical claims data supplied by the Company’s broker to estimate its self-funded insurance liability. This liability is subject to a total limitation that varies based on employee enrollment and factors that are established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. Costs related to the administration of the plan and related claims are expensed as incurred. Revenue Recognition The first step in its process for revenue recognition is to identify the contract with a customer. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. A contract can be written, oral, or implied. The Company generally enters into manufacturing service agreements (“MSA”) with its customers that outlines the terms of the business relationship between the customer and the Company. This includes matters such as warranty, indemnification, transfer of title and risk of loss, liability for excess and obsolete inventory, pricing, payment terms, etc. The Company will also bid on a program-by-program basis for customers in which an executed MSA may not be in place. In these instances, as well as when we have an MSA in place, we receive customer purchase orders for specific quantities and timing of products. As a result, the Company considers its contract with a customer to be the combination of the MSA and the purchase order. The transaction price is fixed and set forth in each purchase order. In the Company's normal course of business, there are no variable pricing components, or material amounts refunded to customers in the form of refunds or rebates. The Company assesses whether control of the product or services promised under the contract is transferred to the customer at a point in time (shipment) or over time (as we manufacture the product). The Company is first required to evaluate whether its contracts meet the criteria for 'over-time' or 'point-in-time' recognition. The Company has determined that for the majority of its contracts the Company is manufacturing products for which there is no alternative use due to the unique nature of the customer-specific product, IP and other contract restrictions. The Company has an enforceable right to payment including a reasonable profit for performance completed to date with respect to these contracts. As a result, revenue is recognized under these contracts 'over-time' based on the input cost-to-cost method as it better depicts the transfer of control. This input method is based on the ratio of costs incurred to date as compared to the total estimated costs at completion of the performance obligation. For all other contracts that do not meet these criteria, such as manufacturing contracts for which the terms do not provide an enforceable right to payment for performance completed to date, the Company recognizes revenue when it has transferred control of the related manufactured products which generally occurs upon shipment to the customer. Revenue from engineering services is recognized over time as the services are performed. 36 Shipping and Handling Fees The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and handling fees are reported as revenue. Research, Development and Engineering Research, development and engineering expenses include unreimbursed contract manufacturing costs as well as design and engineering costs associated with the production of contract manufacturing programs. Research, development and engineering costs are expensed as incurred. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50 % likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments based on new assessments and changes in estimates and which may not accurately forecast actual outcomes. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax provision. The tax years 2001 through the present remain open to examination by the major U.S. taxing jurisdictions to which we are subject. For further discussions, please refer to Footnote “Income Taxes” of the “Notes to Consolidated Financial Statements.” Derivative Instruments and Hedging Activities The Company has previously entered into foreign currency forward contracts and an interest rate swap which are accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging . The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (AOCI) and is reclassified into earnings in the same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. As of July 2, 2022, the Company did not have any outstanding foreign currency forward contracts. The Company uses derivatives to manage the variability of foreign currency fluctuations of expenses in our Mexico facilities. The foreign currency forward contracts and interest rate swaps have terms that are matched to the underlying transactions being hedged. As a result, these transactions fully offset the hedged risk and no ineffectiveness has been recorded. The Company’s foreign currency forward contracts and interest rate swaps potentially expose the Company to credit risk to the extent the counterparties may be unable to meet the terms of the agreement. The Company minimizes such risk by seeking high quality counterparties. The Company’s counterparties to the foreign currency forward contracts and interest rate swaps are major banking institutions. These institutions do not require collateral for the contracts, and the Company believes that the risk of the counterparties failing to meet their contractual obligations is remote. The Company does not enter into derivative instruments for trading or speculative purposes. Earnings Per Common Share Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing net income by the combination of other potentially dilutive weighted average common shares and the weighted average number of common shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per common share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on earnings per share. Foreign Currency Transactions The functional currency of the Company’s subsidiaries in Mexico, China and Vietnam is the U.S. dollar. Realized foreign currency transaction gains and losses for local currency denominated assets and liabilities are included in cost of goods sold. 37 Fair Value of Financial Instruments The carrying values of cash and cash equivalents, accounts receivable, current liabilities, and non-current operating lease liability are reflected on the balance sheets at July 2, 2022 and July 3, 2021, reasonably approximate their fair value. The Company had an outstanding balance on the line of credit of $ 95.1 million as of July 2, 2022 and $ 90.9 million as of July 3, 2021, with a carrying value that reasonably approximates the fair value. The Company had an outstanding balance on the term loan of $ 3.3 million as of July 2, 2022 and $ 4.2 million as of July 3, 2021, with a carrying value that reasonably approximates the fair value. The equipment term loan was $ 4.6 million as of July 2, 2022 and $ 5.8 million as of July 3, 2021, with a carrying value that reasonably approximates the fair value. Share-based Compensation The Company’s incentive plan may provide for equity awards to employees in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is included in cost of goods sold, research, development and engineering, and selling, general, and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations. Newly Adopted and Recent Accounting Pronouncements In January 2021, FASB issued Accounting Standard Update (ASU) 2021-01, Reference Rate Reform (Topic 848) to identify alternative reference rates that are more observable or transaction based and less susceptible to manipulation. The Company is currently assessing the effects on its consolidated financial statements, and if it will elect this optional standard. In March of 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments, which clarifies specific issues raised by stakeholders. Specifically, the ASU clarifies the following: 1) that all entities are required to provide the fair value option disclosures in ASC 825, Financial Instruments 2) clarifies that the portfolio exception in ASC 820, Fair Value Measurement, applies to nonfinancial items accounted for as derivatives under ASC 815, Derivatives and Hedging; 3) clarifies that for purposes of measuring expected credit losses on a net investment in a lease in accordance with ASC 326, Financial Instruments - Credit Losses, the lease term determined in accordance with ASC 842, Leases, should be used as the contractual term; 4) clarifies that when an entity regains control of financial assets sold, it should recognize an allowance for credit losses in accordance with ASC 326; and 5) aligns the disclosure requirements for debt securities in ASC 320, Investments - Debt Securities, with the corresponding requirements for depository and lending institutions in ASC 942, Financial Services - Depository and Lending. The amendments in the ASU have various effective dates and transition requirements which are dependent on timing of adoption of ASU 2016-13. The Company is currently assessing the effects on its consolidated financial statements, and it intends to adopt the guidance as they become effective. In June 2016, the FASB issued ASU 2016-13 “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” and also issued subsequent amendments to the initial guidance: ASU 2018-19, ASU 2019-04 and ASU 2019-05, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. The guidance is effective for the Company beginning in the first quarter of fiscal year 2024 with early adoption permitted. The Company is currently assessing the impact on its consolidated financial statements, and it intends to adopt the guidance when it becomes effective in the first quarter of fiscal year 2024. As a result of adopting ASC 842, Leases , using a modified retrospective approach as of June 30, 2019, the Company recognized a right of use asset of $21.4 million, a corresponding lease liability of $20.4 million, a reduction in prepaid rent of $0.4 million, a reduction of favorable lease agreement intangible of $0.7 million, and no adjustment to retained earnings or future P&L impact. Fiscal Year The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2022, 2021, and 2020, ended on July 2, 2022, July 3, 2021, and June 27, 2020, respectively. Fiscal year 2021 was a 53 week year. Fiscal years 2022 and 2020 were 52 week years. 2. INVENTORIES Net inventory as of July 2, 2022 is $ 155.7 million compared to $ 137.3 million as of July 3, 2021. Substantially all of the Company’s inventory balances are raw materials. 38 3. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following: Life July 2, 2022 July 3, 2021 (in years) (in thousands) Land — $ 4,034 $ 4,034 Buildings and improvements 3 to 30 25,841 25,513 Equipment 1 to 10 71,180 77,509 Furniture and fixtures 3 to 5 5,286 5,271 Total Property, Plant and Equipment 106,341 112,327 Accumulated depreciation ( 80,329 ) ( 76,592 ) Property, Plant and Equipment, net $ 26,012 $ 35,735 Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 (in thousands) Depreciation expense $ 4,940 $ 6,631 $ 5,369 4. LONG-TERM DEBT On August 14, 2020, the Company entered into a loan agreement with Bank of America. The Loan Agreement replaces the Company’s prior amended and restated credit agreement, as amended, with Wells Fargo Bank. The Loan Agreement provides for a five-year asset-based senior secured revolving credit facility of up to $ 93 million, maturing on August 14, 2025. Subsequent to July 2, 2022, the company entered into a third amendment to the loan agreement with Bank of America. The amendment removed the cash flow leverage ratio covenant and increased the interest rate by 25 basis points. As of July 2, 2022, the Company had an outstanding balance under the asset-based revolving credit facility of $ 95.1 million, $ 0.3 million in outstanding letters of credit and $ 10.8 million available for future borrowings. As of July 3, 2021, the Company had an outstanding balance under the asset-based revolving credit facility of $ 90.9 million, $ 0.3 million in outstanding letters of credit and $ 2.1 million available for future borrowings. On August 14, 2020, the Company also entered into a $ 5.0 million equipment financing facility with Bank of America relating to the Company’s existing U.S. manufacturing equipment that bears interest at 4.85% and matures on August 14, 2025. Under this loan agreement, equal monthly payments of approximately $ 94,000 commenced on September 14, 2020 and will continue through the maturity of the equipment financing facility on August 14, 2025. As of July 2, 2022, the Company had an outstanding balance of $ 3.3 million. As of July 3, 2021, the Company had an outstanding balance of $ 4.2 million. Generally, the interest rate applicable to loans under the Bank of America loan agreement are, at the Company’s option: (i)(A) the base rate which is the highest of (1) the prime rate for the applicable day (as such rate is determined from time to time by the Bank), (2) the federal funds rate for the applicable day plus 0.50%, and (3) LIBOR for a 30-day interest period as of the applicable day plus 1.00% (provided that in no event shall the base rate be less than zero), plus the applicable interest margin for base rate loans; and (B) LIBOR rate for an applicable interest period (provided that in no event shall the LIBOR rate be less than 0.50%), plus the applicable interest margin for LIBOR rate loans. Depending on average daily excess borrowing availability over applicable periods under the Credit Facility, applicable interest margins on: (x) base rate loans are 1.25-1.75%; and (y) LIBOR rate loans are 2.25-2.75%, resetting on a quarterly basis. If there is an event of default under the loan agreement, all loans and other obligations will bear interest at a rate of an additional 2.00% on the otherwise applicable interest rates. In addition to interest charges, the Company is required to pay a fee of 0.25% per annum on the unused portion of the Credit Facility, monthly in arrears. Under the loan agreement with Bank of America, the asset-based revolving credit facility bears interest at LIBOR plus 2.5 %, as elected by the Company. 39 On November 24, 2020, the Company entered into a $ 6.0 million equipment financing facility related to the Company’s existing manufacturing equipment that bears interest at 5.52% and matures on April 24, 2026. Under this loan agreement, equal monthly payments of $ 100,000 commenced on May 24, 2021 and will continue through the maturity of the equipment financing facility on April 24, 2026. The Company had an outstanding balance of $ 4.6 million and $ 5.8 million as of July 2, 2022 and July 3, 2021, respectively. On September 3, 2021, the Company entered into an amendment to the Company's current loan agreement with Bank of America. The amendment increases the Company's current credit facility of $ 93 million to $120 million, subject to the Company's borrowing base, maturing on September 3, 2026. The interest rates on outstanding debt as of July 2, 2022 range from 4.50 % - 5.52 % compared to 3.25 % - 5.52 % as of July 3, 2021. Debt maturities as of July 2, 2022 for the next five years are as follows (in thousands): Fiscal Years Ending Amount 2023 $ 2,190 2024 2,239 2025 2,290 2026 1,187 2027 95,077 Total debt $ 102,983 Unamortized debt issuance costs ( 499 ) Long-term debt, net of debt issuance costs $ 102,484 The Company must comply with certain financial covenants, including a fixed charge coverage ratio and a cash flow leverage ratio. The credit agreement requires the Company to grant certain inspection rights to Bank of America, limit or restrict the Company’s cash management; limit or restrict the ability of the Company to incur additional liens, make acquisitions or investments, incur additional indebtedness, engage in mergers, consolidations, liquidations, dissolutions, or dispositions, pay dividends or other restricted payments, prepay certain indebtedness, engage in transactions with affiliates, and use proceeds. Management believes the Company was in compliance with all financial covenants as of July 2, 2022. 5. TRADE ACCOUNTS RECEIVABLE PURCHASE PROGRAMS Sale Programs The Company has utilized an Account Purchase Agreement with Wells Fargo Bank, N.A. ("WFB") which allowed the Company to sell and assign to WFB and WFB to purchase from Company the accounts receivable of certain Company customers in a maximum aggregate amount outstanding of $ 25.0 million. As of July 2, 2022, the Company had no factored receivables with WFB. The Company did not sell any accounts receivables during the twelve months ended July 2, 2022 or July 3, 2021. There were no accounts receivables sold and not yet collected as of July 2, 2022 or July 3, 2021. The receivables that were sold were removed from the consolidated balance sheets and the cash received is reflected as cash provided by operating activities in the consolidated statements of cash flows. Cash receipts related to the deferred purchase price from receivables factored by the Company is reflected as cash provided by investing activities. 40 6. INCOME TAXES Income tax benefit consists of the following: Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 (in thousands) Current income tax benefit: United States $ ( 2,179 ) $ 1,416 $ 365 Foreign 2,012 1,098 154 ( 167 ) 2,514 519 Deferred income tax benefit: United States 443 ( 858 ) ( 1,850 ) Foreign 38 ( 84 ) 892 481 ( 942 ) ( 958 ) Total income tax provision (benefit) $ 314 $ 1,572 $ ( 439 ) The Company has gross tax credit carryforwards of approximately $ 11.0 million at July 2, 2022 consisting of federal research and development (R&D) tax credits, and approximately $ 1.9 million of net operating loss carryovers in China which expire in fiscal years 2025 through 2027. Management has reviewed all deferred tax assets for purposes of determining whether or not a valuation allowance may be required. A valuation allowance against deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Based upon the Company’s profitability, forecasted income, and evaluation of all other positive and negative evidence, management determined that it is more likely than not that the deferred tax assets will be realized. In the fourth quarter of fiscal year 2022, the Company, with its fiscal year 2021 federal income tax return, made automatic changes in tax accounting methods that created a fiscal year 2021 tax net operating loss. This loss is permitted to be carried back to the tax years ending in 2016, 2017, and 2019, resulting in a tax benefit of $0.6 million due to the higher federal income tax rate in effect in the years ending in 2016 and 2017. On January 27, 2021, the Company received official notice from the Vietnamese tax authorities, confirming tax benefits awarded related to the Company’s principal product line in Vietnam (the “Tax Holiday”). Under the Tax Holiday, the tax rate applied to income derived from this product line will be zero percent for four years beginning with fiscal year 2021, then five percent for nine years, then ten percent for one year (as opposed to the normal twenty percent Vietnamese statutory rate). Consequently, Management has revalued its net operating loss in Vietnam at the zero percent Tax Holiday rate, as the net operating loss carryovers are projected to expire before the end of the Tax Holiday. The Company eliminated the deferred tax assets attributable to the Vietnam net operating loss carryover ($0.2 million) in the third quarter of fiscal year 2021. The Company evaluated tax law changes and regulatory guidance issued through the quarter. Such changes and regulations include guidance under Sec. 162(m), Sec. 245A, Sec. 951A, foreign tax credits, and rules relating to consolidated NOL carryback claims. The Company evaluated the ongoing impact of these law and regulatory changes, which did not have a material impact on its provision for income taxes. Subsequent to the end of the fiscal year ending July 2, 2022, on August 16, 2022, the Inflation Reduction Act of 2022 was signed into law. This act includes a new book minimum tax on certain large corporations and an excise tax on corporate stock buybacks among other provisions. The Company is evaluating the impacts of this act, and at this time the Company does not believe they will have a material impact on our consolidated financial position, results of operations, or cash flows. Subsequent to the end of the fiscal year ending June 27, 2020, the Treasury Department issued final regulations applicable to the Company’s position with respect to the U.S. taxability of foreign earnings under the global intangible low taxed income (also known as “GILTI”) regime and the deductibility of interest expense under IRC Section 163(j). These regulations did not have a material impact to the Company's income tax positions. 41 On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits net operating loss (NOL) carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in years beginning in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company is taking advantage of this NOL carryback provision by carrying back the fiscal year 2021 NOL to the fiscal 2016 and 2017 years, as described above. In addition, the CARES Act contains modifications on the limitation of business interest for tax years beginning in 2019 and 2020. The modifications to Section 163(j) increase the allowable business interest deduction from 30% of adjusted taxable income to 50% of adjusted taxable income. This modification did not have a material impact on the fiscal year 2020 or fiscal year 2021 provisions for income taxes. Also, under the CARES Act, AMT credits not previously refunded for the tax year beginning in 2018 are refundable in the tax year beginning in 2019 rather than in years beginning in 2019-2021, and taxpayers can elect to claim 100% of the AMT credits in the first taxable year beginning in 2018 by applying for a tentative refund claim on or before December 31, 2020. The Company has made this election by applying for a tentative refund claim. The Company took advantage of the deferred payment payroll taxes provision, resulting in decreased deductible payroll tax payments, and increased taxable income, in fiscal years 2020 and 2021. Other aspects of the CARES Act did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows. In future years, repatriations of cash will generally be tax-free in the U.S. However, withholding taxes in China may still apply to any such future repatriations. Management has not changed its indefinite investment assertions regarding to the portion of accumulated earnings and profits in China that may be repatriated in the future. Accordingly, management estimates that future repatriations of cash from China may result in approximately $ 0.7 million of withholding tax. There would be no offsetting foreign tax credits in the U.S. and as such, this potential liability is a direct cost associated with actual repatriations. Withholding taxes will not apply to future repatriations from Mexico or Vietnam. The Company expects to repatriate a portion of its foreign earnings based on increased net sales growth driving additional capital requirements domestically, cash requirements for potential acquisitions and to implement certain tax strategies. The Company expects to repatriate approximately $ 7.1 million from China, in the future. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed assets purchases and improvements in foreign locations. 42 The Company’s effective tax rate differs from the federal tax rate as follows: Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 (in thousands) Federal income tax provision at statutory rates $ 775 $ 1,242 $ 907 State income taxes, net of federal tax effect 86 76 90 Foreign tax rate differences 336 ( 36 ) 336 Tax rate change — 184 — Federal rate differences applied to net operating loss carryback ( 593 ) — — Effect of income tax credits ( 920 ) ( 413 ) ( 310 ) Previously unrecognized tax benefits 146 ( 296 ) ( 1,345 ) Effect of repatriation of foreign earnings, net — ( 61 ) — Tax penalties & interest 179 — — Global Intangible Low-Taxed Income (GILTI) tax 59 34 — Provision to return reconciliation ( 32 ) 50 ( 241 ) Equity compensation shortfall 104 572 — Other 174 220 124 Income tax provision (benefit) $ 314 $ 1,572 $ ( 439 ) The domestic and foreign components of income before income taxes were: Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 (in thousands) Domestic $ ( 2,890 ) $ 2,839 $ 1,142 Foreign 6,581 3,074 3,177 Income before income taxes $ 3,691 $ 5,913 $ 4,319 43 Deferred income tax assets and liabilities consist of the following at: July 2, 2022 July 3, 2021 (in thousands) Deferred tax assets: Net operating loss $ 486 $ 465 Tax credit carryforwards, net 7,990 3,581 Inventory 247 1,190 Identifiable intangibles 370 432 Accruals 2,406 3,132 Fixed assets 1,200 — ASC 606 deferred costs 4,216 4,670 Lease liabilities 3,671 2,909 Interest expense deduction carryforward 580 — Other 465 385 Deferred income tax assets $ 21,631 $ 16,764 Deferred tax liabilities: Accrued withholding tax - unremitted earnings ( 754 ) ( 754 ) Fixed assets — ( 794 ) Right-of-use assets ( 3,663 ) ( 2,930 ) Tax capital lease liabilities ( 2,385 ) — Mark-to-market adjustments — ( 816 ) ASC 606 accelerated revenue ( 3,736 ) ( 672 ) Other ( 1,102 ) ( 1,142 ) Deferred income tax liabilities $ ( 11,640 ) $ ( 7,108 ) Net deferred income tax assets $ 9,991 $ 9,656 Balance sheet caption reported in: Long-term deferred income tax asset $ 10,055 $ 9,656 Long-term deferred income tax liability ( 64 ) — Net deferred income tax asset $ 9,991 $ 9,656 Uncertain Tax Positions: The Company has R&D tax credits that approximate $ 11.0 million that have 20 -year carryforwards before expiring. The Company’s R&D tax credits expire in various fiscal years from 2025 to 2042. As of July 2, 2022, the Company had unrecognized tax benefits of $ 3.0 million related to its gross R&D tax credits. The unrecognized tax benefits relate to certain R&D tax credits generated from 2001 to 2022. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Fiscal Year Ended July 2, 2022 July 3, 2021 June 27, 2020 (in thousands) Beginning Balance $ 4,863 $ 2,863 $ 4,099 Additions based on tax positions related to the current year 286 193 109 Adjustment to prior year tax positions & amended tax returns ( 2,296 ) 2,102 — Lapse of statute of limitations 145 ( 295 ) ( 1,345 ) Ending Balance $ 2,998 $ 4,863 $ 2,863 The $ 2.998 million of unrecognized tax benefits at the end of fiscal year 2022, if recognized, would reduce the effective tax rate. Management does not anticipate any material changes to this amount during the next 12 months. 44 The Company recognizes interest accrued related to unrecognized tax benefits and penalties in its income tax provision. The Company has not recognized any interest or penalties in the fiscal years presented in these financial statements, except for $0.2 million in fiscal year 2022. The Company is subject to income tax in the U.S. federal jurisdiction, various state jurisdictions, Mexico, China and Vietnam. Certain years remain subject to examination but there are currently no ongoing exams in any taxing jurisdiction. 7. EARNINGS PER SHARE Basic earnings per share (EPS) is calculated by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of shares outstanding and any dilutive common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share awards that were not included in the diluted earnings per share calculation. These antidilutive securities occur when equity awards outstanding have an option price greater than the average market price for the period: Fiscal Year Ended (in thousands, except per share information) July 2, 2022 July 3, 2021 June 27, 2020 Net income $ 3,377 $ 4,341 $ 4,758 Weighted average shares outstanding– basic 10,762 10,760 10,760 Effect of dilutive common stock awards 301 286 56 Weighted average shares outstanding – diluted 11,063 11,046 10,816 Net income per share – basic $ 0.31 $ 0.40 $ 0.44 Net income per share – diluted $ 0.31 $ 0.39 $ 0.44 Antidilutive SARs not included in diluted earnings per share 619 314 720 8. STOCK OPTION AND BENEFIT PLANS The Company’s incentive plan provides for equity and liability awards to employees and non-employee directors in the form of stock options, stock appreciation rights (SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is recorded as employee compensation expense in cost of goods sold, research, development and engineering, and selling, general and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations. In addition to service conditions, these SARs contain a performance condition. The additional performance condition is based upon the achievement of Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are measured over the vesting period and are charged to compensation expense over the requisite service period based on the number of shares expected to vest. The SARs cliff vest after a three-year period from date of grant and expire five years from date of grant. On August 9, 2021, the Compa ny granted 165,000 SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of $ 7.17 and a grant date fair value of $ 2.73 . As of July 2, 2022, 165,000 remain outstanding. The grant date fair value for the awards granted during fiscal year 2022, were estimated using the Black Scho les option valuation method with the following weighted average assumptions as of August 9, 2021: Fiscal Year 2022 August 9, 2021 Expected dividend yield — % Risk – free interest rate 0.62 % Expected volatility 48.58 % Expected life 4.00 45 On July 23, 2020, the Company granted 155,000 SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of $ 6.94 and a grant date fair value of $ 2.32 . As of July 2, 2022, 150,000 remain outstanding. The grant date fair value for the awards granted during fiscal year 2021, were estimated using the Black Scholes option valuation method with the following weighted average assumptions as of July 23, 2020: Fiscal Year 2021 July 23, 2020 Expected dividend yield — % Risk – free interest rate 0.17 % Expected volatility 42.85 % Expected life 4.00 On July 26, 2019, the Company granted 175,000 SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of $ 4.93 and a grant date fair value of $ 1.23 . As of July 2, 2022, 140,000 remain outstanding. The grant date fair value for the awards granted during fiscal year 2020, were estimated using the Black Scholes option valuation method with the following weighted average assumptions as of July 26, 2019: Fiscal Year 2020 July 26, 2019 Expected dividend yield — % Risk – free interest rate 1.54 % Expected volatility 28.50 % Expected life 4.00 Subsequent to July 2, 2022, the Company granted 145,000 SARs with a strike price of $ 5.10 and a grant date fair value of $ 2.09 . Share-based compensation expense is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. This forfeiture rate will be revised, if necessary, in subsequent periods if actual forfeitures differ from the amount estimated. Share-based compensation expense for fiscal years ended July 2, 2022, July 3, 2021 and June 27, 2020 was $ 0.3 million, $ 0.2 million and $ 0.3 million, respectively. The Black-Scholes option valuation model is used by the Company for estimating the fair value of SARs. Option valuation models require the input of highly subjective assumptions, particularly for the expected term and expected stock price volatility. Changes in these assumptions can materially affect the fair value estimates. There were no SARs exercised during fiscal year 2022. There were 20,000 SARs exercised with an immaterial amount of intrinsic value in fiscal year 2021. There were no SARs exercised during fiscal year 2020. As of July 2, 2022, total unrecognized compensation expense related to nonvested share-based compensation arrangements was approximately $ 0.4 million. This expense is expected to be recognized over a weighted-average period of 1.79 years. 46 The following table summarizes the Company’s Options and SARs activity for all plans from June 30, 2019 through July 2, 2022: SARs Available For Grant SARs Outstanding Aggregate Intrinsic Value (in thousands) Weighted Average Exercise Price Weighted Average Remaining Contractual Life (in years) Balances, June 30, 2019 493,918 985,416 $ — $ 8.35 1.7 Shares authorized — — SARs granted ( 175,000 ) 175,000 4.93 SARs forfeited 290,833 ( 290,833 ) 7.71 SARs exercised — — — — Balances June 27, 2020 609,751 869,583 $ — $ 7.87 1.9 Shares authorized — — SARs granted ( 155,000 ) 155,000 6.94 SARs forfeited 213,333 ( 213,333 ) 9.88 SARs exercised 20,000 ( 20,000 ) — 7.72 Balances, July 3, 2021 688,084 791,250 $ — $ 7.15 1.9 Shares authorized — — SARs granted ( 165,000 ) 165,000 7.17 SARs forfeited 197,500 ( 197,500 ) 8.17 SARs exercised — — — — Balances, July 2, 2022 720,584 758,750 $ — $ 6.89 2.1 Exercisable at July 2, 2022 187,500 $ — $ 7.26 0.1 Additional information regarding SARs outstanding and exercisable as of July 2, 2022, is as follows: Range of Exercise Prices Number Outstanding Weighted Avg. Remaining Contractual Life (yrs.) Weighted Avg. Exercise Price Number Exercisable Weighted Avg. Exercise Price $4.40 – $7.90 642,500 2.2 $ 6.65 187,500 $ 7.26 7.91 – 9.91 116,250 0.9 8.17 — — $4.40 to $9.91 758,750 2.1 $ 6.89 187,500 $ 7.26 The Company has defined contribution plans available to U.S. employees who have attained age 21. Company contributions to the plans were approximately $ 0.9 million, $ 0.9 million, and $ 0.8 million during fiscal years 2022, 2021 and 2020, respectively. 9. COMMITMENTS AND CONTINGENCIES Leases : As of July 3, 2021 and June 27, 2020, the Company did not have any property and equipment financed under finance leases. Please refer to Footnote “Leases” of the “Notes to Consolidated Financial Statements” for information regarding lease commitments. Warranty Costs : The Company provides warranties on certain product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. As of July 2, 2022 and July 3, 2021, the reserve for warranty costs was approximately $ 31,000 and $ 25,000 , respectively. If actual return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be required in future periods. Warranty expense for fiscal years 2022, 2021 and 2020 was related to workmanship claims on certain contract manufacturing products. 47 Litigation : The Company is party to certain lawsuits or claims in the ordinary course of business. The Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow of the Company. Internal Investigation : During fiscal 2021, the Company’s Audit Committee completed an internal investigation arising from a notification from an employee regarding certain alleged accounting irregularities. In January 2021, the Company determined that improper accounting resulted in an understatement of cost of goods sold and an overstatement of inventories. Subsequent to the matter identified in January 2021, additional inventory accounting errors unrelated to the investigation were also identified by management. The investigation did not result in a restatement of our previously filed financial statements. The Company is cooperating with the Securities and Exchange Commission’s (the “SEC”) inquiries related to the internal investigation. The Company cannot currently form an estimate of any possible loss or range of loss, including any potential monetary penalties; or other remedies potentially imposed by the SEC. Indemnification Rights : Under the Company’s bylaws, the Company’s directors and officers have certain rights to indemnification by the Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors in certain circumstances. 10. DERIVATIVE FINANCIAL INSTRUMENTS As of July 2, 2022, the Company did not have any outstanding foreign currency forward contracts. During the fiscal year ended July 2, 2022, the Company entered into $ 13.9 million of foreign currency forward contracts and settled $ 24.6 million of such contracts. During the fiscal year ended July 3, 2021, the Company did not enter into any foreign currency forward contracts and settled $ 26.1 million of such contracts. During the fiscal year ended June 27, 2020, the Company entered into $ 23.8 million of foreign currency forward contracts and settled $ 26.7 million of such contracts. On November 6, 2019, the Company entered into an interest rate swap contract with an effective date of November 6, 2019 and a termination date of September 30, 2022, related to the borrowings outstanding under the term loan with Wells Fargo Bank. This interest rate swap contract was terminated on August 14, 2020 when the Company entered into a loan and security agreement with Bank of America. At date of termination this interest rate swap was in a liability position of $ 148,400 , which will be amortized to interest expense over the original term of the swap. On November 6, 2019, the Company entered into an interest rate swap contract with an effective date of November 6, 2019 and a termination date of November 1, 2023, related to the borrowings outstanding under the line of credit with Wells Fargo Bank. This interest rate swap contract was terminated on August 14, 2020 when the Company entered into a loan and security agreement with Bank of America. At date of termination this interest rate swap was in a liability position of $ 776,500 , which will be amortized to interest expense over the original term of the swap. The following table summarizes the fair value of derivative instruments in the Consolidated Balance Sheets as of July 2, 2022 and July 3, 2021 (in thousands): July 2, 2022 July 3, 2021 Derivatives Designated as Hedging Instruments Balance Sheet Location Fair Value Fair Value Foreign currency forward contracts & swaps Other current assets $ — $ 3,614 The following table summarizes the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the fiscal year 2022 (in thousands): Derivatives Designated as Hedging Instruments Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) AOCI Balance as of July 3, 2021 Effective Portion Recorded In AOCI Effective Portion Reclassified From AOCI Into Income AOCI Balance as of July 2, 2022 Forward contracts Cost of sales $ 2,721 $ 950 $ ( 3,750 ) $ ( 79 ) Interest rate swap Interest expense ( 649 ) — 303 ( 346 ) Total $ 2,072 $ 950 $ ( 3,447 ) $ ( 425 ) The following table summarizes the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the fiscal year 2021 (in thousands): 48 Derivatives Designated as Hedging Instruments Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) AOCI Balance as of June 27, 2020 Effective Portion Recorded In AOCI Effective Portion Reclassified From AOCI Into Income AOCI Balance as of July 3, 2021 Forward contracts Cost of sales $ ( 759 ) $ 4,621 $ ( 1,141 ) $ 2,721 Interest rate swap Interest expense ( 741 ) ( 223 ) 315 ( 649 ) Total $ ( 1,500 ) $ 4,398 $ ( 826 ) $ 2,072 The following table summarizes the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the fiscal year 2020 (in thousands): Derivatives Designated as Hedging Instruments Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) AOCI Balance as of June 29, 2019 Effective Portion Recorded In AOCI Effective Portion Reclassified From AOCI Into Income AOCI Balance as of June 27, 2020 Forward contracts & swaps Cost of sales $ 2,424 $ ( 865 ) $ ( 2,318 ) $ ( 759 ) Interest rate swap Interest expense 2 ( 782 ) 39 ( 741 ) Total $ 2,426 $ ( 1,647 ) $ ( 2,279 ) $ ( 1,500 ) As of July 2, 2022, the Company does not have any foreign exchange contracts with credit-risk-related contingent features. The Company is subject to the risk of fluctuating interest rates from our line of credit and foreign currency risk resulting from our China operations. The Company does not currently manage these risk exposures by using derivative instruments. 11. FAIR VALUE MEASUREMENTS The Company has adopted ASC 820, Fair Value Measurements, which defines fair value, establishes a framework for assets and liabilities being measured and reported at fair value and expands disclosures about fair value measurements. There are three levels of fair value hierarchy inputs used to value assets and liabilities which include: Level 1 – inputs are quoted market prices for identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3 – inputs are unobservable inputs for the asset or liability. There have been no changes in the fair value methodologies used at July 2, 2022 and July 3, 2021. The following table summarizes the fair value of assets (liabilities) of the Company’s derivatives that are required to be measured on a recurring basis as of July 3, 2021 (in thousands): July 3, 2021 Level 1 Level 2 Level 3 Total Fair Value Financial Assets: Foreign currency forward contracts — 3,614 — $ 3,614 The Company had forward contracts to hedge known future cash outflows for expenses denominated in the Mexican peso and had an interest rate swap to mitigate risk associated with certain borrowings under the Company’s debt arrangement. These contracts were measured on a recurring basis based on the foreign currency spot rates and forward rates quoted by banks or foreign currency dealers. These contracts were marked to market using level 2 input criteria every quarter with the unrealized gain or loss, net of tax, reported as a component of shareholders’ equity in accumulated other comprehensive income (loss), as they qualified for hedge accounting. The carrying values of cash and cash equivalents, accounts receivable, contract assets, and current liabilities are reflected on the balance sheets at July 2, 2022 and July 3, 2021, reasonably approximate their fair value. The Company’s long-term debt, which is measured at amortized cost, primarily consists of an asset-based revolving credit facility, lease liability, and equipment loans. These borrowings bear interest at LIBOR plus 2.5% per the loan agreement. Each of these rates is a variable floating rate dependent upon current market conditions and the Company’s current credit risk as discussed in Footnote “Long-Term Debt” of the “Notes to Consolidated Financial Statements.” As a result of the determinable market rates for our asset-based revolving credit facility and equipment loans, they are classified within Level 2 of the fair value hierarchy. Further, the carrying value of each of these instruments reasonably approximates their fair value as of July 2, 2022 and July 3, 2021. 49 12. ENTERPRISE-WIDE DISCLOSURES Operating segments are defined in ASC Topic 280, Segment Reporting as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. As of July 2, 2022, the Company operates and internally manages a single operating segment, Electronics Manufacturing Services as this is the only discrete financial information that is regularly reviewed by the chief operating decision maker. This segment provides integrated electronic and mechanical engineering, assembly, sourcing and procurement, logistics, and new product testing for our customers. Products and Services Of the revenues for the years ended July 2, 2022, July 3, 2021, and June 27, 2020, contract manufacturing sales and services were $ 531.8 million, $ 518.7 million and $ 449.5 million, respectively. Geographic Areas Net sales and long-lived assets (property, plant, and equipment) by geographic area for the years ended and as of July 2, 2022, July 3, 2021 and June 27, 2020 are summarized in the following table. Net sales set forth below are based on the shipping destination. Long-lived assets information is based on the physical location of the asset and includes property, plant and equipment, net, and operating lease right-of-use assets, net. Fiscal Year Ended (in thousands) 2022 2021 2020 Geographic net sales: Domestic (U.S.) $ 438,018 $ 372,217 $ 338,766 Foreign 93,797 146,481 110,714 Total $ 531,815 $ 518,698 $ 449,480 Long-lived assets: United States $ 14,440 $ 20,949 $ 21,078 Mexico 22,473 24,089 20,828 Vietnam 5,229 5,919 6,567 China 601 523 859 Total $ 42,743 $ 51,480 $ 49,332 Percentage of net sales made to customers located in the following countries: Fiscal Year Ended 2022 2021 2020 United States 82 % 72 % 75 % China 16 25 19 Other foreign countries (a) 2 3 5 Canada — — 1 Total 100 % 100 % 100 % (a) No other individual foreign country accounted for 10% or more of the foreign sales in fiscal years 2021, 2020 or 2019. 50 Significant Customers The percentage of net sales to and trade accounts receivables from significant customers were as follows: Percentage of Net Sales Fiscal Year Percentage of Trade Accounts Receivable Fiscal Year 2022 2021 2020 2022 2021 Customer A 13 % * * 5 % * Customer B 12 % 24 % 18 % 13 % 15 % 13. QUARTERLY FINANCIAL DATA (Unaudited) Fiscal Year Ended July 2, 2022 First Quarter Second Quarter Third Quarter Fourth Quarter (in thousands, except per share amounts) Net sales $ 132,762 $ 134,456 $ 138,391 $ 126,206 Gross profit 10,138 9,808 11,508 11,760 Income before income taxes 1,102 556 1,238 795 Net income 815 587 1,007 968 Net income per share - basic $ 0.08 $ 0.05 $ 0.09 $ 0.09 Net income per share - diluted $ 0.07 $ 0.05 $ 0.09 $ 0.09 Weighted average shares outstanding Basic 10,762 10,762 10,762 10,762 Diluted 11,052 11,057 11,062 11,071 Fiscal Year Ended July 3, 2021 First Quarter Second Quarter Third Quarter Fourth Quarter (in thousands, except per share amounts) Net sales $ 123,207 $ 128,262 $ 134,600 $ 132,629 Gross profit 10,015 10,622 11,096 10,306 Income before income taxes 2,115 1,872 1,556 370 Net income 1,719 1,580 867 175 Net income per share - basic $ 0.16 $ 0.15 $ 0.08 $ 0.02 Net income per share - diluted $ 0.16 $ 0.14 $ 0.08 $ 0.02 Weighted average shares outstanding Basic 10,760 10,760 10,760 10,762 Diluted 11,040 11,385 11,429 11,169 14. REVENUE Revenue Recognition The Company specializes in services ranging from product manufacturing to engineering and tooling services. The first step in its process for revenue recognition is to identify the contract with a customer. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. A contract can be written, oral, or implied. The Company generally enters into manufacturing service agreements (“MSA”) with its customers that outlines the terms of the business relationship between the customer and the Company. This includes matters such as warranty, indemnification, transfer of title and risk of loss, liability for excess and obsolete inventory, pricing, payment terms, etc. The Company will also bid on a program-by-program basis for customers in which an executed MSA may not be in place. In these instances, as well as when we have an MSA in place, we receive customer purchase orders for specific quantities and timing of products. As a result, the Company considers its contract with a customer to be the combination of the MSA and the purchase order. The transaction price is fixed and set forth in each purchase order. In the Company's normal course of business, there are no variable pricing components, or material amounts refunded to customers in the form of refunds or rebates. 51 The Company assesses whether control of the product or services promised under the contract is transferred to the customer at a point in time (shipment) or over time (as we manufacture the product). The Company is first required to evaluate whether its contracts meet the criteria for 'over-time' or 'point-in-time' recognition. The Company has determined that for the majority of its contracts the Company is manufacturing products for which there is no alternative use due to the unique nature of the customer-specific product, IP and other contract restrictions. The Company has an enforceable right to payment including a reasonable profit for performance completed to date with respect to these contracts. As a result, revenue is recognized under these contracts 'over-time' based on the input cost-to-cost method as it better depicts the transfer of control. This input method is based on the ratio of costs incurred to date as compared to the total estimated costs at completion of the performance obligation. For all other contracts that do not meet these criteria, such as manufacturing contracts for which the terms do not provide an enforceable right to payment for performance completed to date, the Company recognizes revenue when it has transferred control of the related manufactured products which generally occurs upon shipment to the customer. Revenue from engineering services is recognized over time as the services are performed. The Company’s typical payment terms are 30 to 45 days and its sales arrangements do not contain any significant financing component for its customers. The Company generally provides a warranty for workmanship on its manufacturing contracts. Although we offer warranties on our products, our warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in ASC 606, assurance-type warranties do not represent separate performance obligations; therefore, the primary performance obligation in the majority of our contracts is the delivery of a specific good through the purchase order submitted by our customer. The Company elected to not disclose information about remaining performance obligations as they are part of contracts that that have expected durations of one year or less. The Company has elected to expense costs to obtain contracts as incurred as these costs are immaterial to the financial statements. During fiscal 2022, 2021 and 2020, no revenues were recognized from performance obligations satisfied or partially satisfied in previous periods. Contract Balances A contract asset is recognized when the Company has recognized revenue, but has not issued an invoice for payment. Contract assets are classified separately on the condensed consolidated balance sheet and transferred to receivables when the right to payment becomes unconditional. The following table summarizes the activity in the Company’s contract assets during the twelve months ended July 2, 2022 (in thousands): Contract Assets Beginning balance, July 3, 2021 $ 24,781 Revenue recognized 515,831 Amounts collected or invoiced ( 518,638 ) Ending balance, July 2, 2022 $ 21,974 The following table summarizes the activity in the Company’s contract assets during the twelve months ended July 3, 2021 (in thousands): Contract Assets Beginning balance, June 27, 2020 23,753 Revenue recognized 509,621 Amounts collected or invoiced ( 508,593 ) Ending balance, July 3, 2021 $ 24,781 52 Disaggregation of Revenue The following table presents the Company’s revenue disaggregated for the twelve months ended July 2, 2022 and the twelve months ended July 3, 2021 (in thousands): Revenue Recognition July 2, 2022 July 3, 2021 June 27, 2020 Over-Time $ 515,831 $ 509,621 $ 441,405 Point-in-Time 15,984 9,077 8,075 Total $ 531,815 $ 518,698 $ 449,480 Revenues and associated costs from engineering design, development services and tooling, which are performed under contract of short term durations, are recognized over time as the services are performed. Revenue from engineering design, development services and tooling represented approximately 9.6 %, 5.6 % and 3.3 % of total revenue in fiscal year 2022, 2021 and 2020, respectively. 15. LEASES The Company has several commitments under operating and financing leases for warehouses, manufacturing facilities, office buildings, and equipment with initial terms that expire at various dates during the next 1 year to 10 years. The Company has some leases that include an extension clause. Management has considered the likelihood of exercising each extension option included and estimated the duration of the extension option, for those leases management determined to be reasonably certain, in calculating the lease term for measurement of the right of use asset and liability. For operating leases, management assumed a discount rate of 4%. The weighted average discount rate is disclosed in the tables below. The components of lease cost were as follows as of July 2, 2022, July 3, 2021 and June 27, 2020 (in thousands): Year Ended Year Ended Year Ended Lease cost Classification July 2, 2022 July 3, 2021 June 27, 2020 Operating lease cost Cost of sales $ 6,442 $ 4,818 $ 4,511 Operating lease cost Selling, general and administrative expenses 929 1,270 1,266 Financing lease cost Cost of sales $ 2,054 $ — $ — Financing lease cost Selling, general and administrative expenses $ 64 $ — $ — Total lease cost $ 9,489 $ 6,088 $ 5,777 Fixed lease cost $ 7,941 $ 4,943 $ 5,335 Short-term lease cost $ 1,548 $ 1,145 $ 442 Total lease cost $ 9,489 $ 6,088 $ 5,777 53 Amounts reported in the Consolidated Balance Sheet as of July 2, 2022 and July 3, 2021 were (in thousands, except weighted average lease term and discount rate): July 2, 2022 July 3, 2021 Operating Leases: Operating lease right of use assets $ 16,731 $ 15,745 Operating lease liabilities (1) 16,731 15,653 Weighted-average remaining lease term (in years) Operating leases 5.28 5.95 Weighted-average discount rate Operating leases 4.00 % 4.05 % Financing Leases (2) : Financing lease right of use assets $ 12,464 $ — Financing lease liabilities 11,211 — Weighted-average remaining lease term (in years) Financing leases 2.56 0.00 Weighted-average discount rate Financing leases 8.82 % — % (1) For fiscal year 2022 and 2021, the current portion of the total operating lease liabilities is classified under Other Current Liabilities. (2) The total finance lease right of use assets of $12.5 million is classified under Other Long-term Assets. The current portion of the total finance lease liabilities of $5.2 million is classified under Current portion of debt, net, resulting in $6.0 million classified in Other Long-term Liabilities section of the condensed consolidated balance sheet. 54 Other information related to leases was as follows (in thousands): July 2, 2022 July 3, 2021 June 27, 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases 4,261 4,976 4,237 Financing cash flows used in financing leases 2,331 — — Future lease payments under non-cancellable leases as of July 2, 2022 are as follows (in thousands): Fiscal Years Ending Operating Leases Finance Leases 2023 $ 4,709 $ 5,213 2024 3,811 3,960 2025 2,972 2,539 2026 2,351 107 2027 1,450 71 Thereafter 3,071 — Total undiscounted lease payments 18,364 11,890 Less: present value discount 1,633 679 Total lease liabilities $ 16,731 $ 11,211 Item 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None