MTS SYSTEMS CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in nine sections:
•Overview
•Financial Results •Cash Flow Comparison •Liquidity and Capital Resources •Off-balance Sheet Arrangements •Critical Accounting Policies •Recently Issued Accounting Pronouncements •Other Matters •Forward-looking Statements Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q. All dollar and share amounts are in thousands unless otherwise noted. OverviewMTS Systems Corporation's testing and simulation hardware, software and service solutions help customers accelerate and improve their design, development and manufacturing processes and are used to determine the mechanical behavior of materials, products and structures, or create a desired human experience such as amusement rides, vehicle simulators or flight training simulators. Our precision sensors provide measurements of vibration, pressure, position, force and sound in a variety of applications. Further globalization and expansion of many industries along with growth in emerging markets, such asChina andIndia , provide a strong and vibrant market base from which we can grow revenue. We have aligned our organizational structure to be more flexible to the demands of globalized and volatile markets by adjusting our structure to be more cost effective and nimble in responding to our customers' needs. We continue to deliver distinctive business performance through our commitment to sustain the differentiated competitive advantage that comes from offering an innovative portfolio of Test & Simulation and Sensor solutions that create value for customers and are delivered with total customer satisfaction. Definitive Merger Agreement OnDecember 8, 2020 , we entered into a definitive agreement under which Amphenol will acquire MTS for$58.50 per share in cash, or approximately$1.7 billion , including the assumption of outstanding debt and liabilities, net of cash. The acquisition is expected to close by the middle of 2021, subject to certain regulatory approvals, shareholder approval and other customary closing conditions. During the three months endedJanuary 2, 2021 , we incurred$11,577 of acquisition-related expense recognized in general and administrative expense in the Consolidated Statements of Income. Coronavirus 2019 (COVID-19) Pandemic The global spread of COVID-19 has created significant volatility, uncertainty and economic disruption. As an essential critical infrastructure business, we have continued to operate in theU.S. and other parts of the world as permitted. Our production capacity continues to recover as jurisdictions ease work restrictions throughout the world; however, restrictions on our employees' ability to access our customers and delays in customer spending are anticipated to impact our sales and operating results in fiscal year 2021. We anticipate these challenges to continue to negatively impact our fiscal year 2021 revenue and operating results. The future impact COVID-19 will have on our business, operations and financial results remains unknown at this time, and we are unable to accurately quantify the impact due to the significant global economic uncertainty. In response, we right-sized our operations and managed short-term business risk to allow for bottom-line improvement through the execution of cost savings initiatives including workforce reduction actions taken in fiscal year 2020 and continued temporary furloughs and workshare arrangements in fiscal year 2021. Additionally, we continue to evaluate our global business operations and may take future actions as deemed necessary to improve our profitability and optimize our overall cost structure. See Note 17 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for further discussion of COVID-19. Ransomware Incident InNovember 2020 , we were the victim of a ransomware incident that temporarily impacted our operations. As a result of the incident, certain of our data was encrypted, some of our data was exfiltrated from our systems, and business activities at several of our facilities were temporarily disrupted. As of the date hereof, our investigation indicates that the incident has been contained. We recovered the impacted data from the unauthorized actor, and we are not currently aware of any evidence of the 30 -------------------------------------------------------------------------------- Table of Contents impacted data being publicly released. We continue to investigate what information the unauthorized actor may have accessed or exfiltrated and resolve open items related to the incident. During the three months endedJanuary 2, 2021 , we incurred$739 of expenses, net of insurance related to this event recognized in general and administrative expense in the Consolidated Statements of Income. We expect total expenses, net of insurance, related to this event to be approximately$2.0 to$3.0 million , with the majority incurred in the first half of fiscal year 2021. The temporary operational disruption that occurred has not had a material impact on our financial results as ofJanuary 2, 2021 . Any failure or perceived failure by us to comply with applicable privacy or security laws, regulations, policies or obligations in connection with this incident, could result in government enforcement actions, regulatory investigations, litigation, fines and penalties and/or adverse publicity, which could impact expenses associated with the incident. Foreign Currency Over the past 15 years, approximately 60 to 70% of our revenue has been derived from customers outside of theU.S. Our financial results are principally exposed to changes in exchange rates between theU.S. dollar and the Euro, the Japanese yen and the Chinese yuan. A change in foreign exchange rates could positively or negatively affect our reported financial results. The discussion below quantifies the impact of foreign currency translation on our financial results for the periods discussed. Terms The terms "MTS," "we," "us," "the Company" or "our" in this Quarterly Report on Form 10-Q, unless the context otherwise requires, refer toMTS Systems Corporation and its wholly owned subsidiaries. Financial ResultsTotal Company Results of Operations The following tables compare results of operations, separately identifying the estimated impact of currency translation, the acquisition of R&D in the second quarter of fiscal year 2020, acquisition-related expenses incurred as a result of the pending merger with Amphenol and restructuring costs incurred in fiscal year 2021. Three Months Ended Estimated January 2, Business Acquisition / Currency December 28, 2021 Change Restructuring1 Translation 2019 Revenue$ 198,804 $ (33,196) $ 21,601$ 4,556 $ 205,843 Cost of sales 124,389 (24,531) 16,571 3,115 129,234 Gross profit 74,415 (8,665) 5,030 1,441 76,609 Gross margin 37.4 % 37.2 % Operating expenses Selling and marketing 28,422 (5,908) 886 725 32,719 General and administrative 34,159 (3,348) 15,604 210 21,693 Research and development 7,203 80 - 84 7,039 Total operating expenses 69,784 (9,176) 16,490 1,019 61,451 Income from operations$ 4,631 $ 511 $ (11,460)$ 422 $ 15,158 1 The Acquisition / Restructuring column includes operating results and costs incurred as a result of the acquisition of R&D, acquisition-related expenses of$11,577 incurred as a result of the pending merger with Amphenol and restructuring costs of$978 for the three months endedJanuary 2, 2021 . See Note 1, Note 15 and Note 16 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on the pending merger with Amphenol, restructuring and the R&D acquisition, respectively. 31 -------------------------------------------------------------------------------- Table of Contents Revenue Three Months Ended January 2, December 28, Increased / (Decreased) 2021 2019 $ % Revenue$ 198,804 $ 205,843 $ (7,039) (3.4) % Revenue for the three months endedJanuary 2, 2021 declined 3.4% primarily driven by a decline in Test & Simulation, partially offset by the favorable impact of currency translation. Both businesses continue to be negatively impacted by COVID-19. Test & Simulation revenue for the three months endedJanuary 2, 2021 decreased$7,507 , primarily driven by lower volume from weakness in all sectors and all regions, excluding the contributions from the acquisition of R&D, as Test & Simulation continues to be negatively impacted by COVID-19. The decline was partially offset by contributions from the acquisition of R&D of$21,601 and the favorable impact of currency translation. Sensors revenue for the three months endedJanuary 2, 2021 increased$268 primarily due to the favorable impact of currency translation, partially offset by lower volume primarily in the industrial sector. Excluding the impact of currency translation and the R&D acquisition, total Company revenue decreased 16.1%. Gross Profit Three Months Ended January 2, December 28, Increased / (Decreased) 2021 2019 $ % Gross profit$ 74,415 $ 76,609 $ (2,194) (2.9) % Gross margin 37.4 % 37.2 % 0.2 ppts Gross profit for the three months endedJanuary 2, 2021 declined 2.9% primarily driven by lower revenue volume in both Test & Simulation and Sensors, partially offset by the gross profit contribution from the R&D acquisition, lower compensation expense in both businesses and the favorable impact of currency translation. Both businesses continue to be negatively impacted by COVID-19. Gross margin increased 0.2 percentage points primarily due to lower compensation expense in both businesses, improved project execution in Test & Simulation and the Endevco acquisition inventory fair value adjustment in the prior year of$540 . This increase was partially offset by unfavorable leverage on lower revenue volumes and lower gross margin contribution from product mix in both Test & Simulation and Sensors, along with restructuring costs of$594 . Excluding the impact of currency translation, the R&D acquisition, restructuring costs and the Endevco acquisition inventory fair value adjustment in the prior year, gross profit declined 11.9% and gross margin increased 1.9 percentage points. Selling and Marketing Expense Three Months Ended January 2, December 28, Increased / (Decreased) 2021 2019 $ % Selling and marketing$ 28,422 $ 32,719 $ (4,297) (13.1) % % of revenue 14.3 % 15.9 % Selling and marketing expense for the three months endedJanuary 2, 2021 declined 13.1% primarily due to lower compensation, marketing and travel expense driven by the realization of cost savings from restructuring actions taken in fiscal year 2020, along with reduced travel stemming from COVID-19 restrictions. The decline was partially offset by the addition of R&D expenses and restructuring costs of$257 . Excluding the impact of currency translation, R&D expenses, restructuring costs and acquisition-related expenses, selling and marketing expense decreased 18.1%. 32 -------------------------------------------------------------------------------- Table of Contents General and Administrative Expense Three Months Ended January 2, December 28, Increased / (Decreased) 2021 2019 $ % General and administrative$ 34,159 $ 21,693 $ 12,466 57.5 % % of revenue 17.2 % 10.5 % General and administrative expense for the three months endedJanuary 2, 2021 increased 57.5% primarily due to higher acquisition-related expenses of$10,089 , the addition of R&D expenses and expenses related to the ransomware incident of$739 , partially offset by lower compensation expense in both businesses primarily from the realization of cost savings from Test & Simulation restructuring actions taken in fiscal year 2020. Excluding the impact of currency translation, the addition of R&D expenses, restructuring costs, acquisition-related expenses in both fiscal years and ransomware incident expenses, general and administrative expense decreased 11.7%. Research and Development Expense Three Months Ended January 2, December 28, Increased / (Decreased) 2021 2019 $ % Research and development$ 7,203 $ 7,039 $ 164 2.3 % % of revenue 3.6 % 3.4 %
Research and development expense for the three months ended
Three Months Ended
January 2 , December 28 , Increased / (Decreased)
2021 2019 $ %
Income from operations $ 4,631 $ 15,158 $ (10,527) (69.4) %
% of revenue 2.3 % 7.4 %
Income from operations for the three months ended January 2, 2021 declined
69.4%, primarily due to lower gross profit in both Test & Simulation and
Sensors, higher acquisition-related expenses of $10,111 , higher restructuring
costs of $978 and expenses related to the ransomware incident of $739 , partially
offset by lower operating compensation expense from the realization of cost
savings from Test & Simulation restructuring actions taken in fiscal year 2020.
Excluding the impact of currency translation, the R&D acquisition, restructuring
costs, the Endevco acquisition inventory fair value adjustment in the prior
year, acquisition-related expenses in both fiscal years and ransomware incident
expenses, income from operations decreased 5.9%.
Interest Expense, Net
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Interest expense, net $ 8,467 $ 8,272 $ 195 2.4 %
Interest expense, net for the three months ended January 2, 2021 increased
primarily due to accretion on the contingent consideration purchase price for
the R&D acquisition and higher interest on an increased debt level to fund the
R&D acquisition, partially offset by debt financing costs incurred in the prior
period related to the fourth amendment to the Credit Agreement.
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Other Income (Expense), Net
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Other income (expense), net $ 6,413 $ (431) $ 6,844 1,587.9 %
The increase in other income (expense), net for the three months ended
January 2, 2021 was primarily driven by the $5,794 gain on sale of our China
manufacturing facility and associated assets along with a gain on foreign
currency transactions.
Income Tax Provision (Benefit)
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Income tax provision (benefit) $ 862 $ 1,149 $ (287) (25.0) %
Effective tax rate 33.4 % 17.8 %
The effective tax rate of 33.4% for the three months ended January 2, 2021
increased primarily due to certain discrete tax expenses of $443 for stock-based
compensation activity and future limitations on the deductibility of officer
compensation. Excluding the impact of these discrete items, the effective tax
rate for the three months ended January 2, 2021 would have been 16.3%, a
decrease from the prior year primarily driven by favorable GILTI regulations
issued in July 2020 .
Net Income
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Net income $ 1,715 $ 5,306 $ (3,591) (67.7) %
Diluted earnings per share $ 0.09 $ 0.27 $ (0.18) (66.7) %
Net income and diluted earnings per share for the three months ended January 2,
2021 decreased primarily due to lower income from operations in both Test &
Simulation and Sensors, partially offset by higher other income from the gain on
sale of our China manufacturing facility.
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Segment Results
Test & Simulation Segment
Results of Operations
The following tables compare results of operations for Test & Simulation,
separately identifying the estimated impact of currency translation, the
acquisition of R&D, acquisition-related expenses incurred as a result of the
pending merger with Amphenol and restructuring costs incurred in fiscal year
2021. See Note 14 to the Consolidated Financial Statements included in Item 1 of
Part I of this Quarterly Report on Form 10-Q for additional information on our
reportable segments.
Three Months Ended
Estimated
January 2, Business Acquisition / Currency December 28,
2021 Change Restructuring1 Translation 2019
Revenue $ 113,223 $ (31,721) $ 21,601 $ 2,613 $ 120,730
Cost of sales 78,820 (23,547) 16,571 2,036 83,760
Gross profit 34,403 (8,174) 5,030 577 36,970
Gross margin 30.4 % 30.6 %
Operating expenses
Selling and marketing 15,067 (3,105) 886 407 16,879
General and administrative 19,319 (2,000) 10,150 164 11,005
Research and development 2,968 848 - 30 2,090
Total operating expenses 37,354 (4,257) 11,036 601 29,974
Income from operations $ (2,951) $ (3,917) $ (6,006) $ (24) $ 6,996
1 The Acquisition / Restructuring column includes operating results and costs
incurred as a result of the acquisition of R&D, acquisition-related expenses of
$6,123 incurred as a result of the pending merger with Amphenol and
restructuring costs of $978 for the three months ended January 2, 2021 . See Note
1, Note 15 and Note 16 to the Consolidated Financial Statements included in Item
1 of Part I of this Quarterly Report on Form 10-Q for additional information on
the pending merger with Amphenol, restructuring costs and the R&D acquisition,
respectively.
Revenue
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Revenue $ 113,223 $ 120,730 $ (7,507) (6.2) %
Revenue for the three months ended January 2, 2021 decreased 6.2%, primarily
driven by lower volume from weakness in all sectors and all regions, excluding
the contributions from the acquisition of R&D, as Test & Simulation continues to
be negatively impacted by COVID-19. The decline was partially offset by
contributions from the acquisition of R&D of $21,601 and the favorable impact of
currency translation. Excluding the impact of currency translation and the R&D
acquisition, revenue decreased 26.3%.
Gross Profit
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Gross profit $ 34,403 $ 36,970 $ (2,567) (6.9) %
Gross margin 30.4 % 30.6 % (0.2) ppts
Gross profit for the three months ended January 2, 2021 declined 6.9%, primarily
due to lower revenue volume and restructuring costs of $594 , partially offset by
contributions from the R&D acquisition and lower compensation expense from the
realization of cost savings from restructuring initiatives taken in fiscal year
2020. Gross margin declined 0.2 percentage points, primarily driven by reduced
leverage on lower revenue volume, lower gross margin contribution from product
mix and higher restructuring costs, partially offset by lower compensation
expense and improved project execution. Excluding the
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impact of currency translation, the R&D acquisition and restructuring costs,
gross profit declined 22.1% and gross margin increased 1.8 percentage points.
Selling and Marketing Expense
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Selling and marketing $ 15,067 $ 16,879 $ (1,812) (10.7) %
% of revenue 13.3 % 14.0 %
Selling and marketing expense for the three months ended January 2, 2021
declined 10.7%, primarily due to lower compensation, marketing and travel
expenses mainly driven by the realization of cost savings from restructuring
actions taken in fiscal year 2020, along with reduced travel stemming from
COVID-19 restrictions, partially offset by the addition of R&D expenses and
restructuring costs of $257 . Excluding the impact of currency translation, R&D
expenses, restructuring costs and acquisition-related expenses, selling and
marketing expense decreased 18.4%.
General and Administrative Expense
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
General and administrative $ 19,319 $ 11,005 $ 8,314 75.5 %
% of revenue 17.1 % 9.1 %
General and administrative expense for the three months ended January 2, 2021
increased 75.5% primarily driven by higher acquisition-related expenses of
$5,514 , the addition of R&D expenses and expenses related to the ransomware
incident of $391 , partially offset by lower compensation expense and the
realization of cost savings from restructuring actions taken in fiscal year 2020
in response to COVID-19. Excluding the impact of currency translation, R&D
expenses, restructuring costs, acquisition-related expenses in both fiscal years
and ransomware incident expenses, general and administrative expense decreased
15.0%.
Research and Development Expense
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Research and development $ 2,968 $ 2,090 $ 878 42.0 %
% of revenue 2.6 % 1.7 %
Research and development expense for the three months ended January 2, 2021
increased 42.0% primarily due to continued investment in Test & Simulation
technology, partially offset by the realization of cost savings from
restructuring actions taken in fiscal year 2020. Excluding the impact of
currency translation, research and development expense increased 40.6%.
Income from Operations
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Income from operations $ (2,951) $ 6,996 $ (9,947) (142.2) %
% of revenue (2.6) % 5.8 %
Income from operations for the three months ended January 2, 2021 declined
142.2%, primarily due to decreased gross profit on lower revenue volume, higher
acquisition-related expenses of $5,536 , higher restructuring costs of $978 and
expenses related to the ransomware incident of $391 , partially offset by lower
operating compensation expense from the realization of cost savings from
restructuring actions taken in fiscal year 2020 and the contributions from the
R&D acquisition. Excluding the impact of currency translation, the R&D
acquisition, restructuring costs, acquisition-related expenses in both fiscal
years and ransomware incident expenses, income from operations decreased 55.9%.
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Sensors Segment
Results of Operations
The following tables compare results of operations for Sensors, separately
identifying the estimated impact of currency translation and acquisition-related
expenses incurred as a result of the pending merger with Amphenol in fiscal year
2021. See Note 14 to the Consolidated Financial Statements included in Item 1 of
Part I of this Quarterly Report on Form 10-Q for additional information on our
reportable segments.
Three Months Ended
Estimated
January 2, Business Currency December 28,
2021 Change Acquisition1 Translation 2019
Revenue $ 85,803 $ (1,675) $ - $ 1,943 $ 85,535
Cost of sales 45,792 (1,186) - 1,079 45,899
Gross profit 40,011 (489) - 864 39,636
Gross margin 46.6 % 46.3 %
Operating expenses
Selling and marketing 13,355 (2,803) - 318 15,840
General and administrative 14,840 (1,348) 5,454 46 10,688
Research and development 4,235 (768) - 54 4,949
Total operating expenses 32,430 (4,919) 5,454 418 31,477
Income (loss) from operations $ 7,581 $ 4,430
1 The Acquisition column includes costs incurred as a result of the pending
merger with Amphenol. See Note 1 to the Consolidated Financial Statements
included in Item 1 of Part I of this Quarterly Report on Form 10-Q for
additional information.
Revenue
Three Months Ended
January 2, December 28, Increased /(Decreased)
2021 2019 $ %
Revenue $ 85,803 $ 85,535 $ 268 0.3 %
Revenue for the three months ended January 2, 2021 increased 0.3% primarily due
to the favorable impact of currency translation, partially offset by lower
volume primarily in the industrial sector. Excluding the impact of currency
translation, revenue decreased 2.0%.
Gross Profit
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Gross profit $ 40,011 $ 39,636 $ 375 0.9 %
Gross margin 46.6 % 46.3 % 0.3 ppts
Gross profit for the three months ended January 2, 2021 increased 0.9% primarily
due to the favorable impact of currency translation, lower compensation expense
and the Endevco acquisition inventory fair value adjustment in the prior year of
$540 , partially offset by lower revenue volume. Gross margin increased 0.3
percentage points primarily driven by lower compensation expense and the Endevco
acquisition inventory fair value adjustment in the prior year, partially offset
by lower gross margin contribution from product mix and the unfavorable leverage
on lower revenue volumes. Excluding the impact of currency translation and the
Endevco acquisition inventory fair value adjustment in the prior year, gross
profit declined 2.6% and gross margin declined 0.3 percentage points.
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Selling and Marketing Expense
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Selling and marketing $ 13,355 $ 15,840 $ (2,485) (15.7) %
% of revenue 15.6 % 18.5 %
Selling and marketing expense for the three months ended January 2, 2021
decreased 15.7% primarily driven by lower compensation, marketing and travel
expense driven by temporary cost savings initiatives and travel restrictions
stemming from COVID-19. Excluding the impact of currency translation, selling
and marketing expense decreased 17.7%.
General and Administrative Expense
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
General and administrative $ 14,840 $ 10,688 $ 4,152 38.8 %
% of revenue 17.3 % 12.5 %
General and administrative expense for the three months ended January 2, 2021
increased 38.8% primarily driven by higher acquisition-related expenses of
$4,575 and expenses related to the ransomware incident of $348 , partially offset
by lower compensation expense. Excluding the impact of currency translation,
acquisition-related expenses in both fiscal years and ransomware incident
expenses, general and administrative expense decreased 8.3%.
Research and Development Expense
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Research and development $ 4,235 $ 4,949 $ (714) (14.4) %
% of revenue 4.9 % 5.8 %
Research and development expense for the three months ended January 2, 2021
decreased 14.4% primarily driven by lower compensation expense from temporary
cost savings initiatives taken in response to COVID-19. Excluding the impact of
currency translation, research and development expense decreased 15.5%.
Income from Operations
Three Months Ended
January 2, December 28, Increased / (Decreased)
2021 2019 $ %
Income from operations $ 7,581 $ 8,159 $ (578) (7.1) %
% of revenue 8.8 % 9.5 %
Income from operations for the three months ended January 2, 2021 declined 7.1%
primarily due to higher acquisition-related expenses of $4,575 , expenses related
to the ransomware incident of $348 and reduced revenue volume, partially offset
by lower compensation expenses, cost savings initiatives and lower travel and
marketing expense. Excluding the impact of currency translation,
acquisition-related expenses, and ransomware incident expenses, income from
operations increased 35.1%.
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Cash Flow Comparison
The following table summarizes our cash flows from total operations:
Three Months Ended
2021 2019
Total cash provided by (used in):
Operating activities $ 19,254 $ (5,743)
Investing activities 6,146 (10,572)
Financing activities (5,915) 21,532
Effect of exchange rate changes on cash and cash equivalents 4,186 917
Increase (decrease) in cash and cash equivalents during the period
23,671 6,134
Cash and cash equivalents balance, beginning of period 88,913 57,937
Cash and cash equivalents balance, end of period $
112,584
Operating Activities The increase in cash provided by operating activities was primarily due to an increase in cash provided by working capital associated with timing fluctuations from accounts receivable payments received, accounts payable payments made, advanced payments received from customers, and inventory purchases. These increases were partially offset by lower net income and higher cash used by other assets and liabilities related to accrued project costs. Investing Activities The increase in cash provided by investing activities was primarily due to proceeds received from the sale of a building in the first quarter of fiscal year 2021, and a decrease in cash used to purchase property and equipment due to cost containment measures. Financing Activities The increase in cash used in financing activities was primarily due to payments of short-term notes payable. This increase was partially offset by a decrease in payment of cash dividends and an increase in proceeds from exercise of stock options as a result of the increased share price. Liquidity and Capital Resources We had cash and cash equivalents of$112,584 as ofJanuary 2, 2021 . Of this amount,$12,347 was located inNorth America ,$60,165 inEurope and$40,072 inAsia . Repatriation of certain foreign earnings is restricted by local law. The North American cash balance was primarily invested in bank deposits. The cash balances inEurope andAsia were primarily invested in money market funds and bank deposits. In accordance with our investment policy, we place cash equivalent investments with issuers who have high-quality investment credit ratings. In addition, we limit the amount of investment exposure we have with any particular issuer. Our investment objectives are to preserve principal, maintain liquidity and achieve the best available return consistent with our primary objectives of safety and liquidity. As ofJanuary 2, 2021 , we held no short-term investments. As a result of the transition tax related to the enactment of the Tax Act, we are able to repatriate cash held in our foreign subsidiaries without such funds being subject to additional federal income tax liability. As ofJanuary 2, 2021 , our capital structure was comprised of$37,600 in short-term debt,$548,921 in long-term debt and$232,963 in shareholders' equity. The consolidated balance sheets also included$9,436 of unamortized debt issuance costs as ofJanuary 2, 2021 . Total interest-bearing debt as ofJanuary 2, 2021 was$586,521 . As ofJanuary 2, 2021 , we had$68,576 outstanding borrowings and$27,502 outstanding letters of credit under the Revolving Credit Facility, leaving approximately$103,922 of unused borrowing capacity. We have a credit agreement with a consortium of financial institutions (the Credit Agreement) that provides for senior secured credit facilities consisting of a Revolving Credit Facility and a Term Facility. The maturity date of the Revolving Credit Facility and the loans under the Term Facility isJuly 5, 2023 , unless a term loan lender agrees to extend the maturity date pursuant to a loan modification agreement made in accordance with the terms of the Credit Agreement. The Credit Agreement also requires mandatory prepayments on our Term Facility in certain circumstances, including the potential for an annual required prepayment of a certain percentage of our excess cash flow. Under the Credit Agreement, we are subject to customary affirmative and negative covenants, including, among others, restrictions on our ability to incur debt, create liens, dispose of assets, make investments, loans, advances, guarantees and acquisitions, enter into transactions with affiliates and enter into any restrictive agreements and customary events of default 39 -------------------------------------------------------------------------------- Table of Contents (including payment defaults, covenant defaults, change of control defaults and bankruptcy defaults). The Credit Agreement also contains financial covenants, including the ratio of consolidated total indebtedness to adjusted consolidated earnings before interest, taxes, depreciation and amortization (Adjusted EBITDA), as defined in the Credit Agreement, as well as the ratio of Adjusted EBITDA to consolidated interest expense. These covenants restrict our ability to pay dividends and purchase outstanding shares of common stock. OnJuly 30, 2020 , we entered into a fifth amendment to the Credit Agreement, which governs the Term Facility and Revolving Credit Facility, to increase the maximum leverage ratio to 6.0x throughMarch 31, 2021 with step downs thereafter. In addition, we amended the interest coverage ratio to maintain 3.0x throughMarch 31, 2021 with subsequent revisions thereafter. This amendment was completed to maximize flexibility and available liquidity under our current capital structure in the event we would need to access additional funds. As ofJanuary 2, 2021 , we were in compliance with these financial covenants. Specifically, we ended the first quarter of fiscal year 2021 with a leverage ratio of 4.7x, which is below the current maximum leverage ratio of 6.0x under the Credit Agreement. In fiscal year 2019, we issued$350,000 in aggregate principal amount of 5.750% senior unsecured notes due in 2027 (the Notes). The Notes were issued pursuant to an Indenture dated as ofJuly 16, 2019 among us, the Guarantors (as defined therein) andWells Fargo Bank, National Association , as trustee (the Indenture). The Notes will mature onAugust 15, 2027 . The Indenture governing the Notes contains covenants that limit, among other things, our ability and the ability of our restricted subsidiaries to incur additional indebtedness or issue certain preferred shares; create liens; pay dividends, redeem stock or make other distributions; make investments; for our restricted subsidiaries to pay dividends to us or make other intercompany transfers; transfer or sell assets; merge or consolidate; enter into certain transactions with our affiliates; and designate subsidiaries as unrestricted subsidiaries. As ofJanuary 2, 2021 , we were in compliance with these financial covenants. See Note 9 to the Consolidated Financial Statements included in Item I of Part I of this Quarterly Report on Form 10-Q for additional information on our financing arrangements. Shareholders' equity increased by$11,780 during the three months endedJanuary 2, 2021 primarily due to$4,997 other comprehensive income,$3,791 stock options exercised,$2,648 stock-based compensation and$1,715 net income. The increase was partially offset by$1,903 common stock purchased and retired related to stock awards. As discussed, we have implemented various permanent and temporary cost reduction initiatives to manage and reduce operating costs and further enhance our financial flexibility in response to COVID-19 and as a part of our general global restructuring efforts in Test & Simulation, including the continued suspension of our quarterly dividend. While we cannot predict the overall impact of COVID-19 on our liquidity position, as ofJanuary 2, 2021 , we believe our current capital resources will be sufficient to fund working capital requirements, capital expenditures and operations for the foreseeable future, including at least the next twelve months. Off-balance Sheet Arrangements As ofJanuary 2, 2021 , we did not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. Critical Accounting Policies The Consolidated Financial Statements have been prepared in accordance with GAAP, which requires us to make estimates and assumptions in certain circumstances that, giving due consideration to materiality, affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of any contingent assets and liabilities at the date of the financial statements. We regularly review our estimates and assumptions, which are based on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For further information, see Note 1, Note 3, Note 6 and Note 18 to the Consolidated Financial Statements included in Item 8 of Part II of our Annual Report on Form 10-K for the fiscal year endedOctober 3, 2020 . For a discussion of our critical accounting policies, see Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year endedOctober 3, 2020 . Recently Issued Accounting Pronouncements Information regarding new accounting pronouncements is included in Note 2 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q. 40 -------------------------------------------------------------------------------- Table of Contents Other Matters Dividends Our dividend policy is to maintain a payout ratio that allows dividends to increase in conjunction with the long-term growth of earnings per share, while sustaining dividends through economic cycles. Our dividend practice is to target, over time, a payout ratio of approximately 25% of net earnings per share. We have historically paid dividends to holders of our common stock on a quarterly basis. The declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, debt repayment obligations, business development needs and regulatory considerations and are at the discretion of our Board of Directors. The quarterly dividend has been suspended as of the third quarter of fiscal year 2020. The reinstatement of the dividend will be considered in future periods at the discretion of the Board of Directors subject to the definitive merger agreement between Amphenol and MTS. Forward-looking Statements Statements contained in this Quarterly Report on Form 10-Q including, but not limited to, the discussion under Item 2 of Part I, that are not statements of historical fact are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, certain statements in our future filings with theSEC , in press releases and in oral and written statements made by us or with our approval that are not statements of historical fact also constitute forward-looking statements. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, Adjusted EBITDA, net income or loss, earnings or loss per share, the payment or nonpayment of dividends, our capital structure, the adequacy of our liquidity and reserves, the anticipated level of expenditures required and other statements concerning future financial performance; (ii) statements of plans and objectives by our management or Board of Directors, including those relating to products or services, restructuring initiatives, merger or acquisition activity; (iii) statements of assumptions underlying such statements; (iv) statements regarding business relationships with vendors, customers or collaborators or statements relating to our order cancellation history, our ability to convert our backlog of undelivered orders into revenue, the timing of purchases, competitive advantages and growth in end markets; (v) statements regarding our products and their characteristics, fluctuations in the costs of raw materials for products, our geographic footprint, performance, sales potential or effect in the hands of customers; (vi) statements about the impact of COVID-19 and related economic uncertainty; and (vii) statements about the proposed merger, including the expected timeline to closing and the receipt of certain approvals. Words such as "believes," "anticipates," "expects," "intends," "targeted," "should," "potential," "goals," "strategy" and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, the currently-unknown impact of COVID-19 and related economic uncertainty, the risk that the proposed merger may not be completed in a timely manner or at all, the failure to satisfy the conditions to the consummation of the proposed merger, the impact of the proposed merger on our operations, and those risks described in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year endedOctober 3, 2020 and in Item 1A of Part II of this Quarterly Report on Form 10-Q. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these forward-looking statements with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made. You should carefully review the disclosures and the risk factors described in our Annual Report on Form 10-K for the fiscal year endedOctober 3, 2020 and in other documents we file from time to time with theSEC , including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk Foreign Currency Exchange Risk Over the past 15 years, approximately 60 to 70% of our revenue has been derived from customers outside of theU.S. Our international subsidiaries have functional currencies other than ourU.S. dollar reporting currency and, occasionally, transact business in currencies other than their functional currencies. These non-functional currency transactions expose us to market risk on assets, liabilities and cash flows recognized on these transactions. The strengthening of theU.S. dollar relative to foreign currencies decreases the value of foreign currency-denominated revenue and earnings when translated intoU.S. dollars resulting in an unfavorable currency translation impact on revenue and earnings. Conversely, a weakening of theU.S. dollar increases the value of foreign currency-denominated revenue and earnings resulting in a favorable currency translation impact on revenue and earnings. 41 -------------------------------------------------------------------------------- Table of Contents A hypothetical 10% appreciation or depreciation in foreign currencies against theU.S. dollar, assuming all other variables are held constant, would result in an increase or decrease in revenue recognized of approximately$8,227 for the three months endedJanuary 2, 2021 . We have operational procedures to mitigate these non-functional currency exposures. We also utilize foreign currency exchange contracts to exchange currencies at set exchange rates on future dates to offset expected gains or losses on specifically identified exposures. Mark-to-market gains and losses on derivatives designated as cash flow hedges in our currency hedging program are recorded within accumulated other comprehensive income (loss) (AOCI) in the Consolidated Balance Sheets. Mark-to-market gains and losses are reclassified from AOCI to earnings in the same line item in the Consolidated Statements of Income and in the same period as the recognition of the underlying hedged transaction. Net gains and losses on foreign currency transactions included in the accompanying Consolidated Statements of Income were net (gains)/losses of$823 and$929 during the three months endedJanuary 2, 2021 andDecember 28, 2019 , respectively. See Note 8 to the Consolidated Financial Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q for additional information on our cash flow hedge currency exchange contracts. Interest Rates We are directly exposed to changes in market interest rates on cash, cash equivalents, short-term investments and long-term debt, and are indirectly exposed to the impact of market interest rates on overall business activity. On floating-rate investments, increases and decreases in market interest rates will increase or decrease future interest income, respectively. On floating-rate debt, increases or decreases in market interest rates will increase or decrease future interest expense, respectively. On fixed-rate investments, increases or decreases in market interest rates do not impact future interest income but may decrease or increase the fair market value of the investments, respectively. On fixed-rate debt, increases or decreases in market interest rates do not impact future interest expense but may decrease or increase the fair market value of the debt, respectively. As ofJanuary 2, 2021 , we had cash and cash equivalents of$112,584 , some of which was invested in interest-bearing bank deposits or money market funds. The interest-bearing bank deposits and money market funds have interest rates that reset every 1 to 89 days and generate interest income that will vary based on changes in short-term interest rates. A hypothetical decrease of 100 basis points in market interest rates, assuming all other variables were held constant, would decrease interest income by approximately$23 for the three months endedJanuary 2, 2021 . As ofJanuary 2, 2021 , we had floating interest rate debt of$236,521 . Secured floating rate credit facilities require interest payments to be calculated at a floating rate tied in part to LIBOR or, if LIBOR is no longer available, at a replacement rate to be determined by the administrative agent for the Credit Facility and consented to by us. As a result, changes in floating rate can affect our operating results and liquidity to the extent we do not have effective interest rate swap arrangements in place. A hypothetical increase of 100 basis points in floating interest rates, assuming all other variables were held constant, would result in an approximately$2,288 increase in future annual interest expense. Item 4. Controls and Procedures Our management, including our Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), as ofJanuary 2, 2021 . Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as ofJanuary 2, 2021 , our disclosure controls and procedures were effective. There were no changes in our internal control over financial reporting during the first quarter of fiscal year 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 42
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