Disaggregation of Revenues
We disaggregate revenue from contracts with customers based on the timing of transfer of goods or services to customers (point-in-time or over time), geographic region based primarily on the billing location of the customer, and customer industry grouping.
Total net sales based on the timing of transfer of goods or services to customers and geographic region are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, | | | |
| | | (Unaudited) | | | |
| | 2023 | | 2022 | | | | |
(In thousands) | | | | | | | | | | | | |
Net sales: | | Point-in-Time(1) | Over Time | Total | | Point-in-Time(1) | Over Time | Total | | | | |
Americas | | $ | 152,342 | | $ | 25,644 | | $ | 177,986 | | | $ | 132,988 | | $ | 26,222 | | $ | 159,210 | | | | | |
EMEA | | 94,696 | | 17,484 | | 112,180 | | | 79,241 | | 21,129 | | 100,370 | | | | | |
APAC | | 135,649 | | 11,010 | | 146,659 | | | 114,995 | | 10,681 | | 125,676 | | | | | |
Total net sales(1) | | $ | 382,687 | | $ | 54,138 | | $ | 436,825 | | | $ | 327,224 | | $ | 58,032 | | $ | 385,256 | | | | | |
(1): Net sales contains hedging gains and losses, which do not represent revenues recognized from customers. See Note 5 - Derivative instruments and hedging activities of Notes to Consolidated Financial Statements for more information on the impact of our hedging activities on our results of operations | | | | |
The industry grouping used to disaggregate net sales is determined at the customer account level. Accounts assigned to one of our three industry-specific groupings are either designated as Semiconductor and Electronics, Transportation, or Aerospace, Defense, and Government. We are able to leverage the investments in these areas to also serve a broad base of diverse customers in the other industries we serve, which are included in our Portfolio grouping. Our recent acquisitions described in Note 17 - Acquisition of Notes to Consolidated Financial Statements are presented within the "Transportation" industry grouping below. We periodically review and update the groupings of customers assigned to a particular industry grouping to ensure that our revenue disaggregation aligns with the way we currently manage our business. As part of this process, we reclassified certain customer accounts between industry groups during the first quarter of 2023. The prior period presented below has been recast to conform to the current period presentation.
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | | | |
(In thousands) | | (Unaudited) | | | | |
Industry Grouping | | 2023 | | 2022 | | | | |
Portfolio | | $ | 135,910 | | | $ | 124,703 | | | | | |
Semiconductor & Electronics | | 113,757 | | | 104,026 | | | | | |
Aerospace, Defense & Government | | 113,114 | | | 94,503 | | | | | |
Transportation | | 74,044 | | | 62,024 | | | | | |
Total net sales | | $ | 436,825 | | | $ | 385,256 | | | | | |
Information about Contract Balances
Amounts billed in advance of services being provided are accounted for as deferred revenue. Nearly all of our deferred revenue balance is related to extended hardware and software maintenance contracts. Payment terms and conditions vary by contract type, although payment is typically due within 30 to 90 days of contract inception. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing.
Changes in deferred revenue, current and non-current, during the three months ended March 31, 2023 were as follows:
| | | | | |
| Amount |
| (In thousands) |
Deferred Revenue at December 31, 2022 | $ | 200,274 | |
Deferral of revenue billed in current period, net of recognition | 56,935 | |
Recognition of revenue deferred in prior periods | (45,765) | |
| |
Foreign currency translation impact | 1,593 | |
Balance as of March 31, 2023 (unaudited) | $ | 213,037 | |
For the three months ended March 31, 2023, revenue recognized from performance obligations satisfied in prior periods (for example, due to changes in transaction price) was not material. Amounts recognized as revenue in excess of amounts billed are recorded as unbilled receivables. Unbilled receivables which are anticipated to be invoiced in the next twelve months are included in "other current assets" on the consolidated balance sheet. Based on the nature of our contracts with customers, we do not typically recognize unbilled receivables related to revenues recognized in excess of amounts billed. For the three months ended March 31, 2023 and December 31, 2022, the amounts recognized that were related to unbilled receivables were not material.
Unsatisfied Performance Obligations
Revenue expected to be recognized in any future period related to remaining performance obligations, excluding revenue pertaining to contracts that have an original expected duration of one year or less, and contracts where revenue is recognized as invoiced, was approximately $118 million as of March 31, 2023. Because we typically invoice customers at contract inception, this amount is included in our current and non-current deferred revenue balances and primarily relates to multi-year payments for hardware service and software service offerings. As of March 31, 2023, we expect to recognize approximately 35% of the revenue related to these unsatisfied performance obligations during the remainder of 2023, 38% during 2024, and 26% thereafter.
Assets Recognized from the Costs to Obtain a Contract with a Customer
We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Capitalized incremental costs related to initial contracts and renewals are amortized over the same period because the commissions paid on both the initial contract and renewals are commensurate with one another. Total capitalized costs to obtain a contract were not material during the periods presented and are included in other long-term assets on our consolidated balance sheets.
Note 3 – Investments
Equity-Method Investments
The carrying value of our equity method investments was $28 million and $29 million as of March 31, 2023 and December 31, 2022, respectively. During the three months ended March 31, 2023 and 2022, net sales to our equity-method investees were approximately $0.5 million and $1.5 million, respectively and purchases from our equity-method investees were not material.
Refer to Note 17 - Acquisitions of Notes to Consolidated Financial Statements for additional discussion on a step acquisition of one of our existing equity-method investments, SET, during the first quarter of 2023.
Note 4 – Fair value measurements
We define fair value to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, we consider the principal or most advantageous market that market participants may use when pricing the asset or liability.
We follow a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. Fair value measurement is determined based on the lowest level input that is significant to the fair value measurement. The three values of the fair value hierarchy are the following:
Level 1 – Quoted prices in active markets for identical assets or liabilities
Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly
Level 3 – Inputs that are not based on observable market data
Assets and liabilities measured at fair value on a recurring basis are summarized below:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Fair Value Measurements at Reporting Date Using |
(In thousands) | | (Unaudited) |
Description | | March 31, 2023 | | Level 1 | | Level 2 | | Level 3 |
Assets | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Derivatives (interest rate swaps) | | 1,954 | | | | | 1,954 | | | |
Derivatives (foreign exchange contracts) | | 8,449 | | | — | | | 8,449 | | | |
Total Assets | | $ | 10,403 | | | $ | — | | | $ | 10,403 | | | $ | — | |
| | | | | | | | |
Liabilities | | | | | | | | |
Derivatives (interest rate swaps) | | $ | (2,634) | | | | | $ | (2,634) | | | |
Derivatives (foreign exchange contracts) | | $ | (10,221) | | | $ | — | | | $ | (10,221) | | | $ | — | |
Total Liabilities | | $ | (12,855) | | | $ | — | | | $ | (12,855) | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
(In thousands) | | Fair Value Measurements at Reporting Date Using |
Description | | December 31, 2022 | | Level 1 | | Level 2 | | Level 3 |
Assets | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Derivatives (interest rate swaps) | | 2,299 | | | — | | | 2,299 | | | — | |
Derivatives (foreign exchange contracts) | | 10,025 | | | — | | | 10,025 | | | — | |
Total Assets | | $ | 12,324 | | | $ | — | | | $ | 12,324 | | | $ | — | |
| | | | | | | | |
Liabilities | | | | | | | | |
Derivatives (interest rate swaps) | | $ | (1,013) | | | $ | — | | | $ | (1,013) | | | $ | — | |
Derivatives (foreign exchange contracts) | | $ | (18,313) | | | $ | — | | | $ | (18,313) | | | $ | — | |
Total Liabilities | | $ | (19,326) | | | $ | — | | | $ | (19,326) | | | $ | — | |
The valuation techniques used to measure the fair value of our financial instruments having Level 2 inputs were derived from non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models, such as discounted cash flow techniques.
Derivatives include foreign currency forward and interest rate swap contracts. Our derivatives are valued using an income approach (Level 2) based on the spot rate less the contract rate multiplied by the notional amount. We consider counterparty credit risk in the valuation of our derivatives. However, counterparty credit risk did not impact the valuation of our derivatives during the three months ended March 31, 2023. There were no transfers in or out of Level 1 or Level 2 during the three months ended March 31, 2023.
Non-financial assets such as equity-method investments, goodwill, intangible assets, and property, plant and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment is recognized. The amounts related to all assets and liabilities required to be measured at fair value on a nonrecurring basis were not material at March 31, 2023 and December 31, 2022.
We did not have any items that were measured at fair value on a nonrecurring basis at March 31, 2023 and December 31, 2022. The carrying value of net accounts receivable, accounts payable, and long-term debt contained in the consolidated balance sheets approximates fair value.
Note 5 – Derivative instruments and hedging activities
We recognize all of our derivative instruments as either assets or liabilities in our statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, we designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.
We have direct operations in approximately 40 countries. Sales outside of the Americas accounted for approximately 59% of our net sales during the three months ended March 31, 2023 and 2022. Our activities expose us to a variety of market risks, including the effects of changes in foreign currency exchange rates. These financial risks are monitored and managed by us as an integral part of our overall risk management program.
The vast majority of our foreign sales are denominated in the customers’ local currency. Movements in foreign currency exchange rates pose a risk to our operations and competitive position, in that exchange rate changes may affect our profitability and cash flow, and the business or pricing strategies of our non-U.S. based competitors. We use foreign currency forward contracts as hedges of forecasted sales and expenses that are denominated in foreign currencies and as hedges of foreign currency denominated financial assets or liabilities. These contracts are entered into to help protect against the risk that the eventual dollar-net-cash inflows or outflows resulting from these transactions will be adversely affected by changes in exchange rates. We designate foreign currency forward contracts as cash flow hedges of forecasted net sales or forecasted expenses. In addition, we hedge our foreign currency denominated balance sheet exposures using foreign currency forward contracts that are not designated as hedging instruments. None of our derivative instruments contain a credit-risk-related contingent feature.
Cash flow hedges
To help minimize the financial impact of fluctuations in foreign currency exchange rates of forecasted foreign currency cash flows resulting from international sales over the next one to three years, we have instituted a foreign currency cash flow hedging program. We hedge portions of our forecasted net sales and forecasted expenses denominated in foreign currencies with forward contracts. For forward contracts, when the value of the dollar changes significantly against the foreign currencies, the change in the present value of future foreign currency cash flows may be offset by the change in the fair value of the forward contracts designated as hedges. We use foreign currency forward contracts for up to 100% of our forecasted exposures in selected currencies (primarily in Euro, Japanese yen, Hungarian forint, British pound, Malaysian ringgit, Korean won and Chinese yuan) and limit the duration of these contracts to 40 months or less.
For foreign currency derivative instruments that are designated and qualify as a cash flow hedge, the gain or loss on the derivative is reported as a component of accumulated other comprehensive income ("OCI") and reclassified into earnings in the same line item (net sales, operating expenses, or cost of sales) associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings. Cash flows from derivative instruments are classified in the statement of cash flows in the same category as the cash flows from the hedged or economically hedged item, primarily in operating activities. Hedge effectiveness of foreign currency forwards designated as cash flow hedges is measured by comparing the hedging instrument’s cumulative change in fair value from inception to maturity to the forecasted transaction’s terminal value.
We held forward contracts designated as cash flow hedges with the following notional amounts:
| | | | | | | | | | | | | | |
(In thousands) | | US Dollar Equivalent |
| | As of March 31, 2023 | | As of December 31, |
| | (Unaudited) | | 2022 |
Chinese yuan | | $ | 109,576 | | | $ | 73,419 | |
Euro | | 136,422 | | | 109,091 | |
Japanese yen | | 29,444 | | | 21,285 | |
Hungarian forint | | 13,799 | | | 19,529 | |
British pound | | 17,993 | | | 13,929 | |
Malaysian ringgit | | 5,997 | | | 8,856 | |
Korean won | | 22,076 | | | 14,048 | |
Total forward contracts notional amount | | $ | 335,307 | | | $ | 260,157 | |
The contracts in the foregoing table had contractual maturities of 21 months or less and 12 months or less at March 31, 2023 and December 31, 2022, respectively.
At March 31, 2023, we expect to reclassify $0.7 million of gains on derivative instruments from accumulated OCI to net sales during the next twelve months when the hedged international sales occur, $1.2 million of losses on derivative instruments from accumulated OCI to cost of sales during the next twelve months when the cost of sales are incurred, and $0.9 million of losses on derivative instruments from accumulated OCI to operating expenses during the next twelve months when the hedged operating expenses occur. Expected amounts are based on derivative valuations at March 31, 2023. Actual results may vary materially as a result of changes in the corresponding exchange rates subsequent to this date.
In 2022, we entered into interest rate swap agreements with an aggregate notional value of $300 million and a term of three years. The economic effect of the swap agreements is to mitigate the uncertainty of the cash flows associated with floating-rate interest payments due under our term loan and revolving credit facility (“Credit Facility") by fixing the underlying annual interest rate for a portion of our outstanding debt under the Credit Facility at 3.9%, plus a margin. We have designated these interest rate swap agreements as qualifying hedging instruments and are accounting for these as cash flow hedges pursuant to ASC 815, Derivatives and Hedging.
The fair values of these interest rate swap agreements are included in prepaid expenses and other current assets and other long-term liabilities in our consolidated balance sheets at March 31, 2023 and December 31, 2022. Changes in the fair values of these interest rate swap agreements are reported in accumulated other comprehensive loss in our consolidated balance sheets and an amount is reclassified out of accumulated other comprehensive loss into Other (expense) income in the same period that the corresponding interest expense is recognized.
We do not use any interest rate swap agreements for trading purposes.
Other Derivatives
Other derivatives not designated as hedging instruments consist primarily of foreign currency forward contracts that we use to hedge our foreign denominated monetary assets and liabilities to help protect against the change in value caused by a fluctuation in foreign currency exchange rates. We typically attempt to hedge up to 90% of our outstanding foreign denominated net receivables or net payables and typically limit the duration of these foreign currency forward contracts to approximately 90 days or less. The gain or loss on the derivatives as well as the offsetting gain or loss on the hedge item attributable to the hedged risk is recognized in current earnings under the line item “Other (expense) income.” As of March 31, 2023 and December 31, 2022, we held foreign currency forward contracts that were not designated as hedging instruments with a notional amount of $266 million and $282 million, respectively.
The following tables present the fair value of derivative instruments on our Consolidated Balance Sheets at March 31, 2023 and December 31, 2022, respectively.
| | | | | | | | | | | | | | | | | | | | |
| | Asset Derivatives |
| | | | March 31, 2023 | | December 31, 2022 |
| | | | (Unaudited) | | |
| | | | | | |
(In thousands) | | Balance Sheet Location | | Fair Value | | Fair Value |
Derivatives designated as hedging instruments | | | | | | |
Foreign exchange contracts - ST forwards | | Prepaid expenses and other current assets | | $ | 5,760 | | | $ | 8,968 | |
Interest rate contracts - ST forwards | | Prepaid expenses and other current assets | | 1,954 | | | 2,299 | |
Foreign exchange contracts - LT forwards | | Other long-term assets | | 470 | | | — | |
Total derivatives designated as hedging instruments | | | | $ | 8,184 | | | $ | 11,267 | |
| | | | | | |
Derivatives not designated as hedging instruments | | | | | | |
Foreign exchange contracts - ST forwards | | Prepaid expenses and other current assets | | $ | 2,219 | | | $ | 1,057 | |
Total derivatives not designated as hedging instruments | | | | $ | 2,219 | | | $ | 1,057 | |
| | | | | | |
Total derivatives | | | | $ | 10,403 | | | $ | 12,324 | |
| | | | | | | | | | | | | | | | | | | | |
| | Liability Derivatives |
| | | | March 31, 2023 | | December 31, 2022 |
| | | | (Unaudited) | | |
(In thousands) | | Balance Sheet Location | | Fair Value | | Fair Value |
|
Derivatives designated as hedging instruments | | | | | | |
Foreign exchange contracts - ST forwards | | Accrued expenses and other current liabilities | | $ | (7,175) | | | $ | (9,940) | |
Foreign exchange contracts - LT forwards | | Other long-term liabilities | | — | | | (196) | |
Interest rate contracts - LT forwards | | Other long-term liabilities | | (2,634) | | | (1,013) | |
Total derivatives designated as hedging instruments | | | | $ | (9,809) | | | $ | (11,149) | |
| | | | | | |
Derivatives not designated as hedging instruments | | | | | | |
Foreign exchange contracts - ST forwards | | Other current liabilities | | $ | (3,046) | | | $ | (8,177) | |
Total derivatives not designated as hedging instruments | | | | $ | (3,046) | | | $ | (8,177) | |
| | | | | | |
Total derivatives | | | | $ | (12,855) | | | $ | (19,326) | |
The following tables present the effect of derivative instruments on our Consolidated Statements of Income for the three-months ended March 31, 2023 and 2022, respectively:
| | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2023 | | | | |
(In thousands) | | | | |
(Unaudited) | | | | |
Derivatives in Cash Flow Hedging Relationship | | Gain or (Loss) Recognized in OCI on Derivative | | Location of Gain or (Loss) Reclassified from Accumulated OCI into Income | | Gain or (Loss) Reclassified from Accumulated OCI into Income | | | | |
Foreign exchange contracts - forwards | | $ | (1,729) | | | Net sales | | $ | 2,244 | | | | | |
| | | | | | | | | | |
Foreign exchange contracts - forwards | | 1,143 | | | Cost of sales | | (560) | | | | | |
| | | | | | | | | | |
Foreign exchange contracts - forwards | | 876 | | | Operating expenses | | (328) | | | | | |
| | | | | | | | | | |
Interest rate swap contracts - forwards | | (1,966) | | | Other (expense) income | | 527 | | | | | |
Total | | $ | (1,676) | | | | | $ | 1,883 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2022 | | | | |
(In thousands) | | | | |
(Unaudited) | | | | |
Derivatives in Cash Flow Hedging Relationship | | Gain or (Loss) Recognized in OCI on Derivative | | Location of Gain or (Loss) Reclassified from Accumulated OCI into Income | | Gain or (Loss) Reclassified from Accumulated OCI into Income | | | | |
Foreign exchange contracts - forwards | | $ | 1,884 | | | Net sales | | $ | 1,739 | | | | | |
| | | | | | | | | | |
Foreign exchange contracts - forwards | | (21) | | | Cost of sales | | (327) | | | | | |
| | | | | | | | | | |
Foreign exchange contracts - forwards | | 4 | | | Operating expenses | | (239) | | | | | |
Total | | $ | 1,867 | | | | | $ | 1,173 | | | | | |
| | | | | | | | | | | | | | | | | | | | |
(In thousands) | | | | | | |
Derivatives not Designated as Hedging Instruments | | Location of Gain (Loss) Recognized in Income | | Amount of Gain (Loss) Recognized in Income | | Amount of Gain (Loss) Recognized in Income |
| | | | March 31, 2023 | | March 31, 2022 |
| | | | (Unaudited) | | (Unaudited) |
Foreign exchange contracts - forwards | | Other (expense) income | | $ | (856) | | | (803) | |
Total | | | | $ | (856) | | | $ | (803) | |
Note 6 – Inventories, net
Inventories, net consist of the following:
| | | | | | | | | | | | | | |
| | March 31, 2023 | | December 31, |
(In thousands) | | (Unaudited) | | 2022 |
| | | | |
Raw materials | | $ | 280,246 | | | $ | 273,311 | |
Work-in-process | | 13,629 | | | 14,968 | |
Finished goods | | 129,606 | | | 119,302 | |
Total | | $ | 423,481 | | | $ | 407,581 | |
| | | | |
Less: Inventory reserve | | $ | (22,421) | | | $ | (19,417) | |
Total | | $ | 401,060 | | | $ | 388,164 | |
Note 7 – Intangible assets, net and goodwill
Intangible assets at March 31, 2023 and December 31, 2022 were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2023 | | |
(In thousands) | | (Unaudited) | | December 31, 2022 |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Capitalized software development costs | | $ | 14,216 | | | $ | (10,560) | | | $ | 3,656 | | | $ | 18,810 | | | $ | (15,321) | | | $ | 3,489 | |
Acquired technology | | 177,521 | | | (60,929) | | | 116,592 | | | 167,686 | | | (54,351) | | | 113,335 | |
Customer relationships | | 96,935 | | | (29,150) | | | 67,785 | | | 98,827 | | | (33,514) | | | 65,313 | |
Patents | | 37,395 | | | (31,756) | | | 5,639 | | | 37,240 | | | (31,368) | | | 5,872 | |
Other | | 29,516 | | | (14,981) | | | 14,535 | | | 34,078 | | | (21,237) | | | 12,841 | |
Total | | $ | 355,583 | | | $ | (147,376) | | | $ | 208,207 | | | $ | 356,641 | | | $ | (155,791) | | | $ | 200,850 | |
Amortization of capitalized software development costs is computed on an individual product basis for those products available for market and is recognized based on the product’s estimated economic life, which generally range from three to six years. Acquired technology, customer relationships and other intangible assets are amortized over their useful lives, which generally range from five to ten years. Patents are amortized using the straight-line method over their estimated period of benefit, which generally range from ten to seventeen years. Total intangible assets amortization expenses were $12.7 million and $12.4 million for the three months ended March 31, 2023 and 2022, respectively.
Goodwill
The carrying amount of goodwill as of March 31, 2023 was as follows:
| | | | | |
| Amount |
| (In thousands) |
Balance as of December 31, 2022 | $ | 615,734 | |
Acquisitions | 12,050 | |
| |
Foreign currency translation impact | 3,095 | |
| |
Balance as of March 31, 2023 (unaudited) | $ | 630,879 | |
The excess purchase price over the fair value of assets acquired is recorded as goodwill. As businesses are acquired, we assign assets acquired (including goodwill) and liabilities assumed to either our existing reporting unit or a newly identified reporting unit as of the date of the acquisition. In the event a disposal group meets the definition of a business, goodwill is allocated to the disposal group based on the relative fair value of the disposal group to the related reporting unit. As we have one operating segment comprised of components with similar economic characteristics, we allocate goodwill to one reporting unit for goodwill impairment testing. Goodwill is tested for impairment on an annual basis, and between annual tests if indicators of potential impairment exist, using a fair-value-based approach based on the market capitalization of the reporting unit. Our annual impairment test is performed in the fourth quarter of each year.
No impairment of goodwill was identified during the three months ended March 31, 2023 or the twelve months ended December 31, 2022.
Note 8 – Leases
We have operating leases for corporate offices, automobiles, and certain equipment. Our leases have remaining terms of 1 year to 91 years, some of which may include options to extend the leases for up to 9 years, and some of which may include options to terminate the leases within 1 year. Leases with an initial term of 12 months or less are not recorded on the balance sheet. We recognize lease expense for these leases on a straight-line basis over the lease term.
Amounts related to finance lease activities and income from leasing activities were not material for the periods presented.
The components of operating lease expense were as follows (unaudited):
| | | | | | | | |
(In thousands) | March 31, 2023 | March 31, 2022 |
Operating Lease Cost (1) | $ | 6,314 | | $ | 5,417 | |
(1) includes variable and short-term lease costs | | |
Maturities of lease liabilities as of March 31, 2023 were as follows (unaudited): | | | | | | | | |
(In thousands) | | |
Years ending December 31, | | Operating Leases |
2023 (Excluding the three months ended March 31, 2023) | | $ | 13,616 | |
2024 | | 14,332 | |
2025 | | 10,498 | |
2026 | | 8,743 | |
2027 | | 4,582 | |
Thereafter | | 6,009 | |
Total future minimum lease payments | | 57,780 | |
Less imputed interest | | 5,683 | |
Total lease liabilities | | $ | 52,097 | |
As of March 31, 2023, we have additional operating leases that have not commenced, which were not material.
Note 9 – Income taxes
We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized. We had a valuation allowance of $75 million and $74 million at March 31, 2023 and December 31, 2022, respectively. A majority of the valuation allowance is related to the deferred tax assets of National Instruments Hungary Kft. (“NI Hungary”).
We account for uncertainty in income taxes recognized in our financial statements using prescribed recognition thresholds and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on our tax returns. We had $16.0 million and $12.6 million of gross unrecognized tax benefits at March 31, 2023 and December 31, 2022, respectively, all of which would affect our effective income tax rate if recognized. We recorded a gross increase in unrecognized tax benefits of $3.4 million for the three months ended March 31, 2023, as a result of the tax positions taken during this period. As of March 31, 2023, it is reasonably possible that we will recognize gross tax benefits in the amount of $0.8 million in the next twelve months due to the closing of open tax years. The nature of the uncertainty is related to positions taken on returns that have not been examined by the applicable tax authority. Our continuing policy is to recognize interest and penalties related to income tax matters in income tax expense. During the three months ended March 31, 2023, we recognized interest expense related to uncertain tax positions of approximately $0.1 million. As of March 31, 2023, we had approximately $0.3 million accrued for interest related to uncertain tax positions. The tax years 2016 through 2023 remain open to examination by the major taxing jurisdictions to which we are subject.
Our provision for income taxes reflected an effective tax rate of 13% and 17% for the three months ended March 31, 2023 and 2022, respectively. For the three months ended March 31, 2023, our effective tax rate was lower than the U.S. federal statutory rate of 21% primarily as a result of an enhanced deduction for certain research and development expenses, deduction for foreign-derived intangible income and the research and development tax credit, which were offset by the change in unrecognized tax benefits. For the three months ended March 31, 2022, our effective tax rate was lower than the U.S. federal statutory rate of 21% primarily as a result of deduction for foreign-derived intangible income, an enhanced deduction for certain research and development expenses and the research and development tax credit, offset by the change in unrecognized tax benefits, nondeductible officer compensation and state income taxes net of federal benefit and U.S. tax on global intangible low-taxed income.
Our earnings in Hungary are subject to a statutory tax rate of 9%. In addition, our research and development activities in Hungary benefit from a tax law in Hungary that provides for an enhanced deduction for qualified research and development expenses. The tax position of our Hungarian operations resulted in income tax benefits of $6.1 million and $2.0 million for the three months ended March 31, 2023, and March 31, 2022, respectively.
Earnings from our operations in Malaysia are free of tax under a tax holiday effective January 1, 2013. This tax holiday expires in 2037. If we fail to satisfy the conditions of the tax holiday, this tax benefit may be terminated early. The income tax benefits of the tax holiday for the three months ended March 31, 2023, and March 31, 2022 were approximately $1.3 million and $0.6 million, respectively. The impact of the tax holiday on a per share basis for each of the three months ended March 31, 2023 and March 31, 2022 was a benefit of $0.01 per share.
No other taxing jurisdictions had a significant impact on our effective tax rate. We have not entered into any advanced pricing or other agreements with the Internal Revenue Service ("IRS") with regard to any foreign jurisdictions.
Note 10 – Comprehensive income
Our OCI is comprised of net income, foreign currency translation adjustments, and unrealized gains and losses on forward contracts. The accumulated OCI, net of tax, for the three months ended March 31, 2023 and 2022, consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2023 |
| | (Unaudited) |
(In thousands) | | Currency translation adjustment | | Investments | | Derivative instruments | | Accumulated other comprehensive income/(loss) |
Balance as of December 31, 2022 | | $ | (38,250) | | | $ | — | | | 385 | | | $ | (37,865) | |
Current-period other comprehensive income (loss) | | 4,889 | | | — | | | 207 | | | 5,096 | |
Reclassified from accumulated OCI into income | | — | | | — | | | (1,883) | | | (1,883) | |
Income tax benefit | | — | | | — | | | 384 | | | 384 | |
Balance as of March 31, 2023 | | $ | (33,361) | | | $ | — | | | $ | (907) | | | $ | (34,268) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2022 |
| | (Unaudited) |
(In thousands) | | Currency translation adjustment | | Investments | | Derivative instruments | | Accumulated other comprehensive income/(loss) |
Balance as of December 31, 2021 | | $ | (23,179) | | | $ | — | | | 3,048 | | | $ | (20,131) | |
Current-period other comprehensive (loss) income | | (3,805) | | | — | | | 3,040 | | | (765) | |
Reclassified from accumulated OCI into income | | — | | | — | | | (1,173) | | | (1,173) | |
Income tax expense | | — | | | — | | | (425) | | | (425) | |
Balance as of March 31, 2022 | | $ | (26,984) | | | $ | — | | | $ | 4,490 | | | $ | (22,494) | |
Note 11 – Authorized shares of common and preferred stock and stock-based compensation plans
Authorized shares of common and preferred stock
The total number of shares which we are authorized to issue is 365,000,000 shares, consisting of (i) 5,000,000 shares of preferred stock, par value $0.01 per share, and (ii) 360,000,000 shares of common stock, par value $0.01 per share.
Stock-Based Compensation Plan
Our stockholders approved our 2010 Incentive Plan (the “2010 Plan”) on May 11, 2010. At the time of approval, 3,000,000 shares of our common stock were reserved for issuance under the 2010 Plan, as well as the 3,362,304 shares of common stock that were reserved but not issued under our 1994 Incentive Stock Options Plan (the "1994 Plan") and the 2005 Incentive Plan (the "2005 Plan") as of May 11, 2010, and any shares that are returned to the 1994 Plan and the 2005 Plan as a result of the forfeiture or termination of options or RSUs or repurchase of shares issued under those plans. The 2010 Plan provided for the granting of incentive awards in the form of restricted stock and RSUs to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company. Awards vest over a three, five or ten-year period, beginning on the date of grant. Vesting of ten-year awards may accelerate based on our previous year’s earnings and growth but ten-year awards cannot accelerate to vest over a period of less than five years. The 2010 Plan terminated on May 12, 2015, except with respect to the outstanding awards previously granted thereunder. There were 2,518,416 shares of common stock that were reserved but not issued under the 2010 Plan as of May 12, 2015.
Our stockholders approved our 2015 Equity Incentive Plan (the “2015 Plan”) on May 12, 2015. At the time of approval, 3,000,000 shares of our common stock were reserved for issuance under the 2015 Plan, as well as the 2,518,416 shares of common stock that were reserved but not issued under the 2010 Plan as of May 12, 2015, and any shares that were returned to the 1994 Plan, 2005 Plan, and 2010 Plan as a result of the forfeiture or termination of options or RSUs or repurchase of shares issued under those plans. The 2015 Plan provides for the granting of incentive awards in the form of restricted stock and RSUs, to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company and such awards may be subject to performance-based vesting conditions. Awards generally vest over a three, four, five or ten-year period, beginning on the date of grant. Vesting of ten-year awards may accelerate based on our previous year’s earnings and growth but ten-year awards cannot accelerate to vest over a period of less than five years. The 2015 Plan terminated on May 5, 2020, except with respect to the outstanding awards previously granted thereunder. There were 567,142 shares of common stock that were reserved but not issued under the 2015 Plan as of May 5, 2020.
Our stockholders approved our 2020 Equity Incentive Plan (the “2020 Plan”) on May 5, 2020. At the time of approval, 4,500,000 shares of our common stock were reserved for issuance under the 2020 Plan, as well as the 567,142 shares of common stock that were reserved but not issued under the 2015 Plan as of May 5, 2020, and any shares that were returned to the 2005 Plan, 2010 Plan, and 2015 Plan as a result of the forfeiture or termination of options or RSUs or repurchase of shares issued under those plans. The 2020 Plan provides for the granting of incentive awards in the form of restricted stock and RSUs to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company. Awards generally vest over a one, two, three or four-year period, beginning on the date of the grant and awards may be subject to performance-based vesting conditions. There were 1,568,571 shares of common stock that were reserved but not issued under the 2020 Plan as of May 10, 2022.
Our stockholders approved our 2022 Equity Incentive Plan (the “2022 Plan”) on May 10, 2022. At the time of approval, 4,500,000 shares of our common stock were reserved for issuance under the 2022 Plan, as well as the 1,568,571 shares of common stock that were reserved but not issued under the 2020 Plan as of May 10, 2022, and any shares that were returned to the 2005 Plan, 2010 Plan, 2015 Plan and 2020 Plan as a result of the forfeiture, repurchase or termination of unissued shares subject to options or RSUs issued under those plans. The 2022 Plan provides for the granting of incentive awards in the form of restricted stock and RSUs to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company. Awards generally vest over a one, two, three or four years period, beginning on the date of the grant and awards may be subject to performance-based vesting conditions. There were 6,109,748 shares available for grant under the 2022 Plan at March 31, 2023.
Performance-based stock units
During the three months ended March 31, 2023 and 2022, we granted 70,224 and 164,843 PRSUs, respectively, to executive officers pursuant to the 2022 Plan and 2020 Plan. The PRSUs may be earned based on our total shareholder return ("TSR") compared to the TSR of the Russell 2000 Index or, for awards granted on or after March 3, 2023, the NASDAQ Composite Index (the “Index”) over a three-year performance period. For the PRSUs granted during the three months ended March 31, 2023, the three-year performance period commenced on January 1, 2023, and will end on December 31, 2025, and for the PRSUs granted during the three months ended March 31, 2022, the three-year performance commenced on January 1, 2022 and will end on December 31, 2024, using the average daily closing price over a 30-day lookback in each case. The number of awards earned could range from 0% to 200% of the target number of units granted. Additionally, for awards granted on or after March 3, 2023, the number of PRSUs that may vest pursuant to an award agreement shall not exceed 100% of the target number of PRSUs subject to such award if our absolute total shareholder return is negative during the performance period for such award.
The fair values of PRSUs are estimated using a Monte Carlo simulation. The determination of fair value of the PRSUs is based on our stock price and a number of assumptions including the expected volatility, expected dividend yield and the risk-free interest rate. The expected volatility at the date of grant was based on the historical volatilities of our stock and the companies included in the Index over the performance period. The Monte Carlo model is based on random projections of stock-price paths and must be repeated numerous times to achieve a probabilistic assessment. The key assumptions used in valuing these market-based awards are as follows:
| | | | | | | | |
| Three Months Ended |
| (unaudited) |
| March 31, 2023 | March 31, 2022 |
Number of simulations | 100,000 | 100,000 |
Expected volatility | 32.27% | 37.81% |
Expected life in years | 2.84 years | 2.95 years |
Risk-free interest rate | 4.45% | 1.33% |
Dividend yield | 2.45% | 2.52% |
The weighted average grant date fair value of the market-based awards, as determined by the Monte Carlo valuation model, was $84.45 per share and $59.65 per share in 2023 and 2022, respectively.
Employee stock purchase plan
Our employee stock purchase plan ("ESPP") permits substantially all domestic employees and employees of designated subsidiaries to acquire our common stock at a purchase price of 85% of the lower of the market price at the beginning or the end of the purchase period. The plan has quarterly purchase periods generally beginning on February 1, May 1, August 1 and November 1 of each year. Employees may designate up to 15% of their compensation for the purchase of common stock under the ESPP. Pursuant to the terms of our merger agreement with Emerson, our ESPP program will be suspended indefinitely after the May 1, 2023 purchase. Refer to Note 18 - Subsequent Events of Notes to Consolidated financials for additional information on the proposed transaction.
On May 10, 2022, our stockholders approved an additional 3,000,000 shares for issuance under our ESPP. At March 31, 2023, we had 3,797,114 shares of common stock reserved for future issuance under the ESPP. We issued 275,976 shares under this plan in the three months ended March 31, 2023 and the weighted average purchase price of the shares issued was $32.45 per share. During the three months ended March 31, 2023, we did not make any changes in accounting principles or methods of estimates with respect to our ESPP.
Authorized Preferred Stock and Preferred Stock Purchase Rights Plan
We have 5,000,000 authorized shares of preferred stock.
On January 21, 2004, our Board of Directors designated 750,000 of these shares as Series A Participating Preferred Stock in conjunction with the adoption of a Preferred Stock Rights Agreement which expired on May 10, 2014. There were no shares of Series A Preferred Stock issued and outstanding at March 31, 2023.
On January 13, 2023, our Board of Directors designated 2,000,000 of these shares as Series B Participating Preferred Stock (“Series B Preferred Stock”) in conjunction with its adoption of a stockholder rights plan, as previously disclosed in our Current Report on Form 8-K filed on January 13, 2023. On April 12, 2023, in connection with entering into the merger agreement with Emerson, the stockholder rights plan was modified so that the rights thereunder will not be exercisable by virtue of the merger agreement or any agreement or transactions contemplated thereby, as previously disclosed in our Current Report on Form 8-K filed on April 12, 2023.
Stock repurchases and retirements
On April 21, 2010, our Board of Directors authorized a program to repurchase shares of our common stock from time to time, depending on market conditions and other factors (the “2019 Program”). The Board has amended the 2019 Program several times over the years to increase the number of shares that may be purchased under the program. On October 23, 2019, our Board amended the 2019 Program to increase the number of shares that may be repurchased by 3,000,000 shares.
On January 19, 2022, our Board of Directors approved a new stock repurchase plan for up to $250 million of our common stock, effective immediately (the "2022 Program"). This new repurchase program is in addition to the existing 2019 Program. Under the 2022 Program, shares may be repurchased from time to time in open market transactions, in privately negotiated transactions or otherwise. The timing and the other terms of the repurchase will depend on a variety of factors, including legal requirements, economic and market conditions, and other investment opportunities. The 2022 Program may be changed, suspended or discontinued at any time and does not have a specified expiration date.
At March 31, 2023, there were 0 shares remaining available for repurchase under the 2019 Program and there was $230 million available for repurchase under the 2022 Program. We did not repurchase any shares of our common stock during the three-months ended March 31, 2023 under the 2019 Program and 2022 Program. We repurchased 772,052 shares of our common stock at a weighted average price per share of $40.74 during the three-months ended March 31, 2022 under the 2019 Program and 2022 Program.
Note 12 – Segment and geographic information
We operate as one operating segment. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly by the chief operating decision maker, who is our chief executive officer, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker evaluates our financial information and resources and assesses the performance of these resources on a consolidated basis. Since we operate as one operating segment, all required financial segment information can be found in the condensed consolidated financial statements and the notes thereto.
We sell our products in three geographic regions which consist of: the Americas; Europe, Middle East and Africa region ("EMEA"); and Asia-Pacific region ("APAC"). Our sales to these regions share similar economic characteristics including the nature of products and services we sell, the type and class of customers, and the methods used to distribute our products and services. Revenue from the sale of our products, which are similar in nature, and software maintenance are reflected as total net sales in our Consolidated Statements of Income. (See Note 2 –Revenue of Notes to Consolidated Financial Statements for total net sales by the major geographic regions in which we operate).
The following table presents summarized information for net sales by country. Revenues from external customers are generally attributed to countries based upon the customer's billing location. Net sales attributable to each individual foreign country outside the U.S. and China were not material.
| | | | | | | | | | | | | | |
(in millions) | United States | China(1) | Rest of the World | Total |
Net sales: | | | | |
Three months ended March 31, 2023 | $ | 172 | | 82 | | 183 | | $ | 437 | |
Three months ended March 31, 2022 | $ | 152 | | 55 | | 178 | | $ | 385 | |
(1): Includes Mainland China and the Hong Kong Special Administrative Region |
The following table presents summarized information for long-lived assets by country. Long-lived assets attributable to each individual country outside the U.S., Hungary and Malaysia were not material. Long-lived assets consist of property, plant, and equipment and operating lease right-of-use assets and exclude intangible assets.
| | | | | | | | | | | | | | | | | |
(in millions) | United States | Hungary | Malaysia | Rest of the World | Total |
Long-lived Assets: | | | | | |
March 31, 2023 | $ | 142 | | 59 | 81 | 63 | $ | 345 | |
December 31, 2022 | $ | 124 | | 58 | 82 | 61 | $ | 325 | |
Note 13 - Debt
The following table presents the amounts outstanding related to our borrowing arrangements discussed below as of March 31, 2023, and December 31, 2022, respectively (in thousands):
| | | | | | | | |
| March 31, | December 31, |
| 2023 | 2022 |
Secured | | |
Term Loan | 487,500 | | 493,750 | |
Revolving credit facility | 30,000 | | 50,000 | |
| | |
Total Debt | 517,500 | | 543,750 | |
Less: Unamortized debt issuance costs | (1,995) | | (2,113) | |
Less: Current Portion of Total Debt | (25,000) | | (25,000) | |
Total Debt, non-current | $ | 490,505 | | $ | 516,637 | |
The effective interest rate for the term loan and the revolving credit facility, both drawn under our Credit Facility, was 6.3% as of March 31, 2023. The effective interest rates for the term loan and revolving credit facility as of December 31, 2022 were 5.6% and 5.7%, respectively.
Debt Issuance Costs
Debt issuance costs of approximately $1.9 million attributable to our revolving credit are presented within "Other long-term assets" in our Consolidated Balance Sheet and debt issuance costs of approximately $2.0 million attributable to the term loan are presented within "Debt, non-current" as of March 31, 2023. Debt issuance costs of approximately $2.1 million attributable to our revolving credit are presented within "Other long-term assets" in our Consolidated Balance Sheet and debt issuance costs of approximately $2.1 million attributable to the term loan are presented within "Debt, non-current" as of December 31, 2022. These amounts are amortized to interest expense ratably over the life of the revolving credit and the term loan, respectively.
Credit Facility
On August 24, 2022, we amended the terms of our Credit Facility by entering into a Third Amended and Restated Credit Agreement (the "Credit Agreement") with Wells Fargo Bank, National Association, as the administrative agent, swingline lender and issuing lender (the "Administrative Agent"), Wells Fargo Securities, LLC, BofA Securities, Inc. and Citibank, N.A., as joint lead arrangers and joint bookrunners, BofA Securities, Inc. and Citibank, N.A., as syndication agents, and the lenders party thereto. The Credit Agreement amends and restates and refinances our Second Amended and Restated Credit Agreement, dated as of June 18, 2021, by and among us, the lenders from time-to-time party thereto and Wells Fargo Bank, National Association, as the administrative agent (the "Prior Credit Agreement"). All outstanding loans under the Prior Credit Agreement were repaid in full in connection with the entry into the Credit Agreement. The replacement of the Prior Credit Agreement with the Credit Agreement was treated as a debt modification and the remaining balance of unamortized debt issuance costs were allocated to the new loan facilities, as described below.
The Credit Agreement provides for an initial $1 billion Credit Facility consisting of (a) a secured revolving loan facility in an aggregate principal amount of up to $500 million at any time outstanding, with a sublimit of $25 million for the issuance of letters of credit and (b) a secured term loan facility in an aggregate principal amount of $500 million. Subject to the terms of the Credit Agreement, including obtaining commitments from existing lenders or new lenders, we may request additional term loans and/or revolving loan commitments. The Credit Facility terminates, and all revolving loans outstanding and/or outstanding term loan amounts (together with accrued interest and fees) are payable in full, on August 24, 2027, unless terminated earlier pursuant to the terms of the Credit Agreement. The term loans amortize in quarterly payments equal to 1.25% of the original principal amount of the term loans, with the remaining outstanding balance due at maturity.
The term loans and revolving loans accrue interest, at our option, at: (i) a base rate equal to the highest of (a) the prime rate (b) the federal funds rate plus 0.50%, and (c) an adjusted term SOFR for an interest period of one month plus 1.00%, plus a margin of 0.25% to 0.75%; or (ii) an adjusted term SOFR (for an interest period of one, three or six months) plus a margin of 1.25% to 1.75%, with the margin being determined based upon our consolidated total net leverage ratio. The Credit Agreement contains financial covenants requiring us to maintain a maximum consolidated total net leverage ratio of less than or equal to 3.50 to 1.00 which increases to 4.00 to 1.00 for a specified period following material acquisitions, and a minimum consolidated interest coverage ratio of greater than or equal to 3.00 to 1.00, in each case determined in accordance with the Credit Agreement.
The Credit Agreement provides for a commitment fee of 0.150% to 0.250% per annum, determined based upon our consolidated total net leverage ratio, on the average daily unused portion of the revolving committed amount, payable quarterly in arrears.
Under the circumstances described in the Credit Agreement, certain of our wholly owned domestic subsidiaries (the "Subsidiary Guarantors") are required to enter into a guaranty agreement ("Guaranty") in favor of the Administrative Agent guarantying our obligations under the Credit Agreement, among other things. As of March 31, 2023, there were no Subsidiary Guarantors, and no Guaranty had been executed. In connection with the Credit Agreement, we entered into a Second Amended and Restated Collateral Agreement (the "Collateral Agreement") pursuant to which we granted a continuing security interest on substantially all of our assets, in favor of the Administrative Agent (for the benefit of the lenders of the Credit Facility), to secure our obligations under the Credit Agreement. Subsidiary Guarantors are required to join the Collateral Agreement and make similar grants of security interests.
The Credit Agreement contains customary affirmative and negative covenants. The affirmative covenants include, among other things, delivery of financial statements, compliance certificates and notices, payment of taxes and other obligations, maintenance of existence, maintenance of properties and insurance, maintenance of books and records, and compliance with applicable laws and regulations. The negative covenants include, among other things, limitations on indebtedness, liens, mergers, consolidations, acquisitions and sales of assets, investments, changes in the nature of the business, affiliate transactions and certain restricted payments. The Credit Agreement contains customary events of default including, among other things, payment defaults, breaches of covenants or representations and warranties, cross-defaults with certain other indebtedness, bankruptcy and insolvency events, judgment defaults and change in control events, subject to grace periods in certain instances. Upon an event of default, the Administrative Agent and the lenders may declare all or a portion of the outstanding obligations payable by us to be immediately due and payable and exercise other rights and remedies provided for under the Credit Agreement. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the Credit Agreement at a per annum interest rate equal to 2.00% above the otherwise applicable interest rate.
The proceeds of the term loans made on August 24, 2022 were used to prepay in full the revolving loans outstanding under the Prior Credit Agreement. Remaining proceeds of the term loans made on August 24, 2022 were used to pay associated costs, fees and other expenses and for other working capital and general corporate purposes. Proceeds of current and additional revolving loans under the Credit Agreement may be used for working capital and other general corporate purposes including acquisitions, share repurchases and dividend payouts. We may prepay the loans under the Credit Agreement in whole or in part at any time without premium or penalty.
Note 14 – Commitments and contingencies
We offer a standard warranty on most hardware products which is included in the terms of sale of such products. During 2022, we enhanced the service entitlements included with our standard warranty to include technical support and dependable repair and replacement coverage. Standard warranties sold with these additional entitlements are now accounted for as service-type warranties and the revenue allocated to these performance obligations is now recognized over the service duration of one or three years, and the related warranty costs are recognized as incurred. We also offer additional extensions or enhancements to the service-type warranties described above, for which the related revenue is also recognized ratably over the warranty period. The included service period for the enhanced service entitlements was three years for the vast majority of orders placed during 2022. In late 2022, we shortened the default service period for our service-type warranty entitlements to one year, with the ability to add optional, separately-priced extensions for subsequent years. Consequently, revenue deferrals related to service-type warranties are expected to decrease on a year over year basis during the remainder of 2023.
For hardware previously sold with only an assurance-type warranty, a provision is made for estimated future warranty costs at the time of the sale for the estimated costs that may be incurred. Our estimate is based on historical experience and product sales during the period. The warranty reserve as of March 31, 2023 and December 31, 2022 was $2.4 million and $1.5 million, respectively.
In the ordinary course of business, we enter into purchase orders with suppliers for the purchase of goods and services, including non-cancelable agreements for certain inventory components ("unconditional purchase obligations"). Our unconditional purchase obligations primarily consist of commitments to various suppliers for inventory components and the majority relate to amounts due within the next 12 months. As of March 31, 2023 and 2022, our future payments under unconditional purchase obligations with a remaining term in excess of one year were approximately $13.2 million and $17.7 million, respectively. As of March 31, 2023, our outstanding guarantees for payment of customs and foreign grants were not material.
Note 15 – Restructuring
2023 Restructuring
During the first quarter of 2023, we announced a workforce reduction plan (the "2023 Plan") intended to realign our investments to accelerate our growth strategy and further optimize our operations and cost structure. The 2023 Plan will result in reductions to our worldwide headcount of approximately 4% during 2023. In connection with the Plan, we incurred approximately $15.5 million of charges consisting primarily of cash termination benefits and other employee-related costs during the first quarter of 2023.
We expect to incur an additional $0.9 million of additional costs related to our restructuring plans during the remainder of 2023.
2022 and 2021 Restructuring
During the first quarter of 2023, we recognized approximately $0.4 million in severance-related charges for restructuring activities that were initiated in prior years. The majority of the charges related to the 2022 and 2021 Plans had been fully recognized as of March 31, 2023.
A summary of the charges in our consolidated statement of operations resulting from our restructuring activities is shown below:
| | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | |
(In thousands) | | (Unaudited) | | |
| | 2023 | | 2022 | | | | |
Cost of sales | | $ | 1,520 | | | $ | — | | | | | |
Research and development | | 3,213 | | | 400 | | | | | |
Sales and marketing | | 5,981 | | | — | | | | | |
General and administrative | | 5,256 | | | — | | | | | |
Total | | $ | 15,970 | | | $ | 400 | | | | | |
A summary of balance sheet activity during 2023 related to the restructuring activity is shown below:
| | | | | |
| Restructuring Liability |
| (in thousands) |
Balance as of December 31, 2022 | $ | 10,009 | |
Income statement expense | 15,970 | |
Cash payments | (14,570) | |
Balance as of March 31, 2023 | $ | 11,409 | |
The restructuring liability of $11.4 million at March 31, 2023, relating primarily to future severance payments is recorded in the “Accrued compensation” line item of the consolidated balance sheet.
Note 16 – Litigation
We are not currently a party to any material litigation. However, in the ordinary course of our business, we have in the past, are currently and may likely become involved in various legal proceedings, claims, and regulatory, tax or government inquiries and investigations, and could incur uninsured liability in any one or more of them. We also periodically receive notifications from various third parties related to alleged infringement of patents or intellectual property rights, commercial disputes or other matters. No assurances can be given with respect to the extent or outcome of any investigation, litigation or dispute.
Note 17 – Acquisitions
SET Acquisition
On March 6, 2023, we acquired the remaining 75.1% ownership interest in one of our equity-method investments, SET GmbH ("SET"), for approximately $24.8 million in total cash consideration, subject to certain post-closing adjustments. Of the total cash consideration, approximately $2.7 million will be held back as security for certain representations, warranties, and obligations of the sellers, payable in the first quarter of 2024. SET is a Germany-based expert in aerospace and defense test system development and an innovator in power semiconductor reliability test. This transaction was accounted for as a business combination using the acquisition method of accounting.
We recognized a gain of approximately $3 million on the remeasurement of our existing 24.9% equity-method investment to fair value on the acquisition date. The carrying value of the investment immediately prior to the acquisition date was approximately $3 million. The gain is presented in "Other (expense) income."
All of the acquired assets and liabilities of SET have been recorded at their respective fair values as of the acquisition date. We recognized approximately $12.1 million of goodwill and $16.0 million of other intangible assets as part of our preliminary purchase price allocation. Transaction costs have been expensed as incurred and were not material to the periods presented. The acquisition was funded by cash on hand.
The preliminary purchase price allocation related to the acquisition was not finalized as of March 31, 2023, and is based upon a preliminary valuation which is subject to change as we obtain additional information with respect to certain intangible assets and income taxes. Pro-forma results of operations have not been presented as the impact of the acquired operations was not material.
The excess of the purchase price over the net assets acquired was recorded as goodwill. Goodwill generated from the acquisition is primarily attributable to expected growth in the scope of and market opportunities for our existing offerings related to vehicle electrification and other related applications. Goodwill is not deductible for tax purposes.
Kratzer Acquisition
On May 2, 2022, we completed the acquisition of certain assets of, and assumed certain liabilities of, the test systems business ("TS Business") of Germany-based Kratzer Automation AG (“Kratzer”). As part of this integrated transaction, we also purchased 100% of the shares in certain subsidiaries of Kratzer: Kratzer Automation S.a.r.l. ("Kratzer France"), Kratzer Automation Inc. ("Kratzer US") and Kratzer Automation (Shanghai) Co., Ltd. ("Kratzer China"). The acquisitions of Kratzer France, Kratzer US, and Kratzer China were completed on June 1, 2022, June 2, 2022, and August 26, 2022, respectively. This transaction was accounted for as a business combination using the acquisition method of accounting. Total cash consideration for the transaction was $56.3 million inclusive of $0.7 million in cash acquired. All of the acquired assets and liabilities of the TS Business have been recorded at their respective fair values as of the acquisition date. The acquisition was funded by cash on hand.
Transaction costs have been expensed as incurred. We expensed $2.2 million of transaction costs related to the acquisition of the TS Business, which are included in selling, general and administrative expenses.
The excess of the purchase price over the net assets acquired was recorded as goodwill. The goodwill generated from the acquisition is primarily attributed to expected growth in the scope of and market opportunities for our existing offerings related to vehicle electrification test systems and other related applications. The goodwill is deductible locally and in the U.S. over 15 years for federal income tax purposes.
During the fourth quarter of 2022, we recorded measurement period adjustments to our preliminary estimate of the fair value of intangible assets acquired as a result of new information obtained on acquired customer contracts. The net decrease to the fair value of total intangible assets acquired was $10 million, with a corresponding increase to goodwill. This change to the provisional amount did not have a material impact to the income statements in the current or previous reporting periods.
Fair value of net assets acquired and liabilities assumed
The information below represents the preliminary purchase price allocation of the TS Business (in thousands):
| | | | | |
| May 2, 2022 |
Consideration Transferred | 56,324 | |
| |
Cash and cash equivalents | 672 | |
Accounts receivable | 2,616 | |
Inventories | 5,130 | |
Prepaid expenses and other current assets | 1,900 | |
Property and equipment | 1,145 | |
Goodwill | 29,223 | |
Intangible assets | 25,010 | |
Operating lease right-of-use assets | 4,820 | |
Other long-term assets | 108 | |
Accounts payable and accrued expenses | (966) | |
Accrued compensation | (463) | |
Operating lease liabilities - current | (1,050) | |
Accrued expenses and other current liabilities | (8,233) | |
Operating lease liabilities - non-current | (3,588) | |
Net Assets Acquired | 56,324 | |
The preliminary purchase price allocation related to the acquisition was not finalized as of March 31, 2023. These preliminary estimates of the fair value of the assets acquired and the liabilities assumed are based on the information currently available, and we are continuing to evaluate the underlying inputs and assumptions used in our valuations. Accordingly, these preliminary estimates are subject to change during the measurement period, which is up to one year from the date of acquisition. A decrease in the fair value of assets acquired or an increase in the fair value of liabilities assumed in the acquisition would result in a corresponding increase in the amount of goodwill acquired. The primary areas of purchase price that are not yet finalized relate to intangible assets, income taxes and residual goodwill.
Acquired intangible assets will be amortized over their estimated useful lives on a straight-line basis. The following table summarizes the preliminary purchase price allocation and the preliminary average remaining useful lives for identifiable intangible assets acquired.
| | | | | | | | |
| Estimated Fair Value (in thousands) | Estimated Useful Lives (in years) |
Customer relationships | $ | 2,470 | | 10 |
Developed software | 20,830 | | 5 |
Trade name contractual rights | 1,710 | | 2 |
Total | 25,010 | | |
Customer relationships represent the fair value of future projected revenue that will be derived from sales of products to existing customers. The economic useful life was determined by examining the period of time over which the customer attrition curve falls below a target threshold.
Developed software represents the fair value of automation systems for performing test bench tasks and management systems for all resources and accruing data in the test field. The economic life of this software is estimated to be 5 years based on the expected future utilization of the software in its current form.
Results of operations of the business acquired have been included in our condensed consolidated financial statements subsequent to the dates of acquisition. Pro-forma results of operations have not been presented as the impact of the acquired operations was not material.
Heinzinger Acquisition
On February 28, 2022, we completed the acquisition of the systems business of Heinzinger Electronic GmbH (“Heinzinger”) for $22.5 million in total cash consideration, including a holdback amount of approximately $3.1 million that was released to Heinzinger during the first quarter of 2023. This transaction was accounted for as a business combination using the acquisition method of accounting. All of the acquired assets and liabilities of Heinzinger have been recorded at their respective fair values as of the acquisition date. We recognized approximately $13.5 million of goodwill and $7.2 million of other intangible assets as part of our preliminary purchase price allocation. Transaction costs have been expensed as incurred and were not material to the periods presented. The acquisition was funded by cash on hand.
The excess of the purchase price over the net assets acquired was recorded as goodwill. Goodwill generated from the acquisition is primarily attributable to expected growth in the scope of and market opportunities for our existing offerings related to vehicle electrification and other related applications. Goodwill is not deductible for tax purposes.
The purchase price allocation related to the acquisition was finalized as of February 28, 2023. Pro-forma results of operations have not been presented as the impact of the acquired operations was not material.
Note 18 – Subsequent events
Dividend
On April 26, 2023, our Board of Directors declared a quarterly cash dividend of $0.28 per common share, payable on May 31, 2023, to stockholders of record as of the close of business on May 9, 2023.
Acquisition
On April 12, 2023 the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Emerson Electric Co., a Missouri corporation (“Parent”) and Emersub CXIV, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”). Pursuant to the Merger Agreement, Merger Sub will be merged with and into the Company (the “Merger”), with the Company continuing as the surviving company in the Merger.
Subject to the terms and conditions set forth in the Merger Agreement, at the effective time of the Merger, each share of common stock, par value $0.01 per share, of the Company issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to receive $60.00 per Company share in cash, without interest.
Completion of the Merger is subject to certain conditions, including the receipt of the necessary approval from the Company’s shareholders, the satisfaction of certain regulatory approvals and other customary closing conditions. The parties expect to close the transaction during the last calendar quarter of 2023 or the first calendar quarter of 2024.