KEY TRONIC CORP 10-Q

Item 1: Financial Statements KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited, in thousands; except share data) September 30, 2023 July 1, 2023 ASSETS Current assets: Cash and cash equivalents 3,574 3,603 Trade receivables, net of allowance for doubtful accounts of $ 23 and $ 23 141,442 150,600 Contract assets 32,903 29,925 Inventories 126,778 137,911 Other 22,930 27,510 Total current assets 327,627 349,549 Property, plant and equipment, net 28,085 28,870 Operating lease right-of-use assets, net 15,928 16,202 Other assets: Deferred income tax asset 13,205 12,254 Other 7,500 11,397 Total other assets 20,705 23,651 Total assets 392,345 418,272 LIABILITIES AND SHAREHOLDERS ’ EQUITY Current liabilities: Accounts payable 101,638 115,899 Accrued compensation and vacation 11,860 13,351 Current portion of debt, net 6,196 7,849 Other 13,330 14,867 Total current liabilities 133,024 151,966 Long-term liabilities: Term loans 6,272 6,726 Revolving loan 109,517 114,805 Operating lease liabilities 10,939 10,317 Deferred income tax liability 324 274 Other long-term obligations 1,201 3,567 Total long-term liabilities 128,253 135,689 Total liabilities 261,277 287,655 Commitments and contingencies (Note 8) Shareholders’ equity: Common stock, no par value—shares authorized 25,000 ; issued and outstanding 10,762 and 10,762 shares, respectively 47,786 47,728 Retained earnings 83,321 82,986 Accumulated other comprehensive (loss) ( 39 ) ( 97 ) Total shareholders’ equity 131,068 130,617 Total liabilities and shareholders’ equity 392,345 418,272 3 See accompanying notes to consolidated financial statements. 4 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited, in thousands, except share and per share amounts) Three Months Ended September 30, 2023 October 1, 2022 Net sales $ 147,763 $ 137,263 Cost of sales 136,901 126,884 Gross profit 10,862 10,379 Research, development and engineering expenses 2,241 2,296 Selling, general and administrative expenses 5,784 5,656 Gain on insurance proceeds, net of losses ( 431 ) ( 934 ) Total operating expenses 7,594 7,018 Operating income 3,268 3,361 Interest expense, net 3,011 1,887 Income before income taxes 257 1,474 Income tax provision ( 78 ) 322 Net income $ 335 $ 1,152 Net income per share — Basic $ 0.03 $ 0.11 Weighted average shares outstanding — Basic 10,762 10,762 Net income per share — Diluted $ 0.03 $ 0.11 Weighted average shares outstanding — Diluted 11,003 10,832 See accompanying notes to consolidated financial statements. 5 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited, in thousands) Three Months Ended September 30, 2023 October 1, 2022 Comprehensive income: Net income $ 335 $ 1,152 Other comprehensive income (loss): Unrealized gain (loss) on hedging instruments, net of tax 58 153 Comprehensive income $ 393 $ 1,305 See accompanying notes to consolidated financial statements. 6 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited, in thousands) Three Months Ended September 30, 2023 October 1, 2022 Operating activities: Net income $ 335 $ 1,152 Adjustments to reconcile net income to cash used in operating activities: Depreciation and amortization 2,787 2,385 Amortization of interest rate swap 58 153 Amortization of deferred loan costs 55 37 Noncash Lease Expense 1,528 1,847 Inventory write-down to net realizable value 265 175 Provision for warranty 118 152 Provision for doubtful accounts — 14 Loss (Gain) on disposal of assets — ( 123 ) Gain on insurance proceeds, net of losses ( 431 ) ( 934 ) Share-based compensation expense 59 40 Deferred income taxes ( 901 ) ( 344 ) Changes in operating assets and liabilities: Trade receivables 9,157 ( 1,776 ) Contract assets ( 2,978 ) ( 4,384 ) Inventories 10,867 ( 13,719 ) Other assets 1,417 1,754 Accounts payable ( 14,261 ) 12,732 Accrued compensation and vacation ( 1,491 ) ( 2,771 ) Other liabilities ( 961 ) ( 2,227 ) Cash provided by (used in) operating activities 5,623 ( 5,837 ) Investing activities: Purchase of property and equipment ( 527 ) ( 2,526 ) Proceeds from insurance 2,249 — Cash provided by (used in) investing activities 1,722 ( 2,526 ) Financing activities: Payment of financing costs ( 491 ) — Repayments of long term debt ( 707 ) ( 543 ) Borrowings under revolving credit agreement 138,320 151,799 Repayments of revolving credit agreement ( 143,170 ) ( 141,445 ) Principal payments on finance leases ( 1,326 ) ( 1,022 ) Cash (used in) provided by financing activities ( 7,374 ) 8,789 Net (decrease) increase in cash and cash equivalents ( 29 ) 426 Cash and cash equivalents, beginning of period 3,603 1,707 Cash and cash equivalents, end of period $ 3,574 $ 2,133 Non-cash investing activities: Supplemental cash flow information: Interest payments $ 3,042 $ 1,894 Income tax payments, net of refunds $ 1,168 $ 414 Recognition of operating lease liabilities and right-of-use assets $ — $ 4,613 See accompanying notes to consolidated financial statements. 7 KEY TRONIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited, in thousands; except share data) Three Months Ended September 30, 2023 October 1, 2022 Total shareholders’ equity, beginning balances $ 130,617 $ 124,878 Common stock (shares): Beginning balances 10,762 10,762 Exercise of stock appreciation rights — — Ending balances 10,762 10,762 Common stock: Beginning balances $ 47,727 $ 47,474 Share-based compensation $ 59 40 Exercise of stock options $ — — Ending balances $ 47,786 47,514 Retained Earnings: Beginning balances $ 82,986 $ 77,829 Net income $ 335 1,152 Ending balances $ 83,321 78,981 Accumulated other comprehensive income (loss): Beginning balances $ ( 97 ) $ ( 425 ) Unrealized gain (loss) on hedging instruments, net $ 58 153 Ending balances $ ( 39 ) ( 272 ) Total shareholders’ equity, ending balances $ 131,068 $ 126,223 See accompanying notes to consolidated financial statements. 8 KEY TRONIC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The consolidated financial statements included herein have been prepared by Key Tronic Corporation and subsidiaries (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted. The year-end condensed consolidated balance sheet information was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The financial statements reflect all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2022. The Company’s reporting period is a 52/53 week fiscal year ending on the Saturday closest to June 30. The three month periods ended September 30, 2023 and October 1, 2022, were both 13 week periods. Fiscal year 2024 will end on June 29, 2024, which is a 52 week year. Fiscal year 2023 which ended on July 1, 2023, was also a 52 week year. Management’s Assessment of Liquidity Historically, we have financed operations and met our capital expenditure requirements primarily through cash flows provided by operations and borrowings under our credit facilities. We generated operating and net income of $ 3.3 million and $ 0.3 million respectively, during the 3-month period ended September 30, 2023, and have positive working capital of $ 194.6 million as of September 30, 2023. Due to the timing between the procurement of raw materials, production cycle and payment from our customers, we have relied on borrowings on our credit facilities and cash from operations to fund operations as the Company increased its revenues and during the first three months of fiscal year 2024. Based on current projections, we anticipate generating cash from operations as revenue is expected to remain flat during the second quarter of fiscal year 2024 and decreasing working capital requirements as existing backlog is manufactured and shipped. As of September 30, 2023, approximately $ 9.5 million was available under the asset-based revolving credit facility. We are also in discussions with multiple financial institutions to extend the borrowing capacity on our credit facility. If we are unable to meet projected operating results or extend our borrowing capacity, we may need to delay the purchase of raw materials or require our customers to fund inventory raw material costs ahead of production. Other options to increase our liquidity include factoring receivables or leveraging foreign owned assets for additional borrowing capacity. We believe that projected cash from operations, funds available under our asset-based revolving credit facility and additional financing options will be sufficient to meet our working and fixed capital requirements for at least the next 12 months. Certain Significant Risks and Uncertainties Related to Outbreak of Coronavirus Disease 2019 (“COVID-19”) Due to the COVID -19 pandemic, the Company has seen extreme shifts in demand from its customer base, and shifts in 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. 2. Significant Accounting Policies Reclassifications Certain prior period reclassifications were made to conform with the current period presentation. These reclassifications had no effect on reported income, comprehensive income, cash flows, total assets, or shareholders' equity as previously reported. Earnings Per Common Share Basic earnings per common share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) 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 EPS does 9 not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on EPS. 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 September 30, 2023, the Company did not have any outstanding foreign currency forward contracts. The Company occasionally uses derivatives to manage the variability of foreign currency fluctuations of expenses in our Mexico facilities. The foreign currency forward contracts 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, where applicable, potentially expose the Company to credit risk to the extent the counterparty may be unable to meet the terms of the agreement. The Company minimizes such risk by utilizing a counterparty with a strong credit rating. The Company’s counterparty to the foreign currency forward contracts was a major banking institution. This institution did not require collateral for the contracts, and the Company believes that the risk of the counterparty failing to meet their contractual obligations is remote. The Company does not enter into derivative instruments for trading or speculative purposes. Income Taxes We compute our interim income tax provision through the use of an estimated annual effective tax rate (ETR) applied to year-to-date operating results and specific events that are discretely recognized as they occur. In determining the estimated annual ETR, we analyze various factors, including projections of our annual earnings, taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, our ability to use tax credits and available tax planning alternatives. Discrete items, including the effect of changes in tax laws, tax rates, and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments, are reflected in the period in which they occur as an addition to, or reduction from, the income tax provision, rather than included in the estimated annual ETR. 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 and net operating loss 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 expense. The tax years 2001 through the present remain open to examination by the major U.S. taxing jurisdictions to which we are subject. Refer to Note 5 for further discussions related to income taxes. Recently Issued Accounting Standards 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 10 dependent on timing of adoption of ASU 2016-13. The Company adopted this amendment as of the effective date of July 2, 2023. This ASU did not have a material impact on our consolidated financial statements. 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 adopted this amendment as of the effective date of July 2, 2023. This ASU did not have a material impact on our consolidated financial statements. In October 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-08 amending Business Combination: (Topic 805), which was necessary due to 2014-09, Revenue from Contracts with Customers (Topic 606). The FASB issued this Update to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to (1) recognition of an acquired contract liability and (2) payment terms and their effect on subsequent revenue recognized by the acquirer. The Company adopted this amendment as of the effective date of July 2, 2023. These amendments are to be applied prospectively to business combinations occurring on or after the effective date of the amendments. The Company plans to apply the practical expedients as needed for any future acquisitions. The practical expedients cover contracts that were modified prior to acquisition date as well as determining which date an acquirer would have to determine the standalone selling price of each performance obligation in an acquired contract. This ASU did not have a material impact on our consolidated financial statements. In September 2022, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2022-04, Liabilities—Supplier Finance Programs (Subtopic 405-50). This standard requires disclosure of the key terms of outstanding supplier finance programs and a roll forward of the related obligations. The new standard does not affect the recognition, measurement or financial statement presentation of supplier finance program obligations. The ASU became effective for the Company July 2, 2023, except for the roll forward requirement, which becomes effective July 2, 2024. This ASU, except for the roll forward requirement, was adopted retrospectively as of July 2, 2023 and did not have a material impact on our consolidated financial statements. 3. Inventories Inventories as of September 30, 2023 are $ 126.8 million compared to $ 137.9 million as of July 1, 2023. Substantially all of the Company’s inventory balances are raw materials. 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. On September 3, 2021, the Company entered into an amendment to the Company’s current loan agreement with Bank of America. The amendment increased the Company’s current credit facility of $ 93 million to $ 120 million, subject to the Company’s borrowing base, maturing on September 3, 2026. On August 26, 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 September 30, 2023, the Company had an outstanding balance under the asset-based revolving credit facility of $ 110.5 million, $ 0.3 million in outstanding letters of credit and $ 9.5 million available for future borrowings. In the third quarter of fiscal year 2023, the Company entered into equipment financing agreements with Ameris Bank dba Balboa Capital ("Balboa Capital") totaling $ 4.4 million related to the Company’s existing manufacturing equipment that bears an interest rate range of 6 % - 8 % and matures in the third quarter of fiscal 2029. Under these agreements, equal monthly payments of $ 75,000 commenced in the third quarter of fiscal year 2023 and will continue through the maturity of the equipment financing facility in the third quarter of fiscal 2029. The Company had an outstanding balance $ 4.0 million as of September 30, 2023. On August 14, 2020, the Company also entered into a $ 5.0 million equipment financing facility 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 September 30, 2023, the Company had an outstanding balance of $ 2.1 million. As of July 1, 2023, the Company had an outstanding balance of $ 2.3 million under the Bank of America equipment term loan agreement. 11 Generally, the interest rate applicable to loans under the Bank of America loan agreement will be, at the Company’s option: (i)(A) the base rate which is the highest of (a) the Prime Rate for such day, (b) the Federal Funds Rate for such day plus 0.50 %, or (c) Term SOFR for a one month interest period as of such 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) SOFR rate for an applicable interest period, plus the applicable interest margin for SOFR rate loans. Depending on average daily excess borrowing availability over applicable periods under the Credit Facility, applicable interest margins on : (x) base rate loans will be 1.50 - 2.00 %; and (y) SOFR rate loans will be 2.50 - 3.00 %, resetting on a quarterly basis beginning in early 2021. If there is an event of default under the loan agreement, all loans and other obligations will bear interest as 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. On November 24, 2020, the Company entered into a $ 6.0 million financing facility related to the Company’s existing real estate located in Mexico 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 financing facility on April 24, 2026. As of September 30, 2023, the Company had an outstanding balance of $ 3.1 million. As of July 1, 2023, the Company had an outstanding balance of $ 3.4 million. The interest rates on outstanding debt as of September 30, 2023 range from 4.85 % - 8.43 % compared to 4.85 % - 8.22 % as of July 1, 2023. Debt maturities as of September 30, 2023 for the next five years and thereafter are as follows (in thousands): Fiscal Years Ending Amount 2024 (1) $ 2,155 2025 $ 2,959 2026 $ 1,905 2027 $ 111,315 2028 - Thereafter $ 1,367 Total debt 119,701 Unamortized debt issuance costs ( 1,026 ) Long-term debt, net of debt issuance costs $ 118,675 (1) Represents scheduled payments for the remaining nine-month period ending June 29, 2024. The Company must comply with certain financial covenants, including a fixed charge coverage 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 September 30, 2023. 5. Income Taxes 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 currently expects to repatriate approximately $ 7.8 million of foreign earnings in the future. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed assets purchases and improvements in foreign locations. 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 with regard 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 $ 0.8 million of withholding tax. We do not anticipate there would be any offsetting foreign tax credits in the U.S. and as such, this potential liability is a direct cost associated with actual repatriations. Withholding taxes would not apply to future repatriations from Mexico or Vietnam. The Company has available approximately $ 10.0 million of gross federal research and development tax credits as of September 30, 2023. ASC 740 requires the Company to recognize in its financial statements uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. Accordingly, as of September 30, 2023, the Company has recorded $ 3.0 million of unrecognized tax benefits associated with these federal tax credits, resulting in a net deferred tax benefit of approximately $ 7.0 million. 12 The Company evaluated tax law changes and regulatory guidance issued through the prior fiscal year. Such changes and regulations include guidance relating to foreign tax credits and consolidated NOL carryback claims. The Company evaluated the ongoing impact of these law and regulatory changes, and determined that they did not have a material impact on its provision for income taxes. On August 16, 2022, the Inflation Reduction Act of 2022 was signed into law. The Inflation Reduction Act of 2022 includes a new book minimum tax on certain large corporations and an excise tax on corporate stock buybacks, among other provisions. The Company has evaluated 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. On January 27, 2021, the Company received official notice from the Vietnamese tax authorities, confirming tax benefits awarded (the “Tax Holiday”) related to the Company’s principal product line in Vietnam. The tax rate related to 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 each year). 6. Earnings Per Share The following table presents a reconciliation of the denominator in the basic and diluted EPS calculation 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. Three Months Ended (in thousands, except share and per share information) September 30, 2023 October 1, 2022 Net income $ 335 $ 1,152 Weighted average shares outstanding—basic 10,762 10,762 Effect of dilutive common stock awards 241 70 Weighted average shares outstanding—diluted 11,003 10,832 Net income per share—basic $ 0.03 $ 0.11 Net income per share—diluted $ 0.03 $ 0.11 Antidilutive SARs not included in diluted earnings per share 270 904 7. Share-based Compensation 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, 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 evaluated quarterly to determine the likelihood that performance metrics will be achieved during the performance period. These awards 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. The grant date fair value for the awards granted below were estimated using the Black-Scholes option valuation method: July 29, 2022 SARs Granted 145,000 Strike Price $ 5.10 Fair Value $ 2.09 Total share-based compensation expense recognized during the three months ended September 30, 2023 and October 1, 2022 was approximately $ 59,000 and $ 40,000 , respectively. As of September 30, 2023, total unrecognized compensation expense related to unvested share-based compensation arrangements was approximately $ 0.3 million. This expense is expected to be recognized over a weighted average period of 1.46 years. No SARs were exercised during the three months ended September 30, 2023 or October 1, 2022. 13 8. Commitments and Contingencies Litigation and Other Matters 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. Warranties The Company provides warranties on certain product sales. 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. If actual return rates and/or repair and replacement costs differ significantly from management’s estimates, adjustments to recognize additional cost of sales may be required in future periods. The Company’s warranty reserve was approximately $ 113,000 as of September 30, 2023 and $ 29,000 as of July 1, 2023, respectively. Gain from Insurance Recoveries, Net of Losses Gain from insurance recoveries, net of losses, relate to losses incurred from storm damage to the Company’s Arkansas facility on July 29, 2022, as the result of a lightning strike. During the three months ended September 30, 2023, the Company recorded a gain from insurance recoveries, net of losses, of $ 0.4 million due to the storm event. 9. Derivative Financial Instruments As of September 30, 2023, the Company did not have any outstanding foreign currency forward contracts. For the three months ended September 30, 2023, the Company did not enter into or settle any foreign currency forward contracts. During the same period of the previous year, the Company did not enter into or settle any foreign currency forward 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. On the 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. On the 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. 14 The following tables summarize the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the three months ended September 30, 2023 and October 1, 2022, respectively (in thousands): Derivatives Designated as Hedging Instruments Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) AOCI Balance as of July 1, 2023 Effective Portion Recorded In AOCI Effective Portion Reclassified From AOCI Into Income AOCI Balance as of September 30, 2023 Forward contracts Cost of sales $ — — — — Interest rate swap Interest expense ( 97 ) — 58 ( 39 ) Total $ ( 97 ) $ — $ 58 $ ( 39 ) Derivatives Designated as Hedging Instruments Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) AOCI Balance as of July 2, 2022 Effective Portion Recorded In AOCI Effective Portion Reclassified From AOCI Into Income AOCI Balance as of October 1, 2022 Forward contracts Cost of sales ( 79 ) — 79 — Interest rate swap Interest expense ( 346 ) — 74 ( 272 ) Total $ ( 425 ) $ — $ 153 $ ( 272 ) As of September 30, 2023, 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. 10. 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 outline 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. 15 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 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 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 the first three months of fiscal year 2024, 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 three months ended September 30, 2023 (in thousands): Contract Assets Beginning balance, July 1, 2023 $ 29,925 Revenue recognized $ 129,980 Amounts collected or invoiced $ ( 127,002 ) Ending balance, September 30, 2023 $ 32,903 Disaggregation of Revenue The following table presents the Company’s revenue disaggregated for the three months ended September 30, 2023 and October 1, 2022 (in thousands): Revenue Recognition Three Months Ended September 30, 2023 October 1, 2022 Over-Time $ 129,980 $ 134,558 Point-in-Time 17,783 2,705 Total $ 147,763 $ 137,263 16 11. 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 4.2 %. The weighted average discount rate is disclosed in the tables below. 17 The components of lease cost for the three months ended September 30, 2023 and October 1, 2022 were (in thousands): Lease cost Classification September 30, 2023 October 1, 2022 Operating lease cost Cost of sales $ 1,126 $ 1,334 Operating lease cost Selling, general and administrative expenses $ 184 $ 184 Financing lease cost Cost of sales $ 1,279 $ 900 Financing lease cost Selling, general and administrative expenses $ 55 $ 38 Total lease cost $ 2,644 $ 2,456 Fixed lease cost $ 1,547 $ 2,221 Short-term lease cost $ 1,097 $ 235 Total lease cost $ 2,644 $ 2,456 Amounts reported in the Consolidated Balance Sheet as of September 30, 2023 were (in thousands, except weighted average lease term and discount rate): September 30, 2023 Operating Leases: Operating lease right of use assets $ 15,928 Operating lease liabilities (1) $ 15,928 Weighted-average remaining lease term (in years) Operating leases 4.52 Weighted-average discount rate Operating leases 4.2 % Financing Leases (2) : Financing lease right of use assets $ 5,952 Financing lease liabilities $ 4,511 Weighted-average remaining lease term (in years) Financing leases 1.64 Weighted-average discount rate Financing leases 10.6 % (1) The current portion of the total operating lease liabilities of $ 5.0 million is classified under Other Current Liabilities , resulting in $ 10.9 million classified under Operating Lease Liabilities in the Long-term Liabilities section of the condensed consolidated balance sheet. (2) The total finance lease right of use assets of $ 6.0 million is classified under Other Long-term Assets . The current portion of the total finance lease liabilities of $ 3.3 million is classified under Current portion of debt, net , resulting in $ 1.2 million classified in Other Long-term Liabilities section of the condensed consolidated balance sheet. 18 Other information related to leases was as follows (in thousands): Three Months Ended September 30, 2023 October 1, 2022 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 1,528 $ 1,847 Financing cash flows used in financing leases $ 1,326 $ 1,022 Future lease payments under non-cancellable leases as of September 30, 2023 are as follows (in thousands): Fiscal Years Ending Operating Leases Finance Leases 2024 (1) $ 3,895 $ 2,552 2025 $ 4,186 $ 1,909 2026 $ 3,472 $ 501 2027 $ 2,536 $ — 2028 $ 1,551 $ — Thereafter $ 1,689 $ — Total undiscounted lease payments $ 17,329 $ 4,962 Less: present value discount $ ( 1,401 ) $ ( 451 ) Total lease liabilities $ 15,928 $ 4,511 (1) Represents estimated lease payments for the remaining nine-month period ending June 29, 2024.