LIGHTPATH TECHNOLOGIES, INC. You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes.
The following discussion contains forward-looking statements that involve risks
and uncertainties, such as statements of our plans, objectives, expectations and
intentions. Our actual results could differ materially from those discussed in
the forward-looking statements. Please also see the cautionary language at the
beginning of this Annual Report on Form 10-K regarding forward-looking
statements.
24
Table of Contents
The following discussions also include use of the non-GAAP term "gross margin,"
as well as other non-GAAP measures discussed in more detail under the heading
"Non-GAAP Financial Measures." Gross margin is determined by deducting the cost
of sales from operating revenue. Cost of sales includes manufacturing direct
and indirect labor, materials, services, fixed costs for rent, utilities and
depreciation, and variable overhead. Gross margin should not be considered an
alternative to operating income or net income, both of which are determined in
accordance with GAAP. We believe that gross margin, although a non-GAAP
financial measure, is useful and meaningful to investors as a basis for making
investment decisions. It provides investors with information that demonstrates
our cost structure and indicates the amount of funds available to cover our
total costs and expenses. We use gross margin in measuring the performance of
our business and have historically analyzed and reported gross margin
information publicly. Other companies may calculate gross margin in a different
manner.
Potential Impact of COVID-19
In March 2020 , the WHO declared the outbreak of COVID-19 as a pandemic based on
the rapid increase in global exposure. COVID-19 has spread throughout world,
including the U.S. , and continues to spread as additional variants emerge. As a
result of the COVID-19 pandemic, our employees at our facilities in China ,
Latvia , and the U.S. were subject to stay-at-home orders during a portion of
fiscal year 2021, which restrictions have since been lifted as of the date of
this Annual Report on Form 10-K. In addition to stay-at-home orders, many
jurisdictions also implemented social distancing and other restrictions and
measures to slow the spread of COVID-19. These restrictions significantly
impacted economic conditions in the U.S. in 2020 and continued into 2021 and
2022. Beginning in the spring of 2021, restrictions began to lift as vaccines
became more available. Despite these stay-at-home orders and other measures and
restrictions implemented in the areas in which we operate, as a critical
supplier to both the medical and defense industries, we were deemed to be an
essential business; thus, regardless of the stay-at-home orders, our workforce
was permitted to work from our facilities and our business operations have
generally continued to operate as normal. Nonetheless, despite the lifting of
these stay-at-home orders, out of concern for our workforce, our U.S. - and
Latvia -based non-manufacturing employees have continued to work remotely to some
extent. To date, we have not seen any significant direct financial impact of
COVID-19 to our business. However, the COVID-19 pandemic continues to impact
economic conditions, which could impact the short-term and long-term demand from
our customers and, therefore, has the potential to negatively impact our results
of operations, cash flows, and financial position in the future. Management is
actively monitoring this situation and any impact on our financial condition,
liquidity, and results of operations. However, given the daily evolution of the
COVID-19 pandemic and the global responses to curb its spread, we are not
presently able to estimate the effects of the COVID-19 pandemic on our future
results of operations, financials, or liquidity in fiscal year 2023 or beyond.
Effect of Certain Events Occurring at Our Chinese Subsidiaries
InApril 2021 , we terminated several employees of ourChina subsidiaries, LPOIZ and LPOI, including the General Manager, the Sales Manager, and the Engineering Manager, after determining that they had engaged in malfeasance and conduct adverse to our interests, including efforts to misappropriate certain of our proprietary technology, diverting sales to entities owned or controlled by these former employees and other suspected acts of fraud, theft and embezzlement.
In
connection with such terminations, our
We have incurred various expenses associated with our investigation into these matters prior and subsequent to the termination of the employees and the associated legal proceedings. These expenses, which included legal, consulting and other transitional management fees, totaled$718,000 during the year endedJune 30, 2021 . During the year endedJune 30, 2022 , approximately$400,000 of related expenses were incurred. Such expenses were recorded as "Selling, general and administrative" expenses in the accompanying Consolidated Statements of Comprehensive Income (Loss). We also identified a further liability in the amount of$210,000 , which could have been incurred in the future due to the actions of these employees. This amount was accrued as ofJune 30, 2021 , pending further investigation, and was included in "Other Expense, net" in the Consolidated Statement of Comprehensive Income (Loss) for the year endedJune 30, 2021 . During the third quarter of fiscal year 2022, it was determined that our Chinese subsidiary would not be responsible for this amount. As such, this accrual was reversed and is included in the accompanying Consolidated Statements of Comprehensive Income (Loss) in the line item entitled "Other income (expense), net" for the year endedJune 30, 2022 .
Knowing that employee transitions in international subsidiaries can lead to lengthy legal proceedings that can interrupt the subsidiary's ability to operate, compounded by the fact that our officers could not travel toChina to oversee the transitions because of the travel restrictions imposed by COVID-19, we chose to enter into severance agreements with certain of the employees at the time of termination. Pursuant to the severance agreements, LPOIZ and LPOI agreed to pay such employees severance of approximately$485,000 in the aggregate, to be paid over a six-month period. After the execution of the severance agreements, we discovered additional wrongdoing by the terminated employees. As a result, LPOIZ and LPOI have not yet paid the severance payments and have disputed the employees' rights to such payments. Currently, there are ongoing civil actions inChina in connection with LPOIZ's and LPOI's refusal to pay these severance amounts due to the employees' non-compliance. However, based on the likelihood that the courts inChina will determine that our subsidiaries will ultimately be obligated to pay these amounts, we have accrued for these payments as ofJune 30, 2021 , and such expenses were recorded as "Selling, general and administrative" expenses in the accompanying Consolidated Statement of Comprehensive Income (Loss) in fiscal year 2021. As ofJune 30, 2022 , approximately$430,000 remains accrued. The Chinese Labor Court has ruled in favor of the former employees, as expected. We are continuing litigation and negotiation as an option. 25 Table of Contents We have transitioned the management of LPOI and LPOIZ to a new management team without any significant detrimental effects on their ability to operate. We do not expect any material adverse impact to the business operations of LPOI or LPOIZ as a result of the transition.
We expect to incur additional legal fees and consulting expenses in future periods as we continue to pursue our legal options and remedies; however, such future fees are expected to be at lower levels than have been incurred to date.
Although we have taken steps to minimize the business impacts from the termination of the local management employees and transition to new management personnel, we experienced some short-term adverse impacts on LPOIZ's and LPOI's domestic sales inChina and results of operations in the three-month period endedJune 30, 2021 , which continued through fiscal year 2022. We have not experienced, nor do we anticipate, any material adverse impact on LPOIZ's or LPOI's production and supply of products to LightPath for LightPath's customers. Results of Operations
Operating Results for Fiscal Year Ended
Revenue. Revenue for fiscal year 2022 was approximately$35.6 million , a decrease of 8%, as compared to$38.5 million in fiscal year 2021. Revenue generated by infrared products was approximately$18.7 million in fiscal year 2022, a decrease of 11%, as compared to the prior fiscal year. The decrease in revenue is primarily driven by sales to customers in the industrial market, particularly for our BD6-based molded infrared products. Industrial applications, firefighting cameras, and other public safety applications continue to be the primary drivers of demand for infrared products, including thermal imaging assemblies. During fiscal years 2020 and 2021, we saw an increase in demand for medical and temperature sensing applications, such as fever detection. Demand for temperature sensing applications were accelerated by COVID-19, and although the demand has leveled off since the initial spike, it remains elevated. Revenue generated by PMO products was approximately$15.0 million for fiscal year 2022, a decrease of 5%, as compared to the prior fiscal year. The decrease in revenue is primarily attributed to a reduction in orders from a key customer in the telecommunications market, due to a decrease in that customer's market share. This decrease was partially offset by an increase in sales through our catalog and distribution channels, as well as increases in sales to customers in the industrial and medical industries. Revenue generated by specialty products was approximately$1.8 million in fiscal year 2022, an increase of approximately 12% as compared to fiscal year 2021. This increase is primarily due to higher NRE project revenue in fiscal year 2022. NRE revenue is project based and the timing of any such projects is wholly dependent on our customers and their project activity.
Cost of Sales and Gross Margin.
Gross margin for fiscal year 2022 was approximately$11.8 million , a decrease of 12%, as compared to approximately$13.4 million in fiscal year 2021. Total cost of sales was approximately$23.7 million for fiscal year 2022, compared to$25.0 million for fiscal year 2021, a decrease of 5%. Gross margin as a percentage of revenue was 33% for fiscal year 2022, compared to 35% for the prior fiscal year. Although the product mix is similar for PMO and infrared products for fiscal year 2022, as compared to the prior fiscal year, the gross margin as a percentage of revenue is unfavorably impacted by the 8% decrease in revenue, which resulted in under-utilized capacity in some areas. Infrared product margins also reflect increased costs associated with the completion of the coating department in our Riga Facility, which began to improve in the fourth quarter of fiscal year 2022 and is expected to continue to improve over time, as that facility works through the qualification stages for more products and begins to produce at higher volumes. In the second half of fiscal year 2022, margins were also negatively impacted by inflationary pressure in the cost of raw materials, and significantly increased energy costs, particularly inLatvia .
Selling, General and Administrative.
For fiscal year 2022, Selling, General and Administrative ("SG&A") costs were
approximately $11.2 million , a decrease of approximately $768,000 , or 6%, as
compared to the prior fiscal year. The decrease in SG&A for fiscal year 2022 is
primarily due to an approximate $800,000 decrease in expenses associated with
the previously described events that occurred at our Chinese subsidiaries,
including severance, legal and consulting fees. This decrease was partially
offset by an increase in expenses for travel and tradeshows, with fewer COVID-19
restrictions in place, as well as expenses for certain "value-added taxes"
("VAT") and related taxes owed by one of our Chinese subsidiaries from prior
years, which was identified and settled in fiscal year 2022. These increases
were offset by the absence of the following non-recurring expenses that were
incurred in fiscal year 2021: (i) approximately $400,000 of additional
compensation to our former Chief Executive Officer, as previously disclosed in
the Current Report on Form 8-K filed with the SEC on November 18, 2020 , and (ii)
approximately $150,000 of additional stock compensation recorded as certain RSUs
vested upon the retirement of two directors.
26
Table of Contents
New Product Development.
New product development costs were approximately $2.1 million in fiscal year
2022, a decrease of approximately 4%, as compared to approximately $2.2 million
in the prior fiscal year. This decrease was primarily due to lower spending on
internally-funded development projects, while customer- and government-funded
NRE projects increased in fiscal year 2022.
Other Expense.
Interest expense was approximately$229,000 for fiscal year 2022, compared to approximately$215,000 in the prior fiscal year. The increase in interest expense is due to rising interest rates, partially offset by a 14% reduction in our total debt, including finance lease obligations, and excluding operating lease liabilities, as ofJune 30, 2022 , as compared to the end of the prior fiscal year. Other income, net, was approximately$177,000 in for fiscal year 2022, compared to other expense, net, of approximately$194,000 for fiscal year 2021. Other income, net, for fiscal year 2022 includes a benefit of$210,000 , which represents the reversal of a potential liability related to the actions of the terminated employees of our subsidiaries inChina , as previously discussed. This potential liability was accrued as ofJune 30, 2021 , pending further investigation, and it was determined in the third quarter of fiscal year 2022 that our Chinese subsidiary would not be responsible for this amount. Other expense, net, for fiscal year 2021 included an expense of$210,000 associated with this accrual. Other income (expense), net also includes net foreign currency transaction gains and losses, which were minimal for fiscal years 2022 and 2021. We execute all foreign sales from ourU.S. facilities and inter-company transactions inU.S. dollars, partially mitigating the impact of foreign currency fluctuations. Assets and liabilities denominated in non-United States currencies, primarily the Chinese Yuan and Euro, are translated at rates of exchange prevailing on the balance sheet date, and revenues and expenses are translated at average rates of exchange for the year. During fiscal year 2022, we incurred net foreign currency transaction losses of approximately$3,000 , compared to$1,000 for fiscal year 2021.
Income Taxes.
During fiscal year 2022, we recorded income tax expense of approximately$863,000 , compared to approximately$934,000 in fiscal year 2021, primarily related to income taxes from our operations inChina . Income taxes for fiscal years 2022 and 2021 also included Chinese withholding tax expenses of$230,000 and$524,000 , respectively, the majority of which are associated with intercompany dividends declared by LPOIZ, payable to us as the parent company. While this repatriation transaction resulted in some additional Chinese withholding taxes, LPOIZ currently qualifies for a reduced Chinese income tax rate; therefore, the total tax on those earnings was still below the normal income tax rate. The income tax provision for fiscal year 2022 also includes a true-up of deferred tax liabilities for LPOIZ, and the income tax provision for fiscal year 2021 reflects an increase in the valuation allowance on ourU.S. deferred tax assets. Please refer to Note 8, Income Taxes, in the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K for additional information related to each of our tax jurisdictions.
Net Income (Loss).
Net loss for fiscal year 2022 was approximately$3.5 million , or$0.13 basic and diluted loss per share, compared to approximately$3.2 million , or$0.12 basic and diluted loss per share, for fiscal year 2021. The increase in net loss for fiscal year 2022, as compared to fiscal year 2021, is primarily attributable to a$785,000 increase in operating loss resulting from lower gross margin, which was partially offset by lower operating expenses. Non-operating items include a$420,000 favorable difference for the aforementioned accrual and subsequent reversal of a potential liability associated with the actions of our terminated employees of our Chinese subsidiaries. In addition, there was a favorable difference of approximately$71,000 in the provision for income taxes. Weighted-average common stock shares outstanding were 27,019,534 for both basic and diluted in fiscal year 2022, compared to 26,314,025 for both basic and diluted in fiscal year 2021. The increase in the weighted-average basic common shares was due to the issuance of shares of Class A common stock under the 2014 ESPP and underlying vested RSUs. Potential dilutive common stock equivalents were excluded from the calculation of diluted shares for fiscal years 2022 and 2021, as their effects would have been anti-dilutive due to the net loss in those periods.
Liquidity and Capital Resources
AtJune 30, 2022 , we had working capital of approximately$10.4 million and total cash and cash equivalents of approximately$5.5 million . Greater than 50% of our total cash and cash equivalents was held by our foreign subsidiaries inChina andLatvia . Cash and cash equivalents held by our foreign subsidiaries inChina andLatvia were generated in-country as a result of foreign earnings. Historically, we considered unremitted earnings held by our foreign subsidiaries to be permanently reinvested. However, during fiscal year 2020, we began declaring intercompany dividends to remit a portion of the earnings of our foreign subsidiaries to us, as theU.S. parent company. It is still our intent to reinvest a significant portion of earnings generated by our foreign subsidiaries, however we also plan to repatriate a portion of their earnings. 27 Table of Contents
InChina , before any funds can be repatriated, the retained earnings of the legal entity must equal at least 50% of the registered capital. During fiscal years 2022 and 2021, we repatriated approximately$2.8 million and$4 million , respectively, from LPOIZ. As ofJune 30, 2022 , LPOIZ had approximately$3.9 million in retained earnings available for repatriation, and LPOI did not have any earnings available for repatriation, based on earnings accumulated throughDecember 31, 2021 , the end of the most recent statutory tax year, that remained undistributed as ofJune 30, 2022 . Based on our previous intent, we had not historically provided for future Chinese withholding taxes on the related earnings. However, during fiscal year 2020 we began to accrue for these taxes on the portion of earnings that we intend to repatriate. Loans payable as ofJune 30, 2022 consisted of the term loan in the original principal amount of approximately$5.8 million (the "BankUnited Term Loan") issued in favor ofBankUnited, N.A. ("BankUnited") and an equipment loan with a third party. Details of the loans are as follows: BankUnited Loans. OnFebruary 26, 2019 , we entered into the Loan Agreement (the "Loan Agreement") with BankUnited for the BankUnited Term Loan, a revolving line of credit up to a maximum amount of$2 million (the "BankUnited Revolving Line"), and a non-revolving guidance line of credit up to a maximum amount of$10 million (the "Guidance Line" and together with the BankUnited Revolving Line and BankUnited Term Loan, the "BankUnited Loans"). OnMay 6, 2019 , we entered into that certain First Amendment to Loan Agreement, effectiveFebruary 26, 2019 , with BankUnited (the "Amendment" and, together with the Loan Agreement, the "Amended Loan Agreement"). OnSeptember 9, 2021 , we entered into a letter agreement with BankUnited (the "Letter Agreement"). The Letter Agreement: (i) reduced the fixed charge coverage ratio to 1.0 for the quarter endingSeptember 30, 2021 and to 1.1 for the quarter endedDecember 31, 2021 ; (ii) modified the calculation for both the fixed charge coverage ratio and the total leverage ratio to provide for adjustments related to expenses incurred in connection with the events at LPOI and LPOIZ, which expenses must be approved by BankUnited; (iii) terminated the Guidance Line; and (iv) required approval from BankUnited prior to our being able to draw upon the Revolving Line, subject to our compliance with the fixed charge coverage ratio for the quarters endingSeptember 30, 2021 andDecember 31, 2021 . The Letter Agreement also granted us a waiver of default arising prior to the Letter Agreement for our failure to comply with the fixed charge coverage ratio measured onJune 30, 2021 . Based on the waiver, we were no longer in default of the Amended Loan Agreement. Finally, in connection with the Letter Agreement, we paid BankUnited a fee equal to$10,000 . OnNovember 5, 2021 , we entered into a letter agreement with BankUnited (the "Second Letter Agreement"). In accordance with the Second Letter Agreement, the parties agreed to initiate discussions regarding a possible modification, forbearance, or other resolution of the Amended Loan Agreement (as defined below), which resolution would occur on or beforeDecember 31, 2021 . OnDecember 20, 2021 , we entered into the Second Amendment to the Loan Agreement datedFebruary 26, 2019 (the "Second Amendment"), which further amended the Loan Agreement with BankUnited. In accordance with the Second Amendment, the parties agreed to the following terms, among others: (i) a maturity date ofApril 15, 2023 with respect to the Term Loan (as defined in the Amended Loan Agreement); (ii) an increased monthly payment amount of$100,000 commencing onNovember 1, 2022 ; (iii) beginning onDecember 20, 2021 , each facility will bear interest at BankUnited's then-prime rate of interest minus fifty (50) basis points (4.25% as ofJune 30, 2022 ), as adjusted from time to time, (iv) the Term Loan will bear a higher interest rate commencing onAugust 1, 2022 ; (v) an exit fee equal to 4% of the outstanding principal balance of the Term Loan onApril 15, 2023 (to the extent the Term Loan is still outstanding on such date and has not been refinanced with another lender); and (vi) a fee of$50,000 payable upon execution of the Second Amendment. The Second Amendment also granted us a waiver of compliance for the Financial Covenants (as set forth in the Amended Loan Agreement) for the periods endedDecember 31, 2021 ,March 31, 2022 and June
30, 2022.
OnMay 11, 2022 , we entered into the Third Amendment to the Loan Agreement datedFebruary 26, 2019 (the "Third Amendment"; and, together with the First Amendment, the Letter Agreement and the Second Letter Agreement, the "Amended Loan Agreement"), which further amended the Loan Agreement with BankUnited. In accordance with the Third Amendment, the parties agreed to the following terms, among others: (i) an amended maturity date ofApril 15, 2024 with respect to the Term Loan (as defined in the Amended Loan Agreement); and (ii) an amended exit fee equal to (a) 2% of the outstanding principal balance of the Term Loan onSeptember 30, 2022 , (b) 1% of the outstanding principal balance onDecember 31, 2022 , (c) 1% of the outstanding principal balance onMarch 31, 2023 , and (d) 4% of the outstanding principal balance onApril 15, 2024 (to the extent the Term Loan is still outstanding on the respective dates and has not been refinanced with another lender). We have commenced discussions with other lenders, with the intent of refinancing our credit facility prior to maturity with reasonable commercial terms, of which there can be no assurance. If we are unable to refinance the credit facility with other commercial lenders prior to maturity, we may need to raise additional equity financing, source financing through non-commercial lenders or further reduce certain operating expenses and capital expenditures in order to repay our credit facility and all charges related thereto upon its maturity onApril 15, 2024 . For additional information on liquidity, see Note 13, Loans Payable, to the Notes to the Consolidated Financial Statements to this Annual Report on
Form
10-K.
28
Table of Contents
Our obligations under the Amended Loan Agreement are collateralized by a first
priority security interest (subject to permitted liens) in all of our assets and
the assets of our U.S. subsidiaries, GelTech, Inc. ("GelTech") and ISP, pursuant
to a Security Agreement granted by GelTech, ISP, and us in favor of BankUnited.
Our equity interests in, and the assets of, our foreign subsidiaries are
excluded from the security interest.
BankUnited Revolving Line
Pursuant to the Amended Loan Agreement, BankUnited agreed to make loan advances
under the BankUnited Revolving Line to us up to a maximum aggregate principal
amount outstanding not to exceed $2,000,000 , which proceeds could have been used
for working capital and general corporate purposes. The BankUnited Revolving
Line expired on February 26, 2022 . No amounts were outstanding under the
BankUnited Revolving Line on June 30, 2021 or on February 26, 2022 .
BankUnited Term Loan
Pursuant to the Amended Loan Agreement, BankUnited advanced us $5,813,500 to
satisfy in full the amounts owed to Avidbank, including the outstanding
principal amount and all accrued interest under the acquisition term loan and to
pay the fees and expenses incurred in connection with closing of the BankUnited
Loans. The Term Loan was for a 5-year term, but co-terminus with the BankUnited
Revolving Line should the BankUnited Revolving Line not be renewed beyond
February 26, 2022 . Pursuant to the Second Amendment, the maturity date of the
Term Loan was April 15, 2023 , and pursuant to the Third Amendment, the maturity
date of the Term Loan is April 15, 2024 . The Term Loan initially bore interest
at a per annum rate equal to 2.75% above the 30-day LIBOR. However, pursuant to
the Second Amendment, beginning on December 20, 2021 , each facility bears
interest at BankUnited's then-prime rate of interest minus fifty (50) basis
points (4.25% as of June 30, 2022 ), as adjusted from time to time. Equal monthly
principal payments of approximately $48,446 , plus accrued interest, are due and
payable, in arrears, on the first day of each month during the term. Pursuant to
the Second Amendment, the monthly payment, including principal and interest,
will increase to $100,000 , commencing November 1, 2022 . Upon maturity, all
principal and interest shall be immediately due and payable.
As of
Guidance Line The Amended Loan Agreement provided that BankUnited, in its sole discretion, could make loan advances to us under the Guidance Line up to a maximum aggregate principal amount outstanding not to exceed$10,000,000 , which proceeds could have been used for capital expenditures and approved business acquisitions.
The
Guidance Line terminated on
General Terms
The Amended Loan Agreement contains customary covenants, including, but not limited to certain financial covenants. Generally, we must maintain a fixed charge coverage ratio of 1.25 to 1.00 and a total leverage ratio of 4.00 to 1.00. The Letter Agreement granted us a waiver of default arising prior to the Letter Agreement from our failure to comply with the fixed charge coverage ratio measured onJune 30, 2021 . The Second Amendment to the Amended Loan Agreement granted us a waiver of compliance for the Financial Covenants (as set forth in the Amended Loan Agreement) throughJune 30, 2022 . Based on the waivers, we are no longer in default of the Amended Loan Agreement. As ofJune 30, 2022 , we were in compliance with all other covenants. Equipment Loan. InDecember 2020 , ISP Latvia entered into an equipment loan with a third party (the "Equipment Loan"), which party is also a significant customer. The Equipment Loan is subordinate to the BankUnited Loans and is collateralized by certain equipment. The initial advance under the Equipment Loan was225,000 EUR (or USD$275,000 ), payable in equal installments over 60 months, the proceeds of which were used to make a prepayment to a vendor for equipment to be delivered at a future date. The Equipment Loan bears interest at a fixed rate of 3.3%. An additional225,000 EUR (or USD$267,000 ) was drawn inSeptember 2021 , which proceeds were paid to the vendor for the equipment, payable in equal installments over 52 months. As ofJune 30, 2022 , the outstanding balance on the Equipment Loan was335,000 EUR (or USD$352,000 ).
For additional information regarding the BankUnited Loans and the Equipment Loan, see Note 13, Loans Payable, to the Notes to the Consolidated Financial Statements to this Annual Report on Form 10-K.
29
Table of Contents
InFebruary 2022 , we filed a shelf registration statement to facilitate the issuance of our Class A common stock, warrants exercisable for shares of our Class A common stock, and/or units up to an aggregate offering price of$75.8 million from time to time. In connection with the filing of the shelf registration statement, we also included a prospectus supplement relating to an at-the-market equity program under which we may issue and sell shares of our Class A common stock up to an aggregate offering price of$25.2 million from time to time, decreasing the aggregate offering price available under our shelf registration statement to$50.6 million . The shelf registration statement was declared effective by theSEC onMarch 1, 2022 . We have not issued any shares of our Class A common stock pursuant to the at-the-market equity program. We believe we have adequate financial resources to sustain our current and anticipated operations in the coming year. We have established milestones that will be tracked to ensure that as funds are expended we are achieving results before additional funds are committed. We anticipate sales growth in future years, primarily from the engineered solutions we plan to focus on. We generally rely on cash from operations and equity offerings, and commercial debt, to the extent available, to satisfy our liquidity needs and to maintain our ability to meet our payment obligations, including payments due under the BankUnited Term Loan and Equipment Loan. There are a number of factors that could result in the need to raise additional funds, including a decline in revenue or a lack of anticipated sales growth, increased material costs, increased labor costs, planned production efficiency improvements not being realized, increases in property, casualty, benefit and liability insurance premiums, and increases in other costs. We will also continue efforts to keep costs under control as we seek renewed sales growth. Our efforts are directed toward generating positive cash flow and profitability. If these efforts are not successful, we may need to raise additional capital. Should capital not be available to us at reasonable terms, other actions may become necessary in addition to cost control measures and continued efforts to increase sales. These actions may include exploring strategic options for the sale of the Company, the sale of certain product lines, the creation of joint ventures or strategic alliances under which we will pursue business opportunities, the creation of licensing arrangements with respect to our technology, or other
alternatives. Cash Flows - Operating.
Cash flow provided by operations was approximately$1.5 million for fiscal year 2022, compared to approximately$4.7 million for fiscal year 2021. The decrease in cash flows from operations during fiscal year 2022 is primarily due to the increase in net loss, decrease in accounts payable and accrued liabilities, and an increase in accounts receivable, partially offset by a reduction in inventory. The decrease in accounts payable and accrued liabilities was primarily due to the previously described events that occurred at our Chinese subsidiaries, for which certain expenses were accrued as ofJune 30, 2021 , many of which were paid during fiscal year 2022, as well as payment of certain bonuses paid to our executive officers and other employees which were earned during fiscal year 2021. During fiscal year 2022 we also made the first installment payment of payroll taxes deferred in fiscal year 2020 under the CARES Act. We anticipate continued improvement in our cash flows provided by operations in future years, as we continue to focus on managing our receivables, payables and inventory, while continuing to grow our sales and improve gross margins, with moderate increases in general, administrative, sales and marketing and new
product development costs. Cash Flows - Investing.
During fiscal year 2022, we expended approximately$1.6 million for capital equipment, as compared to approximately$3.2 million during fiscal year 2021. Our capital expenditures during fiscal year 2022 were primarily related to the continued expansion of our infrared coating capacity as well as increasing our lens diamond turning capacity to meet current and forecasted demand. During fiscal year 2021, our capital expenditures were primarily related to the continued expansion of our infrared coating capacity as well as increasing our lens pressing and dicing capacity to meet demand. We anticipate a similar level of capital expenditures during fiscal year 2023; however, the total amount expended will depend on sales growth opportunities and other circumstances. Cash Flows - Financings.
Net cash used in financing activities was approximately$636,000 in fiscal year 2022, compared to$843,000 in fiscal year 2021. Cash used in financing activities for fiscal year 2022 reflects approximately$894,000 in principal payments on our loans and finance leases and$61,000 in loan costs, offset by proceeds of approximately$267,000 from the Equipment Loan and approximately$52,000 in proceeds from the sale of Class A common stock under the 2014 ESPP. Cash used in financing activities for fiscal year 2021 reflects approximately$1.3 million in principal payments on our loans and finance leases, offset by proceeds of approximately$275,000 from the Equipment Loan, and approximately$173,000 in proceeds from the exercise of stock options and from the sale of Class A common stock under the 2014 ESPP. 30 Table of Contents How We Operate We have continuing sales of two basic types: sales via ad-hoc purchase orders of mostly standard product configurations (our "turns" business) and the more challenging and potentially more rewarding business of customer product development. In this latter type of business, we work with customers to help them determine optical specifications and even create certain optical designs for them, including complex multi-component designs that we call "engineered solutions." This is followed by "sampling" small numbers of the product for the customers' test and evaluation. Thereafter, should a customer conclude that our specification or design is the best solution to their product need; we negotiate and "win" a contract (sometimes called a "design win") - whether of a "blanket purchase order" type or a supply agreement. The strategy is to create an annuity revenue stream that makes the best use of our production capacity, as compared to the turns business, which is unpredictable and uneven. This annuity revenue stream can also generate low-cost, high-volume type orders. A key business objective is to convert as much of our business to the design win
and annuity model as is possible. We face several challenges in doing so:
· Maintaining an optical design and new product sampling capability,
including a high-quality and responsive optical design engineering staff;
· The fact that as our customers take products of this nature into higher
volume, commercial production (for example, in the case of molded optics,
this may be volumes over one million pieces per year) they begin to work
seriously to reduce costs - which often leads them to turn to larger or
overseas producers, even if sacrificing quality; and
· Our small business mass means that we can only offer a moderate amount of
total productive capacity before we reach financial constraints imposed by
the need to make additional capital expenditures - in other words, because
of our limited cash resources and cash flow, we may not be able to service
every opportunity that presents itself in our markets without arranging
for such additional capital expenditures.
Despite these challenges to winning more "annuity" business, we nevertheless
believe we can be successful in procuring this business because of our unique
capabilities in optical design engineering that we make available on the
merchant market, a market that we believe is underserved in this area of service
offering. Additionally, we believe that we offer value to some customers as a
source of supply in the U.S. should they be unwilling to commit to purchase
their supply of a critical component from foreign merchant production sources.
For information regarding revenue recognition related to our various revenue
streams, refer to Critical Accounting Policies and Estimates in this Annual
Report on Form 10-K.
Our Key Performance Indicators
Usually on a weekly basis, management reviews several performance indicators. Some of these indicators are qualitative and others are quantitative. These indicators change from time to time as the opportunities and challenges in the business change. They are mostly non-financial indicators, such as units of shippable output by product line, production yield rates by major product line, and the output and yield data from significant intermediary manufacturing processes that support the production of the finished shippable product. These indicators can be used to calculate such other related indicators as fully yielded unit production per-shift, which varies by the product and our state of automation in production of that product at any given time. Higher unit production per shift means lower unit cost, and, therefore, improved margins or improved ability to compete, where desirable, for price sensitive customer applications. The data from these reports is used to determine tactical operating actions and changes. We believe that our non-financial production indicators, such as those noted, are proprietary information.
Financial indicators that are usually reviewed at the same time include the major elements of the micro-level business cycle:
· sales backlog; · revenue dollars and units by product group; · inventory levels; · accounts receivable levels and quality; and · other key indicators.
These indicators are similarly used to determine tactical operating actions and
changes and are discussed in more detail below. Management will evaluate these
key indicators as we transition to our new strategic plan to determine whether
any changes or updates to our key indicators are warranted.
31
Table of Contents
Sales Backlog.
We believe sales growth has been and continues to be our best indicator of success. Our best view into the efficacy of our sales efforts is in our "order book." Our order book equates to sales "backlog." It has a quantitative and a qualitative aspect: quantitatively, our backlog's prospective dollar value and qualitatively, what percent of the backlog is scheduled by the customer for date-certain delivery. Historically, we evaluated our backlog on a 12-month basis, which examined orders required by a customer for delivery within a one-year period. To better align with our strategic focus on longer-term customer orders and relationships, beginning in fiscal year 2021, management began evaluating our total backlog, which includes all firm orders requested by a customer that are reasonably believed to remain in the backlog and be converted into revenues. This includes customer purchase orders and may include amounts under supply contracts if they meet the aforementioned criteria. Generally, a higher total backlog is better for us.
Quarterly backlog levels for fiscal years 2022 and 2021 are as follows:
Change
From Prior
Total Backlog Change From Quarter
Quarter ($ 000 ) Prior Year End End
Q1 2021 $ 20,866 -5 % -5 %
Q2 2021 $ 23,835 9 % 14 %
Q3 2021 $ 19,498 -11 % -18 %
Q4 2021 $ 21,329 -3 % 9 %
Q1 2022 $ 19,265 -10 % -10 %
Q2 2022 $ 21,929 3 % 14 %
Q3 2022 $ 19,678 -8 % -10 %
Q4 2022 $ 17,767 -17 % -10 %
The increase in our total backlog from the first quarter to the second quarter
of both fiscal years 2022 and 2021 was largely due to the renewal of a large
annual contract during the second quarter of the respective fiscal year, which
we began shipping against during the third quarter of the respective fiscal
year. The timing of this renewal is similar to the prior fiscal year. The
decrease in our total backlog from June 30, 2021 to June 30, 2022 is primarily
due to the timing of other annual and multi-year contract renewals. These
renewals may substantially increase backlog levels at the time the orders are
received, and backlog will subsequently be drawn down as shipments are made
against these orders. Our annual and multi-year contracts are expected to renew
in future quarters. For example, in August 2022 we announced a $4 million supply
agreement for PMO, with a long time European customer of precision motion
control systems and OEM assemblies. The new supply agreement will go into effect
in the second half of our fiscal year 2023 and is expected to run for around
12-18 months.
Markets continue to experience growing demand for infrared products used in the industrial, defense and first responder sectors. Demand for infrared products continues to be fueled by interest in lenses made with our new BD6 material. With the global supply of germanium currently sourced fromRussia andChina , recent global events are generating renewed interest in BD6 as an alternative to germanium. We expect to maintain moderate growth in our visible PMO product group by continuing to diversify and offer new applications, with a cost competitive structure; however, we believe that, although necessary, the terminations of certain of our management employees in ourChina subsidiaries, LPOIZ and LPOI, and transition to new management personnel has adversely impacted the domestic sales inChina of these subsidiaries through fiscal year 2022. Our former employees, including management personnel, maintained relationships with certain of our customers inChina and we expect that until our new sales and management personnel establish relationships with these customers, of which there can be no assurance, domestic sales inChina may be adversely impacted. Although the recovery has taken longer than initially expected, we have begun to recapture some customers. Our sales and management team inChina was enhanced inOctober 2021 with two key new hires, and we are beginning to see more progress in this area. 32 Table of Contents
Revenue Dollars and Units by
The following table sets forth revenue dollars and units by our three product
groups for the three and twelve months ended
(unaudited)
Three Months Ended
June 30, Year Ended June 30, Quarter Year-to-date
2022 2021 2022 2021 % Change % ChangeRevenue PMO$ 3,411,877 $ 2,941,270 $ 15,020,542 $ 15,882,189 16 % -5 % Infrared Products 5,046,555 4,975,947 18,735,325 20,971,080 1 % -11 % Specialty Products 448,799 415,099 1,803,293 1,611,552 8 % 12 % Total revenue$ 8,907,231 $ 8,332,316 $ 35,559,160 $ 38,464,821 7 % -8 % Units PMO 398,064 323,404 1,999,200 3,139,774 23 % -36 % Infrared Products 100,715 122,127 438,508 579,563 -18 % -24 % Specialty Products 4,079 8,901 18,948 32,980 -54 % -43 % Total units 502,858 454,432 2,456,656 3,752,317 11 % -35 %
Three months ended
Our revenue increased by 7% in the fourth quarter of fiscal year 2022, as compared to the same quarter of the prior fiscal year, primarily as a result of an increase in demand for PMO products.
Revenue from the PMO product group for the fourth quarter of fiscal year 2022 was$3.4 million , an increase of 16%, as compared to the same quarter of the prior fiscal year. The increase in revenue is primarily attributed to increases in sales to customers in the industrial and telecommunications markets, partially offset by a decrease in sales through our catalog and distribution channels. The decrease in sales through our catalog and distribution channels is primarily due to the termination of our distribution agreement inEurope . European customers now order directly from our enhanced direct sales force in the region. This transition will continue through the third quarter of fiscal year 2023. Sales of PMO units increased by 23%, as compared to the prior year period, and average selling prices decreased 6%. The slight decrease in average selling prices is due to a higher mix of telecommunications products unit sales, which typically have higher volumes and lower average selling prices. Revenue generated by the infrared product group for the fourth quarter of fiscal year 2022 was$5.0 million , an increase of 1%, as compared to same quarter of the prior fiscal year. The increase in revenue is primarily driven by sales diamond-turned infrared products, while sales of BD6-based molded infrared products decreased. The increase in sales of diamond-turned infrared products was primarily driven by a new annual contract for a customer in the industrial market, for which we shipped full production volume in the fourth quarter of fiscal 2022. Demand for BD6-based infrared products has leveled off, particularly for temperature sensing applications, demand for which was previously accelerated by COVID-19. Demand for industrial applications, firefighting and other public safety applications continues to be strong. Molded infrared products are higher in volume and lower in average selling prices than diamond-turned infrared products.
Our specialty products revenue increased by 8%, as compared to the same period of the prior fiscal year, and represented 5% of total revenue for both the fourth quarters of fiscal years 2022 and 2021. The increase was primarily driven by NRE project revenue in the fourth quarter of fiscal year 2022.
Year ended
Our revenue decreased by approximately
Revenue from the PMO product group for fiscal year 2022 was$15.0 million , a decrease of 5%, as compared to fiscal year 2021. The decrease in revenue is primarily attributed to a reduction in orders from a key customer in the telecommunications market, inChina , due to a decrease in that customer's market share. This decrease was partially offset by an increase in sales through our catalog and distribution channels, as well as increases in sales to customers in the industrial and medical industries. Sales of PMO units decreased by 36%, as compared to the same period of the prior fiscal year, and average selling prices increased by 49%. The volume decrease was largely driven by a lower mix of telecommunications products, which typically have lower average selling prices. The unit volume for telecommunications products decreased by approximately 62% for fiscal year 2022, as compared to the same period of the prior fiscal year. 33 Table of Contents Revenue generated by the infrared product group for fiscal year 2022 was$18.7 million , a decrease of approximately 11%, as compared to the prior fiscal year. The decrease in revenue is primarily driven by sales to customers in the industrial market, particularly for our BD6-based molded infrared products. During fiscal year 2022, sales of infrared units decreased by 24%, as compared to the prior year period. The decrease in units is due primarily due to the mix of products shipped, as the prior year period included more molded infrared lenses which are lower in volume and higher in price than the larger diamond-turned lenses. Industrial applications, firefighting cameras, and other public safety applications continue to be the primary drivers of demand for infrared products, including thermal imaging assemblies. During fiscal years 2020 and 2021, we saw an increase in demand for medical and temperature sensing applications, such as fever detection. Demand for temperature sensing applications were accelerated by COVID-19, and although the demand has leveled off since the initial spike, it remains elevated. In fiscal year 2022, our specialty products revenue increased by$192,000 , or 12%, as compared to prior fiscal year, primarily due to higher NRE project revenue in fiscal year 2022. NRE revenue is project based and the timing of any such projects is wholly dependent on our customers and their project activity. Inventory Levels. We manage inventory levels to minimize investment in working capital but still have the flexibility to meet customer demand to a reasonable degree. We review our inventory for obsolete items quarterly. While the mix of inventory is an important factor, including adequate safety stocks of long lead-time materials, an important aggregate measure of inventory in all phases of production is the quarter's ending inventory expressed as a number of days' worth of the quarter's cost of sales, also known as "days cost of sales in inventory," or "DCSI." It is calculated by dividing the quarter's ending inventory by the quarter's cost of goods sold, multiplied by 365 and divided by 4. Generally, a lower DCSI measure equates to a lesser investment in inventory, and, therefore, more efficient use of capital. The table below shows our DCSI for the immediately preceding eight fiscal quarters: Fiscal Quarter Ended DCSI (days) Q4-2022 6/30/2022 104 Q3-2022 3/31/2022 132 Q2-2022 12/31/2021 104 Q1-2022 9/30/2021 134 Fiscal Year 2022 Average 118 Q4-2021 6/30/2021 126 Q3-2021 3/31/2021 119 Q2-2021 12/31/2020 142 Q1-2021 9/30/2020 154 Fiscal Year 2021 Average 135 Our average DCSI for fiscal year 2022 was 118, compared to 135 for fiscal year 2021. The decrease in DCSI is driven by the decrease in inventory levels, due to an increased focus on inventory management. Despite these efforts, we have experienced inventory increases at times driven by shifts in customer activity due to COVID-19, where we are sometimes given short notice to delay shipments of some products and accelerate the manufacturing and shipment of other products. As the COVID-19 impacts begin to level off, and with increasing demand for both infrared and PMO products, we expect DCSI to maintain an average of between
110 to 120.
Accounts Receivable Levels and Quality.
Similarly, we manage our accounts receivable to minimize investment in working
capital. We measure the quality of receivables by the proportions of the total
that are at various increments past due from our normally extended terms, which
are generally 30 days. The most important aggregate measure of accounts
receivable is the quarter's ending balance of net accounts receivable expressed
as a number of days' worth of the quarter's net revenues, also known as "days
sales outstanding," or "DSO." It is calculated by dividing the quarter's ending
net accounts receivable by the quarter's net revenues, multiplied by 365 and
divided by 4. Generally, a lower DSO measure equates to a lesser investment in
accounts receivable and, therefore, more efficient use of capital. The table
below shows our DSO for the preceding eight fiscal quarters:
Fiscal
Quarter Ended DSO (days)
Q4-2022 6/30/2022 54
Q3-2022 3/31/2022 55
Q2-2022 12/31/2021 49
Q1-2022 9/30/2021 59
Fiscal Year 2022 Average 54
Q4-2021 6/30/2021 51
Q3-2021 3/31/2021 53
Q2-2021 12/31/2020 63
Q1-2021 9/30/2020 60
Fiscal Year 2021 Average 57
34
Table of Contents
Our average DSO for fiscal year 2022 was 54, compared to 57 for fiscal year 2021. The improvement in fiscal year 2022 reflects our increased focus on collections, and tightening of payment terms policies. We strive to maintain a DSO of less than 60.
Other Key Indicators. Other key indicators include various operating metrics, some of which are qualitative and others are quantitative. These indicators change from time to time as the opportunities and challenges in the business change. They are mostly non-financial indicators, such as on time delivery trends, units of shippable output by major product line, production yield rates by major product line, and the output and yield data from significant intermediary manufacturing processes that support the production of the finished shippable product. These indicators can be used to calculate such other related indicators as fully-yielded unit production per-shift, which varies by the particular product and our state of automation in production of that product at any given time. Higher unit production per shift means lower unit cost, and, therefore, improved margins or improved ability to compete where desirable for price sensitive customer applications. The data from these reports is used to determine tactical operating actions and changes. Management also assesses business performance and makes business decisions regarding our operations using certain non-GAAP measures. These non-GAAP measures are described in more detail below under the heading "Non-GAAP Financial Measures". Non-GAAP Financial Measures We report our historical results in accordance with GAAP; however, our management also assesses business performance and makes business decisions regarding our operations using certain non-GAAP financial measures. We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition and results of operations computed in accordance with GAAP; however, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use.
EBITDA.
EBITDA is a non-GAAP financial measures used by management, lenders, and certain investors as a supplemental measure in the evaluation of some aspects of a corporation's financial position and core operating performance. Investors sometimes use EBITDA as it allows for some level of comparability of profitability trends between those businesses differing as to capital structure and capital intensity by removing the impacts of depreciation and amortization. EBITDA also does not include changes in major working capital items, such as receivables, inventory, and payables, which can also indicate a significant need for, or source of, cash. Since decisions regarding capital investment and financing and changes in working capital components can have a significant impact on cash flow, EBITDA is not a good indicator of a business's cash flows. We use EBITDA for evaluating the relative underlying performance of our core operations and for planning purposes. We calculate EBITDA by adjusting net income to exclude net interest expense, income tax expense or benefit, depreciation, and amortization, thus the term "Earnings Before Interest, Taxes, Depreciation and Amortization" and the acronym "EBITDA." The following table adjusts net income to EBITDA for the three and twelve months endedJune 30, 2022 and 2021: (unaudited) Quarter Ended June 30, Year Ended June 30, 2022 2021 2022 2021 Net loss$ (1,359,790 ) $ (2,913,210 ) $ (3,542,181 ) $ (3,185,251 ) Depreciation and amortization 854,123 900,964 3,617,743 3,509,436 Income tax provision 534,579 (49,671 ) 862,907 933,915 Interest expense 78,411 48,863 229,475 215,354 EBITDA$ 107,323 $ (2,013,054 ) $ 1,167,944 $ 1,473,454 % of revenue 1 % -24 % 3 % 4 % 35 Table of Contents
Our EBITDA for the quarter endedJune 30, 2022 was approximately$107,000 , compared a loss of$2.0 million for the same period of the prior fiscal year. The increase in EBITDA in the fourth quarter of fiscal year 2022 was primarily attributable to the increase in revenue and gross margin, coupled with the decreases in SG&A and Other expenses incurred related to the previously described events that occurred in our Chinese subsidiaries, as well as certain director and personnel matters that occurred during fiscal year 2021. In addition, there was a favorable difference of approximately$68,000 in foreign exchange gains and losses.
Our EBITDA for fiscal year 2022 was approximately$1.2 million , compared to approximately$1.5 million for fiscal year 2021. The decrease in EBITDA for fiscal year 2022 is primarily attributable to lower revenue and gross margin, partially offset by decreased SG&A and Other expenses, due to the decreases in expenses incurred related to the previously described events that occurred in our Chinese subsidiaries, as well as certain officer, director, and personnel matters that occurred during fiscal year 2021, as discussed above.
Off Balance Sheet Arrangements
We do not engage in any activities involving variable interest entities or off balance sheet arrangements.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted inthe United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of income and expense during the reporting periods presented. Our critical estimates include the allowance for trade receivables, which is made up of allowances for bad debts, allowances for obsolete inventory, valuation of compensation expense on stock-based awards and accounting for income taxes. Although we believe that these estimates are reasonable, actual results could differ from those estimates given a change in conditions or assumptions that have been consistently applied. We also have other policies that we consider key accounting policies, such as our policy for revenue recognition, however, the application of these policies does not require us to make significant estimates or judgments that are difficult or subjective. Management has discussed the selection of critical accounting policies and estimates with our Board, and the Board has reviewed our disclosure relating to critical accounting policies and estimates in this Annual Report on Form 10-K. The critical accounting policies used by management and the methodology for its estimates and assumptions are as follows: Allowance for accounts receivable is calculated by taking 100% of the total of invoices that are over 90 days past due from the due date and 10% of the total of invoices that are over 60 days past due from the due date forU.S. - andLatvia -based accounts and 100% on invoices that are over 120 days past due forChina -based accounts without an agreed upon payment plan. Accounts receivable are customer obligations due under normal trade terms. We perform continuing credit evaluations of our customers' financial condition. Recovery of bad debt amounts which were previously written off is recorded as a reduction of bad debt expense in the period the payment is collected. If our actual collection experience changes, revisions to our allowance may be required. After attempts to collect a receivable have failed, the receivable is written off against the allowance. To date, our actual results have been materially consistent with our estimates, and we expect such estimates to continue to be materially consistent in the future.
Inventory obsolescence allowance is calculated by reserving 100% for items that
have not been sold in two years or that have not been purchased in two years.
These items, as identified, are allowed for at 100%, as well as allowing 50% for
other items deemed to be slow moving within the last twelve months and allowing
25% for items deemed to have low material usage within the last six months.
Items of which we have greater than a two-year supply are also reserved at 25%
to 100%, depending on usage rates. The parts identified are adjusted for recent
order and quote activity to determine the final inventory allowance. To date,
our actual results have been materially consistent with our estimates, and we
expect such estimates to continue to be materially consistent in the future.
Revenue is generally recognized upon transfer of control, including the risks
and rewards of ownership, of products or services to customers in an amount that
reflects the consideration we expect to receive in exchange for those products
or services. The performance obligations for the sale of optical components and
assemblies are satisfied at a point in time. We generally bear all costs, risk
of loss, or damage and retain title to the goods up to the point of transfer of
control of products to customers. Shipping and handling costs are included in
the cost of goods sold. Revenues from product development agreements are
recognized as performance obligations are met in accordance with the terms of
the agreements and upon transfer of control of products, reports or designs to
the customer. Product development agreements are generally short term in
nature, with revenue recognized upon satisfaction of the performance obligation,
and transfer of control of the agreed-upon deliverable. Invoiced amounts for
VAT related to sales are posted to the balance sheet and are not included in
revenue.
36
Table of Contents
Stock-based compensation is measured at grant date, based on the fair value of the award, and is recognized as an expense over the employee's requisite service period. We estimate the fair value of each stock option as of the date of grant using the Black-Scholes-Merton pricing model. Our directors, officers, and key employees were granted stock-based compensation through our Amended and Restated Omnibus Incentive Plan, as amended (the "Omnibus Plan"), throughOctober 2018 and after that date, the 2018 Stock and Incentive Compensation Plan (the "SICP"). Most options granted under the Omnibus Plan and the SICP vest ratably over two to four years and generally have ten-year contract lives. The volatility rate is based on four-year historical trends in common stock closing prices and the expected term was determined based primarily on historical experience of previously outstanding options. The interest rate used is theU.S. Treasury interest rate for constant maturities. The likelihood of meeting targets for option grants that are performance based are evaluated each quarter. If it is determined that meeting the targets is probable, then the compensation expense will be amortized over the remaining vesting period.Goodwill and intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods appropriate for the type of intangible asset and reported separately from goodwill. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. Purchased intangible assets are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally two to fifteen years. We periodically reassess the useful lives of intangible assets when events or circumstances indicate that useful lives have significantly changed from the previous estimate. Definite-lived intangible assets consist primarily of customer relationships, know-how/trade secrets and trademarks. They are generally valued as the present value of estimated cash flows expected to be generated from the asset using a risk-adjusted discount rate. When determining the fair value of our intangible assets, estimates and assumptions about future expected revenue and remaining useful lives are used.Goodwill and intangible assets are tested for impairment on an annual basis and during the period between annual tests if events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. We assess the qualitative factors to determine whether it is more likely than not that the fair value of its reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the goodwill impairment analysis. If we determine that it is more likely than not that its fair value is less than its carrying amount, then the goodwill impairment test is performed. The fair value of the reporting unit is compared to its carrying amount, and if the carrying amount exceeds its fair value, then an impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, up to the total amount of goodwill allocated to that reporting unit.
Accounting for income taxes requires estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of the recognition of revenue and expense for tax and financial statement purposes. We assessed the likelihood of the realization of deferred tax assets and concluded that a valuation allowance is needed to reserve the amount of the deferred tax assets that may not be realized due to the uncertainty of the timing and amount of taxable income in certain jurisdictions. In reaching our conclusion, we evaluated certain relevant criteria, including the amount of pre-tax income generated during the current and prior two years, as adjusted for non-recurring items, the existence of deferred tax liabilities that can be used to realize deferred tax assets, the taxable income in prior carryback years in the impacted jurisdictions that can be used to absorb net operating losses and taxable income in future years. Our judgments regarding future profitability may change due to future market conditions, changes inU.S. or international tax laws and other factors. These changes, if any, may require material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made, which, in turn, may result in an increase or decrease to our tax provision in a subsequent period. In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of cost reimbursement and royalty arrangements among related entities, which could impact our income or loss in each jurisdiction in which we operate. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different than that which is reflected in our historical income tax provisions and accruals. In the event our assumptions are incorrect, the differences could have a material impact on our income tax provision and operating results in the period in which such determination is made. In addition to the factors described above, our current and expected effective tax rate is based on then-current tax law. Significant changes during the year in enacted tax law could affect these estimates. Impact of recently issued accounting pronouncements that have recently been issued but have not yet been implemented by us are described in Note 2, Summary of Significant Accounting Policies, to the Notes to the Consolidated Financial Statements to this Annual Report on Form 10-K, which describes the potential impact that these pronouncements are expected to have on our financial condition, results of operations and cash flows.
© Edgar Online, source
