14) Legal Proceedings
Lufthansa
One of the Company’s subsidiaries is involved in numerous patent infringement actions brought by Lufthansa Technik AG (“Lufthansa”) in Germany, UK and France. The Company is vigorously defending all such litigation and proceedings. Additional information about these legal proceedings can be found in Note 19 “Legal Proceedings” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. As previously disclosed, under English law, Lufthansa has the option of pursuing a claim in the UK matter in relation to the defendants’ profits from their infringing activities or pursuing a claim in relation to Lufthansa’s own lost profits. In September 2022, Lufthansa elected to claim damages based on defendants’ profits. The reserve for the German indirect claim and UK damages and interest was approximately $24.6 million at December 31, 2021 and $24.1 million at October 1, 2022, which included an additional $0.1 million and $0.5 million in interest accrued during the three and nine months ended October 1, 2022. The Company currently believes it is unlikely that the appeals process will be completed or the damages and related interest will be paid within the next twelve months. Therefore, the liability related to these matters is classified within Other Liabilities (non-current) in the Consolidated Condensed Balance Sheets at October 1, 2022 and December 31, 2021. There were no other significant developments in any of these matters during the three and nine months ended October 1, 2022.
At December 31, 2021, we had recorded a liability of $1.0 million for reimbursement of Lufthansa’s legal expenses associated with the UK matter. During the nine months ended October 1, 2022, $0.3 million was paid. The remaining liability of $0.7 million is expected to be paid within the next twelve months and, as such, is classified in Accrued Expenses and Other Current Liabilities in the accompanying Consolidated Condensed Balance Sheet as of October 1, 2022.
Other
On March 23, 2020, Teradyne, Inc. filed a complaint against the Company and its subsidiary, Astronics Test Systems (“ATS”) (together, “the Defendants”) in the United States District Court for the Central District of California alleging patent and copyright infringement, and certain other related claims. The Defendants moved to dismiss certain claims from the case. On November 6, 2020, the Court dismissed the Company from the case, and also dismissed a number of claims, though the patent and copyright infringement claims remain. The case proceeded to discovery. In addition, on December 21, 2020, ATS filed a petition for inter partes review (“IPR”) with the US Patent Trial and Appeal Board (“PTAB”), seeking to invalidate the subject patent, and on July 21, 2021, the PTAB instituted IPR. ATS requested and, on August 26, 2021, the District Court granted, a stay of litigation during the IPR proceeding. Oral arguments on the IPR were held on April 21, 2022. The PTAB issued its decision on July 20, 2022, in which it invalidated all of Teradyne’s patent claims. The stay of litigation was lifted with respect to the remaining claims in August 2022 and discovery has resumed. No amounts have been accrued for this matter in the October 1, 2022 or December 31, 2021 financial statements, as loss exposure was neither probable nor estimable at such times.
In 2019, a former customer filed a lawsuit alleging damages associated with defective product. Mediation of the matter was held in November 2022. The Company agreed to make a payment of $2.0 million to settle the matter, and such amount has been reflected in the Selling, General and Administrative line in the three and nine month periods ended October 1, 2022. The Company expects to be indemnified by other parties for approximately $1.5 million and will record the gain as an offset to Selling, General and Administrative expense when received, likely in the fourth quarter of 2022.
Other than these proceedings, we are not party to any significant pending legal proceedings that management believes will result in a material adverse effect on our financial condition or results of operations.
15) Segment Information
Below are the sales and operating loss by segment for the three and nine months ended October 1, 2022 and October 2, 2021 and a reconciliation of segment operating loss to loss before income taxes. Operating loss is net sales less cost of products sold and other operating expenses excluding interest and corporate expenses. Cost of products sold and other operating expenses are directly identifiable to the respective segment.
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | Three Months Ended |
(In thousands) | October 1, 2022 | | October 2, 2021 | | October 1, 2022 | | October 2, 2021 |
Sales: | | | | | | | |
Aerospace | $ | 322,871 | | | $ | 266,425 | | | $ | 112,177 | | | $ | 95,775 | |
Less Inter-segment Sales | (10) | | | (23) | | | — | | | (9) | |
Total Aerospace Sales | 322,861 | | | 266,402 | | | 112,177 | | | 95,766 | |
Test Systems | 53,899 | | | 62,811 | | | 19,261 | | | 16,128 | |
Less Inter-segment Sales | (19) | | | (357) | | | — | | | (53) | |
Total Test Systems Sales | 53,880 | | | 62,454 | | | 19,261 | | | 16,075 | |
Total Consolidated Sales | $ | 376,741 | | | $ | 328,856 | | | $ | 131,438 | | | $ | 111,841 | |
Segment Measure of Operating Loss and Margins | | | | | | | |
Aerospace | $ | (7,085) | | | $ | (6,352) | | | $ | (6,859) | | | $ | 1,917 | |
| (2.2) | % | | (2.4) | % | | (6.1) | % | | 2.0 | % |
Test Systems | (4,125) | | | (1,958) | | | (2,312) | | | (2,201) | |
| (7.7) | % | | (3.1) | % | | (12.0) | % | | (13.7) | % |
Total Segment Measure of Operating Loss | (11,210) | | | (8,310) | | | (9,171) | | | (284) | |
| (3.0) | % | | (2.5) | % | | (7.0) | % | | (0.3) | % |
Deductions from Segment Measure of Operating Loss | | | | | | | |
Net Gain on Sale of Business | (11,284) | | | — | | | — | | | — | |
Interest Expense, Net of Interest Income | 5,812 | | | 5,252 | | | 2,519 | | | 1,795 | |
Corporate Expenses and Other | 16,847 | | | 13,247 | | | 5,570 | | | 4,760 | |
Loss Before Income Taxes | $ | (22,585) | | | $ | (26,809) | | | $ | (17,260) | | | $ | (6,839) | |
During the three and nine months ended October 1, 2022, the Company settled a customer accommodation dispute for $2.1 million and a litigation for $2.0 million, both recorded within Selling, General and Administrative expense and impacting Aerospace segment profitability.
Total Assets: | | | | | | | | | | | | | | |
(In thousands) | | October 1, 2022 | | December 31, 2021 |
Aerospace | | $ | 478,385 | | | $ | 458,334 | |
Test Systems | | 108,473 | | | 105,335 | |
Corporate | | 12,029 | | | 45,469 | |
Total Assets | | $ | 598,887 | | | $ | 609,138 | |
16) Fair Value
A fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. Fair value is based upon an exit price model. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and involves consideration of factors specific to the asset or liability.
The Company follows a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value.
On a Recurring Basis:
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
On October 4, 2019, the Company acquired the stock of the primary operating subsidiaries as well as certain other assets from mass transit and defense market test solution provider, Diagnosys Test Systems Limited for $7.0 million in cash, plus an earn-out estimated at a fair value of $2.5 million at the time of acquisition. The terms of the Diagnosys acquisition allow for a potential earn-out of up to an additional $13.0 million over the three years post-acquisition based on achievement of new order levels of over $72.0 million during that period. The fair value assigned to the earnout was determined using the real options method, which requires Level 3 inputs such as new order forecasts, discount rate, volatility factors, and other market variables to assess the probability of Diagnosys achieving certain order levels over the period. Based on actual and forecasted new orders, the fair value was zero as of October 1, 2022 and December 31, 2021. The fair value was reduced to zero during the second quarter of 2021, with the contingent consideration liability fair value adjustment of $2.2 million recorded within the Selling, General and Administrative line in the Consolidated Condensed Statement of Operations in the nine months ended October 2, 2021.
There were no other financial assets or liabilities carried at fair value measured on a recurring basis at October 1, 2022 or December 31, 2021.
On a Non-recurring Basis:
There were no non-recurring fair value measurements performed in the nine months ended October 1, 2022 and October 2, 2021.
Due to their short-term nature, the carrying value of cash and equivalents, accounts receivable, accounts payable, and notes payable approximate fair value. The carrying value of the Company’s variable rate long-term debt instruments also approximates fair value due to the variable rate feature of these instruments.
17) Restructuring Charges
The COVID-19 pandemic has significantly impacted the global economy, and particularly the aerospace industry, resulting in reduced expectations of the Company’s anticipated future operating results. As a result, the Company executed restructuring activities in the form of workforce reduction, primarily in the second quarter of 2020, to align capacity with expected demand. Additional restructuring activities occurred during 2021 to align the workforce to expected activities and to consolidate certain facilities.
Restructuring-related severance charges and other charges were insignificant in the three and nine months ended October 1, 2022. There were $0.5 million and $0.7 million in restructuring-related non-severance charges recorded in the three and nine months ended October 2, 2021.
The following table reconciles the beginning and ending liability for restructuring charges: | | | | | | | | |
(In thousands) | | 2022 |
Balance as of January 1 | | $ | 2,400 | |
Restructuring Charges | | 199 | |
Cash Paid | | (2,554) | |
Balance as of October 1 | | $ | 45 | |
The liability is recorded within Accrued Expenses and Other Current Liabilities and is comprised of employee termination benefits expected to be paid within the next 12 months. The cash paid in the nine months ended October 1, 2022 primarily consists of severance payments of $0.4 million and payments under non-cancelable purchase commitments for inventory which was not expected to be purchased prior to the expiration date of such agreements as a result of the restructuring plan of $2.1 million.
18) Subsequent Events
On October 21, 2022 and November 14, 2022, the Company executed amendments to its Fifth Amended and Restated Credit Agreement. For more information, see Note 7, Debt.
CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | Three Months Ended |
($ in thousands) | October 1, 2022 | | October 2, 2021 | | October 1, 2022 | | October 2, 2021 |
Sales | $ | 376,741 | | | $ | 328,856 | | | $ | 131,438 | | | $ | 111,841 | |
Gross Profit (sales less cost of products sold) | $ | 50,030 | | | $ | 46,899 | | | $ | 14,388 | | | $ | 17,231 | |
Gross Margin | 13.3 | % | | 14.3 | % | | 10.9 | % | | 15.4 | % |
| | | | | | | |
Selling, General and Administrative Expenses | $ | 76,907 | | | $ | 66,829 | | | $ | 28,702 | | | $ | 21,729 | |
SG&A Expenses as a Percentage of Sales | 20.4 | % | | 20.3 | % | | 21.8 | % | | 19.4 | % |
| | | | | | | |
Net Gain on Sale of Business | $ | (11,284) | | | $ | — | | | $ | — | | | $ | — | |
Interest Expense, Net of Interest Income | $ | 5,812 | | | $ | 5,252 | | | $ | 2,519 | | | $ | 1,795 | |
Effective Tax Rate | (28.3) | % | | (1.4) | % | | 13.9 | % | | (4.9) | % |
Net Loss | $ | (28,968) | | | $ | (27,182) | | | $ | (14,857) | | | $ | (7,174) | |
A discussion by segment can be found at “Segment Results of Operations and Outlook” in this MD&A.
CONSOLIDATED THIRD QUARTER RESULTS
Consolidated sales were up $19.6 million from the third quarter of 2021. Aerospace sales were up $16.4 million, or 17.1%, and Test Systems sales increased $3.2 million.
Consolidated cost of products sold in the third quarter of 2022 was $117.1 million, compared with $94.6 million in the prior-year period. The increase was primarily due to higher volume combined with material and labor inflation, addressing supply chain constraints to meet customer requirements and the lag in price increases implemented where possible to offset higher costs and product mix. The prior-year period benefited by a $1.1 million offset to cost of products sold from the AMJP Program grant.
Selling, general and administrative (“SG&A”) expenses were $28.7 million in the third quarter of 2022 compared with $21.7 million in the prior-year period primarily due to increased wages and benefits. Third quarter 2022 reflects $4.6 million related to the settlement of a litigation claim, a customer accommodation dispute, and a lease termination settlement. The Company expects to be indemnified by other parties with respect to the litigation matter for approximately $1.5 million and will record the gain as an offset to SG&A when received, likely in the fourth quarter of 2022.
Tax benefit in the quarter was $2.4 million primarily due to changes in the year-to-date and forecasted loss before income taxes.
Consolidated net loss was $14.9 million, or $(0.46) per diluted share, compared with net loss of $7.2 million, or $(0.23) per diluted share, in the prior year.
Bookings were $184.2 million, for a book-to-bill ratio of 1.40:1. Backlog at the end of the quarter was $547.1 million. Approximately $426.5 million, or 78%, of backlog is expected to be recognized as revenue over the next twelve months and the balance thereafter.
CONSOLIDATED YEAR-TO-DATE RESULTS
Consolidated sales were up $47.9 million. Aerospace sales were up $56.5 million from the first nine months of 2021. Test Systems sales decreased $8.6 million.
Consolidated cost of products sold in 2022 was $326.7 million, compared with $282.0 million in the prior-year period. The increase was primarily due to higher volume as the global aerospace industry continues its recovery from the COVID-19 pandemic. The current year period benefited from $6.0 million recognized as an offset to cost of products sold related to the AMJP award, compared to a benefit from the grant of $1.1 million in the prior year. Research and development expenses increased $4.9 million due to higher innovation spend.
SG&A expenses were $76.9 million in 2022 compared with $66.8 million the prior-year period primarily due to increased wages and benefits. The current-year period reflects $4.6 million related to the settlement of a litigation claim, a customer accommodation dispute, and a lease termination settlement. The Company expects to be indemnified by other parties for approximately $1.5 million related to the litigation claim and will record the gain as an offset to SG&A when received, likely in the fourth quarter of 2022. The prior-year period also benefited from a $2.2 million non-cash reduction of the fair value of a contingent consideration liability.
The effective tax rate for 2022 was (28.3)%, compared with (1.4)% in the prior year period. In the past, research and development costs were deducted as incurred. However, beginning with the 2022 tax year, these costs are required to be capitalized for tax purposes and amortized over 5 years. The 2022 tax rate was impacted by a valuation allowance applied against the associated deferred tax asset created by the new treatment, due to the Company’s cumulative losses over the last three years. This was partially offset by the removal of valuation allowances related to net operating losses, tax credit carryovers, and certain timing differences that are expected to reverse during 2022 as well as a Federal research and development credit expected for 2022.
Consolidated net loss was $29.0 million, or $(0.90) per diluted share, compared with net loss of $27.2 million, or $(0.88) per diluted share, in the prior year.
COVID-19 Impacts on Our Business
On March 11, 2020, the World Health Organization classified the COVID-19 outbreak as a pandemic. The spread of the COVID-19 pandemic disrupted businesses on a global scale, led to significant volatility in financial markets and affected the aviation and industrial industries. Substantially all of our operations and production activities have, to-date, remained operational. However, the impacts of the pandemic have placed labor and supply chain pressures on our business and we have been impacted by customer demand variability. Although we saw stable and growing backlog during the first nine months of 2022 in our aerospace business, COVID-19 related disruptions are ongoing and continue to adversely challenge our commercial transport market. While we remain bullish about the aerospace business, we believe the recovery to pre-pandemic activity, particularly in the widebody market, will take longer than originally anticipated at the outset of the pandemic. As economic activity continues to recover, we will continue to monitor the situation, assessing further possible implications on our operations, supply chain, liquidity, cash flow and customer orders.
Outlook
Increasing sales is critical to satisfying our customers’ demand, and improving financial results. Revenue has been starting to ramp and we believe it will accelerate as we move forward. As previously reported, we are expecting sales of $140 million to $150 million in the fourth quarter of 2022, an increase of 10%, or $14 million, at the midpoint over the trailing third quarter. This would result in estimated 2022 sales to be up approximately 17% from last year’s revenue of $445 million. While disappointed with the lower sales level for the year than we had previously anticipated, we remain very encouraged with the demand for our products, our position in the industry and the significant opportunities in which we are engaged.
Our initial look at 2023 suggests sales of $640 million to $680 million. This expectation is supported by cumulative bookings of $686 million over the last four quarters and our record backlog of $547 million. Our supply chain has been a challenge during the last year, but we now see clear signs of improvement and anticipate continued recovery over the course of 2023.
Consolidated backlog at October 1, 2022 was $547.1 million. Approximately 78% of the backlog is expected to be recognized as revenue in over the next twelve months and the balance thereafter.
Planned capital expenditures for 2022 are expected to be approximately $9 million to $10 million.
While core aerospace markets have strengthened as vaccination rates rise and passenger traffic accelerated, the ultimate impact of COVID-19 on our business, results of operations, financial condition and cash flows is dependent on future developments, including the duration of the pandemic, virus variants, vaccination rates and efficacy and the related length of impact on the global economy, supply chain and specifically on the markets we are active in, which are uncertain and cannot be predicted at this time.
SEGMENT RESULTS OF OPERATIONS AND OUTLOOK
Operating loss, as presented below, is sales less cost of products sold and other operating expenses, excluding interest expense, other corporate expenses and other non-operating sales and expenses. Cost of products sold and other operating expenses are directly identifiable to the respective segment. Operating loss is reconciled to loss before income taxes in Note 15 of the Notes to Consolidated Condensed Financial Statements included in this report.
AEROSPACE SEGMENT | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | Three Months Ended |
(In thousands) | October 1, 2022 | | October 2, 2021 | | October 1, 2022 | | October 2, 2021 |
Sales | $ | 322,871 | | | $ | 266,425 | | | $ | 112,177 | | | $ | 95,775 | |
Less Inter-segment Sales | (10) | | | (23) | | | — | | | (9) | |
Total Aerospace Sales | $ | 322,861 | | | $ | 266,402 | | | $ | 112,177 | | | $ | 95,766 | |
Operating (Loss) Profit | $ | (7,085) | | | $ | (6,352) | | | $ | (6,859) | | | $ | 1,917 | |
Operating Margin | (2.2) | % | | (2.4) | % | | (6.1) | % | | 2.0 | % |
| | | | | | | |
Aerospace Sales by Market | | | | | | | |
(In thousands) | | | | | | | |
Commercial Transport | $ | 211,721 | | | $ | 143,550 | | | $ | 78,389 | | | $ | 57,549 | |
Military | 41,336 | | | 54,847 | | | 12,463 | | | 17,064 | |
General Aviation | 48,748 | | | 41,131 | | | 14,751 | | | 12,109 | |
Other | 21,056 | | | 26,874 | | | 6,574 | | | 9,044 | |
| $ | 322,861 | | | $ | 266,402 | | | $ | 112,177 | | | $ | 95,766 | |
Aerospace Sales by Product Line | | | | | | | |
(In thousands) | | | | | | | |
Electrical Power & Motion | $ | 132,757 | | | $ | 102,742 | | | $ | 46,155 | | | $ | 38,650 | |
Lighting & Safety | 90,339 | | | 76,929 | | | 29,740 | | | 25,461 | |
Avionics | 67,453 | | | 47,355 | | | 24,172 | | | 14,491 | |
Systems Certification | 6,656 | | | 7,937 | | | 3,985 | | | 6,099 | |
Structures | 4,600 | | | 4,565 | | | 1,551 | | | 2,021 | |
Other | 21,056 | | | 26,874 | | | 6,574 | | | 9,044 | |
| $ | 322,861 | | | $ | 266,402 | | | $ | 112,177 | | | $ | 95,766 | |
| | | | | | | | | | | |
(In thousands) | October 1, 2022 | | December 31, 2021 |
Total Assets | $ | 478,385 | | | $ | 458,334 | |
Backlog | $ | 464,307 | | | $ | 334,659 | |
AEROSPACE THIRD QUARTER RESULTS
Aerospace segment sales increased $16.4 million, or 17.1%, to $112.2 million. Commercial aerospace sales increased 36.2%, or $20.8 million, and drove the improvement. Sales to this market were $78.4 million compared with $57.5 million in the third quarter of 2021. Improving domestic airline travel that is driving higher fleet utilization and increased narrowbody production rates drove demand for Astronics’ products.
General Aviation sales increased $2.6 million, or 21.8%, to $14.8 million due in part to higher demand in the business jet market for antenna systems and enhanced vision system products. The Company expects the strong end user demand in the business jet industry to drive higher OEM production rates in the near future, resulting in further increases in demand for its products.
Military Aircraft sales decreased $4.6 million, or 27.0%, to $12.5 million. The prior-year period benefited from incremental non-recurring engineering revenue associated with development programs and higher sales of avionics products.
Other revenue decreased $2.5 million to $6.6 million driven by decreased contract manufacturing programs.
Aerospace segment operating loss was $6.9 million compared with operating profit of $1.9 million for the same period last year. Higher operating losses were driven by inflationary impacts on input costs and inefficiencies associated with production execution due to supply chain constraints that restricted shipment volume, as well as the settlement of a litigation claim and a customer accommodation dispute that resulted in $4.1 million of expense during the quarter. We expect to be indemnified by other parties for approximately $1.5 million related to the litigation claim and will record that gain when such proceeds are received, likely in the fourth quarter. Operating profit in the prior-year period benefited from the $1.1 million AMJP benefit.
AEROSPACE YEAR-TO-DATE RESULTS
Aerospace segment sales increased $56.5 million, or 21.2%, to $322.9 million. Sales continued to be positively affected by reasons discussed above.
Aerospace segment operating loss was $7.1 million compared with operating loss of $6.4 million for the same period last year. Aerospace segment experienced increased sales and the $6.0 million AMJP benefit in the 2022 period compared to an AMJP benefit of $1.1 million in the prior year, however, the operating loss was impacted by continued increases to input costs caused by inflationary impacts and supply chain constraints. Additionally, the 2022 period included $4.1 million related to the settlement of a litigation claim and a customer accommodation dispute and a $2.5 million increase of expense associated with the reinstated 401K contribution. As previously noted, we expect to be indemnified by other parties for approximately $1.5 million related to the litigation claim and will record that gain when such proceeds are received, likely in the fourth quarter.
AEROSPACE OUTLOOK
Aerospace bookings in the third quarter of 2022 were $165.7 million, for a book-to-bill ratio of 1.48:1. The Aerospace segment’s backlog at the end of the third quarter of 2022 was $464.3 million with approximately $375.2 million expected to be recognized as revenue over the next twelve months.
TEST SYSTEMS SEGMENT | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | Three Months Ended |
(In thousands) | October 1, 2022 | | October 2, 2021 | | October 1, 2022 | | October 2, 2021 |
Sales | $ | 53,899 | | | $ | 62,811 | | | $ | 19,261 | | | $ | 16,128 | |
Less Inter-segment Sales | (19) | | | (357) | | | — | | | (53) | |
Total Test Systems Sales | $ | 53,880 | | | $ | 62,454 | | | $ | 19,261 | | | $ | 16,075 | |
Operating Loss | $ | (4,125) | | | $ | (1,958) | | | $ | (2,312) | | | $ | (2,201) | |
Operating Margin | (7.7) | % | | (3.1) | % | | (12.0) | % | | (13.7) | % |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
All Test Systems sales are to the Aerospace and Defense Market.
| | | | | | | | | | | |
(In thousands) | October 1, 2022 | | December 31, 2021 |
Total Assets | $ | 108,473 | | | $ | 105,335 | |
Backlog | $ | 82,807 | | | $ | 81,033 | |
TEST SYSTEMS THIRD QUARTER RESULTS
Test Systems segment sales were $19.3 million, up $3.2 million compared with the prior-year period driven by higher defense revenue.
Test Systems’ operating loss was $2.3 million compared with operating loss of $2.2 million in the third quarter of 2021. Continued lower volume has driven operating losses in the third quarters of 2022 and 2021. The current year included a lease termination settlement of $0.5 million.
TEST SYSTEMS YEAR-TO-DATE RESULTS
Test Systems segment sales were $53.9 million, down $8.6 million compared with the prior-year period driven by lower revenue on defense and mass transit programs.
Test Systems operating loss was $4.1 million compared with operating loss of $2.0 million in the prior-year period. An increased operating loss in 2022 was driven by lower volume. The current year included a lease termination settlement of $0.5 million.
TEST SYSTEMS OUTLOOK
Bookings for the Test Systems segment in the quarter were $18.4 million, for a book-to-bill ratio of 0.96:1 for the quarter. The Test Systems segment’s backlog at the end of the third quarter of 2022 was $82.8 million, with approximately $51.3 million expected to be recognized as revenue over the next twelve months.
Our Test business achieved a big win during the quarter when we were down-selected by the U.S. Army as the winner of a major radio test competition. A directed procurement is underway to finalize the terms of a contract, a process that is expected to be completed soon. Preliminarily, the Company expects the program could generate sales of $150 million to $200 million in the coming years.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities:
Cash used for operating activities totaled $39.1 million for the first nine months of 2022, as compared with $18.5 million cash used for operating activities during the same period in 2021. Cash flow from operating activities decreased compared with the same period of 2021 primarily related to increases in net operating assets, primarily accounts receivable and inventory, more than offsetting cash received from income tax refunds and the AMJP program. Accounts receivable has increased with a higher volume of sales while inventory balances have increased to fulfill customer demand in upcoming quarters coupled with increased lead times on certain key components required inventory to be purchased further in advance.
Investing Activities:
Cash provided by investing activities was $17.7 million for the first nine months of 2022 compared with $4.6 million in cash used for investing activities in the same period of 2021. Investing cash flows in 2022 were positively impacted by the receipt of $10.7 million and $11.3 million related to the calendar 2020 and 2021 earnouts, respectively, from the sale of the semiconductor business. The Company expects capital spending in 2022 to be in the range of $9 million and $10 million.
Financing Activities:
Cash used for financing activities totaled $4.9 million for the first nine months of 2022, as compared with $12.3 million cash provided by financing activities during the same period in 2021. Cash used for financing activities increased compared with the same period of 2021 due to net payments on our senior credit facility of $4.0 million in the first nine months of 2022, coupled with $1.0 million in costs associated with amending our credit facility.
The Company's long-term debt consists of borrowings under its Fifth Amended and Restated Credit Agreement (the “Agreement”). On March 1, 2022, the Company executed an amendment to the Agreement, which reduced the revolving credit line from $375 million to $225 million and extended the maturity date of the loans under the facility from February 16, 2023 to May 30, 2023. The definition of Adjusted EBITDA was modified to exclude income from earnout payments and asset sales. On August 9, 2022, the Company executed a further amendment to the Agreement, which reduced the revolving credit line from $225 million to $190 million until September 12, 2022 with further reductions to $180 million effective September 12, 2022 and $170 million effective October 11, 2022. The amendment extended the maturity date of the loans under the facility from May 30, 2023 to August 31, 2023. On October 21, 2022, the Company executed an additional amendment to the Agreement, under which the lenders waived enforcement of their rights against the Company arising from the Company’s failure to comply with the maximum net leverage ratio and minimum liquidity covenants, each as of September 30, 2022. The amendment increased the revolving credit line to $180 million as of October 21, 2022, with a reduction to $170 million effective November 21, 2022. Under the provisions of this amendment, the inclusion of any “going concern” language in the Company’s financial statements would constitute an event of default.
A further amendment to the Agreement was executed on November 14, 2022 (the “Amended Facility”), which extended the maturity date of the loans under the facility from August 31, 2023 to November 30, 2023. Under the Amended Facility, the revolving credit line is set at $180 million, with a reduction to $170 million effective December 21, 2022. The amendment requires the Company to maintain minimum liquidity, defined as unrestricted cash plus the unused revolving credit commitments, of $10 million as of November 30, 2022 and December 31, 2022, and $15 million at the end of any month thereafter. The Amended Facility requires the Company to comply with a minimum Adjusted EBITDA covenant on a trailing twelve month basis, set at $15 million as of December 31, 2022 and March 31, 2023, and $25 million in each quarter thereafter. The amendment eliminated the net leverage ratio covenant for the remaining term of the agreement.
At October 1, 2022, there was $159.0 million outstanding on the revolving credit facility and there remained $19.9 million available subject to the minimum liquidity covenant discussed above, net of outstanding letters of credit. The credit facility allocates up to $20 million of the $180 million revolving credit line for the issuance of letters of credit, including certain existing letters of credit. At October 1, 2022, outstanding letters of credit totaled $1.1 million. Interest is payable on the unpaid principal amount of the facility at a rate equal to the Secured Overnight Financing Rate (“SOFR”, which shall be at least 1.00%), plus 5.50%. Effective January 17, 2023, interest is payable on the unpaid principal amount of the facility at a rate equal to SOFR (which shall be at least 1.00%), plus 8.50%. The Company also pays a commitment fee to the lenders in an amount
equal to 0.40% on the undrawn portion of the Amended Facility. Each amendment executed in 2022 required payment of a consent fee of 5 to 10 basis points of the commitment for each consenting lender.
The Amended Facility restricts dividend payments and share repurchases through the maturity date of the Amended Facility. The Company’s obligations under the Amended Facility are jointly and severally guaranteed by each domestic subsidiary of the Company other than non-material subsidiaries.
The obligations are secured by a first priority lien on substantially all of the Company’s and the guarantors’ assets. In the event of voluntary or involuntary bankruptcy of the Company or any subsidiary, all unpaid principal and other amounts owing under the Amended Facility automatically become due and payable. Other events of default, such as failure to make payments as they become due and breach of financial and other covenants, change of control, judgments over a certain amount, and cross default under other agreements give the agent the option to declare all such amounts immediately due and payable.
We are currently in the process of evaluating terms and conditions for a new long-term financing arrangement, which includes an asset-based lending agreement and separate term loan agreement, and expect to complete the process in the coming weeks. The extent to which we will be able to effect such refinancing, replacement or maturity extension on terms that are favorable to us or at all is dependent on a number of uncertain factors, including then-prevailing credit and other market conditions, economic conditions, particularly in the aerospace and defense markets, disruptions or volatility caused by factors such as COVID-19, regional conflicts, inflation, and supply chain disruptions. In addition, rising interest rates could limit our ability to refinance our existing credit facility when it matures or cause us to pay higher interest rates upon refinancing. As the Company’s long-term debt approaches maturity, if the Company is unable to refinance, replace or extend the maturity on its credit facility, the Company’s liquidity, results of operations, and financial condition could be materially adversely impacted. If we are unable to obtain a new long-term financing facility before we file our 2022 Form 10-K to replace our existing debt facility, borrowings outstanding under our existing credit facility will come due within 12 months of that filing date and could result in substantial doubt about our ability to continue as a going concern in the event that we are not reasonably assured to have sufficient cash balances to repay the remaining obligations at maturity.
The Company expects its sales growth and improvement in inventory management will provide sufficient cash flows to fund operations. However, the Company may also evaluate various actions and alternatives to enhance its cash generation from operating activities, which could include manufacturing efficiency initiatives, working with vendors and suppliers to reduce lead times and expedite shipment of critical components, and working with customers to expedite receivable collections.
Our ability to maintain sufficient liquidity is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on our liquidity, our ability to obtain financing, and our operations in the future.
OFF BALANCE SHEET ARRANGEMENTS
We do not have any material off balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
BACKLOG
The Company’s backlog at October 1, 2022 was $547.1 million compared with $415.7 million at December 31, 2021 and $354.4 million at October 2, 2021.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Except as noted below, our contractual obligations and commitments have not changed materially from the disclosures in our 2021 Annual Report on Form 10-K.
Purchase obligations are comprised of the Company’s commitments for goods and services in the normal course of business and amount to approximately $151.6 million payable in the coming year at October 1, 2022 and $134.0 million at December 31, 2022.
As a result of amendments to our credit facility since December 31, 2021, future interest payments are expected to be $15.7 million through the expiration of the credit facility.
Absent any legislative changes, the Company expects to pay approximately $5 million to $6 million in income tax payments related to the 2022 tax year. These expected tax payments are the result of the requirement to capitalize and amortize certain research and development expenses for U.S. tax purposes beginning in 2022.
MARKET RISK
Interest on our revolving credit facility is payable on the unpaid principal amount of the facility at a rate equal to the SOFR (which shall be at least 1.00%), plus 5.50%. Effective January 17, 2023, interest is payable on the unpaid principal amount of the facility at a rate equal to SOFR (which shall be at least 1.00%), plus 8.50%. As SOFR is a relatively new reference rate with a limited history, there may or may not be more volatility than with other reference rates such as LIBOR, which may result in increased borrowing costs for the Company. A hypothetical increase in the SOFR of 100 basis points would impact annual income by approximately $1.6 million, before income taxes.
Although the majority of our sales, expenses and cash flows are transacted in U.S. dollars, we have exposure to changes in foreign currency exchange rates related primarily to the Euro and the Canadian dollar. The Company believes that the impact of changes in foreign currency exchange rates in 2022 have not been significant.
CRITICAL ACCOUNTING POLICIES
Refer to Note 2 of the Notes to Consolidated Condensed Financial Statements included in this report for the Company’s critical accounting policies with respect to revenue recognition. For a complete discussion of the Company’s other critical accounting policies, refer to the Company’s annual report on Form 10-K for the year ended December 31, 2021.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 1 of the Notes to Consolidated Condensed Financial Statements included in this report.
FORWARD-LOOKING STATEMENTS
Information included in this report that does not consist of historical facts, including statements accompanied by or containing words such as “may,” “will,” “should,” “believes,” “expects,” “expected,” “intends,” “plans,” “projects,” “approximate,” “estimates,” “predicts,” “potential,” “outlook,” “forecast,” “anticipates,” “presume” and “assume,” are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to several factors, risks and uncertainties, the impact or occurrence of which could cause actual results to differ materially from the expected results described in the forward-looking statements. Certain of these factors, risks and uncertainties are discussed in the sections of this report entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” New factors, risks and uncertainties may emerge from time to time that may affect the forward-looking statements made herein. Given these factors, risks and uncertainties, investors should not place undue reliance on forward-looking statements as predictive of future results. We disclaim any obligation to update the forward-looking statements made in this report.