PRCP Perceptron Inc

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.Accounting Policies

Perceptron, Inc. (the “Company”) develops, produces and sells a comprehensive range of automated industrial metrology products and solutions to manufacturers for dimensional gauging, dimensional inspection and 3D scanning.  The Company’s products provide solutions for manufacturing process control as well as sensor and software technologies for non-contact measurement, scanning and inspection applications.  The Company also offer value added services such as training and customer support.

Basis of Presentation and Principles of Consolidation

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and within the rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements.  The Consolidated Financial Statements include accounts of the Company and wholly-owned subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation.  In the Company’s opinion, these statements include all normal recurring adjustments necessary for a fair presentation of the financial statements for the periods presented.  The results of operations for any interim period are not necessarily indicative of the results of operations for a full fiscal year.  The accompanying unaudited Consolidated Financial Statements should be read in conjunction with the Company’s audited Consolidated Financial Statements in Form 10-K for the fiscal year ended June 30, 2020.

Use of Estimates

Management is required to make certain estimates and assumptions under U.S. GAAP during the preparation of these Consolidated Financial Statements.  These estimates and assumptions may affect the reported amounts of assets and liabilities as well as the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

In particular, management has made estimates and assumptions related to the impact of the novel coronavirus ("COVID-19") on its business. COVID-19 was characterized as a pandemic by the World Health Organization on March 11, 2020. To help lessen its spread, many countries have implemented travel restrictions and/or required companies to limit or suspend business operations. These actions have disrupted supply chains and company operations around the world. The current environment resulting from COVID-19 is unprecedented and comes with a great deal of uncertainty. See Note 18 “COVID-19 Pandemic” of the Notes to the Consolidated Financial Statements, contained in this Quarterly Report on Form 10-Q for a discussion of the impact of COVID-19 on the Company’s business.

2.New Accounting Pronouncements  

Recently Issued Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (Topic 326) (ASU 2016-13), which requires the measurement of all expected credit losses for financial assets held at the reporting date to be based on historical experience, current conditions as well as reasonable and supportable forecasts.  In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses (ASU 2018-19).  ASU 2018-19 clarifies that receivables arising from operating leases are not within the scope of ASU 2016-13.  ASU 2016-13, as amended, is effective for the Company on July 1, 2023, with early adoption permitted.  The Company does not expect the impact of the adoption of ASU 2016-13 to be material on its consolidated financial statements.

In November 2019, the FASB issued Accounting Standards Update No. 2019-11—Codification Improvements to Topic 326, Financial Instruments—Credit Losses (ASU 2019-11). The amendments in this Update represent changes to clarify, correct errors in, or improve the Codification. The amendments make the Codification easier to understand and easier to apply by eliminating inconsistencies and providing clarifications. The effective dates and transition requirements for ASU 2019-11 are the same as ASU 2016-13. ASU 2019-11 is effective for the Company on July 1, 2023. The Company does not expect the impact of the adoption of ASU 2019-11 to be material on its consolidated financial statements.

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In December 2019, the FASB issued Accounting Standards Update No. 2019-12—Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12). The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. ASU 2019-12 is effective for the Company on July 1, 2021. The Company is currently evaluating the impact of this standard on its consolidated financial statements and disclosures.

In January 2020, the FASB issued Accounting Standards Update No. 2020-01—Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint  Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force) (ASU 2020-01). The amendments in this ASU clarify certain interactions between the guidance to account for certain equity securities under Topic 321, the guidance to account for investments under the equity method of accounting in Topic 323, and the guidance in Topic 815, which could change how an entity accounts for an equity security under the measurement alternative or a forward contract or purchased option to purchase securities that, upon settlement of the forward contract or exercise of the purchased option, would be accounted for under the equity method of accounting or the fair value option in accordance with Topic 825, Financial Instruments. These amendments improve current GAAP by reducing diversity in practice and increasing comparability of the accounting for these interactions. ASU 2020-01 is effective for the Company on July 1, 2021. The Company is currently evaluating the impact of this standard on its consolidated financial statements and disclosures.

In August 2018, the FASB issued Accounting Standards Update No. 2018-13 – Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirement for Fair Value Measurement (ASU 2018-13), which changes the disclosures related to, among other aspects of fair value, unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurement and the narrative description of measurement uncertainty.  ASU 2018-13 is effective for the Company on July 1, 2021.  The Company is currently evaluating the impact of this standard on its consolidated financial statements and disclosures.

Recently Adopted Accounting Pronouncements

In February 2016, the FASB issued Accounting Standards Update No. 2016-02 Leases (ASU 2016-2), which establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  The Company adopted this guidance on July 1, 2019, using the modified retrospective approach.  

The adoption of the standard resulted in the recognition of net operating lease right-of-use assets of $4.0 million and operating lease liabilities of $3.9 million on the consolidated balance sheet as of July 1, 2019 primarily related to the Company’s real estate operating leases.  The operating lease right-of-use asset includes the impact of deferred rent.  The Company does not have any finance leases.  

The Company elected to apply the package of practical expedients upon transition, which includes no reassessment of whether existing contracts are or contain leases and allowed for the lease classification for existing leases to be retained. The Company did not elect the practical expedient to use hindsight, and accordingly the initial lease term did not differ under the new standard versus prior accounting practice.  After transition, in certain instances, the cost of renewal options will be recognized earlier in the term of the lease than under the previous lease accounting rules.  The Company has selected as its accounting policy to keep leases with a term of twelve months or less off the balance sheet and recognize these lease payments on a straight-line basis over the lease term.

In February 2018, the FASB issued Accounting Standards Update 2018-02—Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act.  ASU 2018-02 was adopted on July 1, 2019 and did not have a significant impact on the Company’s consolidated financial statements or disclosures.   

In August 2018, the FASB issued Accounting Standards Update No. 2018-15 – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract (ASU 2018-15), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing costs incurred to develop or obtain internal use software.  ASU 2018-15 is effective for the Company on July 1, 2020.  ASU 2018-15 was adopted on July 1, 2020 and did not have significant impact on the Company’s consolidated financial statements and disclosures.

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3.Intangible Assets

The Company acquired intangible assets consisting of a Trade Name and Customer/Distributor Relationships in addition to goodwill in connection with the acquisitions of Coord3 and NMS in the third quarter of fiscal 2015 which is considered the Company’s CMM reporting unit.  The customer/distributor relationships were written off via an impairment charge in fiscal 2019.  The goodwill and trade name were written off via impairment charges in fiscal 2019 and 2020.  Furthermore, the Company continues to develop intangibles, primarily software. Intangible assets are susceptible to shortened estimated useful lives and changes in fair value due to changes in their use, market or economic changes, or other events or circumstances.  The amortization periods for software is five years.      

At September 30, 2020, there are no indications of potential impairment of the Company’s software.

The Company’s intangible assets are as follows (in thousands):

Amortization expense was $122,000 and $104,000 for the three months ended September 30, 2020 and 2019, respectively.    

The estimated amortization of the remaining intangible assets by year is as follows (in thousands):

4.Revenue from Contracts with Customers

Sales by product lines are as follows (in thousands):

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The following table summarizes the Company’s revenue categories for the three months ended September 30, 2020 (in thousands):

Contract Balances

Deferred commissions – The Company’s incremental direct costs of obtaining a contract, which consist primarily of sales commissions, are deferred and amortized based on the timing of revenue recognition over the period of contract performance.  As of September 30, 2020, capitalized commissions of $256,000 were included in “Other current assets” on the Consolidated Balance Sheet.  Commission expense recognized during the three months ended September 30, 2020 and 2019 was $273,000 and $190,000, respectively, is included in “Selling, general and administrative expense” in the Consolidated Statement of Operations.

The change in the Company’s net Unbilled receivables / (Deferred revenue) from July 1, 2020 to September 30, 2020 was primarily due to the amount of revenue recognized as the Company satisfied performance obligations during the three months ended September 30, 2020, partially offset by the amount and timing of invoicing during that same timeframe related to the Company’s Measurement Solutions and 3D Scanning Solutions.  During the three months ended September 30, 2020, the Company recognized revenue of $2,517,000 that was included in “Deferred revenue” at July 1, 2020. During the three months ended September 30, 2019, the Company recognized revenue of $3,573,000 that was included in ‘Deferred revenue’ at July 1, 2019.

5.Short-Term and Long-Term Investments

As of September 30, 2020 and June 30, 2020, the Company held restricted cash in short-term bank guarantees.  The restricted cash provides financial assurance that the Company will fulfill certain customer obligations in China.  The cash is restricted as to withdrawal or use while the related bank guarantee is outstanding.  Interest is earned on the restricted cash and recorded as interest income.  As of September 30, 2020 and June 30, 2020, the Company had short-term bank guarantees of $427,000 and $355,000, respectively.

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At September 30, 2020, the Company held a long-term investment in preferred stock that is not registered under the Securities Act of 1933, as amended and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. The preferred stock investment is currently recorded at $725,000 after consideration of impairment charges recorded in fiscal years 2008 and 2009.  At September 30, 2020 there were no changes to the carrying value of the investment resulting from observable price changes in orderly transactions for an identical or similar investment in the issuer.

The following table presents the Company’s Short-Term and Long-Term Investments by category at September 30, 2020 and June 30, 2020 (in thousands):

6.Fair Value Measurements

ASC 820, “Fair Value Measurements and Disclosures” is applicable for all financial assets and liabilities as well as nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis.  ASC 820 defines fair value, establishes a framework for measuring fair value and required specific disclosures about fair value measurements.  The Company’s financial instruments include investments classified as available for sale, mutual funds, fixed deposits and certificate of deposits at September 30, 2020.

ASC 820 establishes a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s assumptions of market participant valuation (unobservable inputs).  These two types of inputs create the following fair value hierarchy:

ASC 820 requires the use of observable market data if such data is available without undue cost and effort.

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The following table presents the Company’s investments at September 30, 2020 and June 30, 2020 that are measured and recorded at fair value on a recurring basis consistent with the fair value hierarchy provisions of ASC 820 (in thousands).  The fair value of the Company’s short-term investments approximates their cost basis.

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect these estimates. At September 30, 2020 the Company did not record any other-than-temporary impairments on its financial assets required to be measured on a recurring basis.

The Company also measures certain assets and liabilities at fair value on a nonrecurring basis.  These assets are tested for impairment when events or circumstances occur which may indicate that the derived fair value is below carrying cost or on an annual basis in accordance with applicable GAAP.  For these assets, the Company do not periodically adjust carrying value fair value except in the event of an impairment.  

There were no assets or liabilities measured at fair value on a non-recurring basis at September 30, 2020.

7.Inventory

Inventory is stated at the lower of cost or net realizable value using the first-in, first-out (“FIFO”) method.  The Company provides a reserve for obsolescence to recognize inventory impairment for the effects of engineering change orders, and for age and use of inventory that affect the value of the inventory.  The reserve for obsolescence creates a new cost basis for the impaired inventory.  When inventory that has previously been impaired is sold or disposed of, the related obsolescence reserve is reduced resulting in the reduced cost basis being reflected in cost of goods sold.  A detailed review of the inventory is performed annually with quarterly updates for known changes that have occurred since the annual review.  Inventory, net of reserves of $2,019,000 and $1,929,000 at September 30, 2020 and June 30, 2020, respectively, is comprised of the following (in thousands):

8.Property and Equipment

The Company’s property and equipment consisted of the following as of September 30, 2020 and June 30, 2020 (in thousands):

Depreciation expense was $229,000 and $260,000 for the three months ended September 30, 2020 and 2019, respectively.

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9. Leases

The Company leases office space for its manufacturing, sales and service operations, vehicles and office equipment under operating leases.  All of the Company’s leases are operating leases.

In accordance with Accounting Standard Codification Topic 842 (“ASC 842”) the Company has elected not to apply ASC 842 to arrangements with lease terms less than 12 months.

Operating lease right-of-use assets and liabilities are reflected within the captions “Right-of-use assets”, “Short-term operating lease liability” and “Long-term operating lease liability”, respectively, on the Consolidated Balance Sheet. Right-of-use assets, Short-term operating lease liability and Long-term operating lease liability were $3,823,000, $500,000 and $3,376,000 as of September 30, 2020, respectively.

When readily determinable, the discount rate used to calculate the lease liability is the rate implicit in the lease. Otherwise the Company applied judgement and used its incremental borrowing rate based on the information available at lease commencement.

Some of the leases include one or more renewal or termination options at the Company’s discretion, which are included in the determination of the lease term if the Company is reasonably certain to exercise the option.

There were no Right-of-use leased assets obtained in exchange for new operating lease liabilities for the three months ended September 30, 2020.

Lease expense, recorded in the cost of sales and selling, general & administrative expense categories in the Consolidated Statement of Operations total $197,000 for the first quarter of fiscal 2021.

Cash paid for operating leases was $204,000 during the three months ended September 30, 2020 and is included in operating cash flows.

Maturities of lease liabilities are as follows:

The weighted average remaining lease term for operating leases was 7 years and the weighted average discount rate was 6.2% as of September 30, 2020.  

10.Warranties

In-Line and Near-Line Measurement Solutions generally carry a one to three-year warranty for parts and a one-year warranty for labor and travel related to warranty.  Product sales to the forest products industry carry a three-year warranty for TriCam® sensors.  Sales of ScanWorks® have a one-year warranty for parts.  Sales of WheelWorks® products have a two-year warranty for parts.  Off-Line Measurement Solutions generally carry a 12-month warranty after the machine passes the acceptance test or a 15-month warranty from the date of shipment, whichever date comes first, on parts only. The Company provides a reserve for warranty based on its experience and knowledge.

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Factors affecting the Company’s warranty reserve include the number of units sold or in service as well as historical and anticipated rates of claims and cost per claim.  The Company periodically assess the adequacy of its warranty reserve based on changes in these factors.  If a special circumstance arises which requires a higher level of warranty, the Company make a special warranty provision commensurate with the facts.  Changes to the Company’s warranty reserve are as follows (in thousands):

11.Credit Facilities

The Company had $2,200,000 outstanding under its lines of credit at September 30, 2020 and June 30, 2020.  

On December 4, 2017, the Company entered into a Loan Agreement (the “Loan Agreement”) with Chemical Bank (“Chemical”), and related documents, including a Promissory Note.  The Loan Agreement is an on-demand line of credit and is cancelable at any time by either Perceptron or Chemical and any amounts outstanding would be immediately due and payable.  The Loan Agreement is guaranteed by the Company’s U.S. subsidiaries.  The Loan Agreement allows for maximum permitted borrowings of $8.0 million.  The borrowing base is calculated at the lesser of (i) $8.0 million or (ii) the sum of 80% of eligible accounts receivable balances of U.S. customers, and subject to limitations, certain foreign customers, plus the lesser of 50% of eligible inventory or $3.0 million.  At September 30, 2020, the Company’s available borrowing under this facility was approximately $3.3 million.  Security for the Loan Agreement is substantially all of the Company’s assets in the U.S.  Interest is calculated at 2.65% above the 30-day LIBOR Rate.  The Company is not allowed to pay cash dividends under the Loan Agreement.

On April 16, 2020, the Company entered into an unsecured loan with TCF National Bank in an aggregate principal amount of $2.5 million (the “PPP Loan”), pursuant to the Paycheck Protection Program “PPP loan” under the Cares Act.

The PPP Loan is evidenced by a promissory note (the “Note”) dated April 16, 2020. The PPP Loan matures two years from the disbursement date and bears interest at a rate of 1.000% per annum.  Principal and interest are payable monthly commencing with a date determined by the lender following the remittance of the amount of the PPP Loan to be forgiven by the SBA to the lender or potentially earlier, as determined under applicable Small Business Administration rules, if the Company’s PPP Loan is reviewed.  The outstanding borrowings may be prepaid by the Company at any time prior to maturity with no prepayment penalties.  As of September 30, 2020, the short and long-term balances of the PPP loan are $0.8 million and $1.7 million, respectively.  As of June 30, 2020, the short and long-term balances of the PPP loan are $0.5 million and $2.0 million, respectively.  The short-term balance was calculated using a five-month grace period after the filing of the Company’s loan forgiveness application before loan payments must commence.  The grace period of five months is the Company’s estimate of the time it will take the SBA to determine forgiveness, if any.  Should the SBA make such determination in less than five months, the loan payments will commence at the time.

Under the terms of the CARES Act, PPP loan recipients can apply for forgiveness for all or a portion of loans granted under the PPP which is dependent upon the Company having initially qualified for the loan. Furthermore, the loans issued under PPP are subject to forgiveness to the extent proceeds are used for payroll costs, including payments required to continue group health care benefits, and certain rent, utility, and mortgage interest expenses incurred or paid during a twenty-four week period following the disbursement date (collectively, “Qualifying Expenses”), pursuant to the terms and limitations of the PPP.  The Company expects to be able to use a significant portion of the PPP Loan proceeds for Qualifying Expenses and to have a significant portion of the PPP Loan eligible for forgiveness.  Any portion of the PPP Loan that is not used for Qualifying Expenses or is not otherwise forgiven is expected to be repaid on the terms set forth above.  The Company cannot be certain as to the amount of the PPP Loan that will be forgiven, if any.

The Company’s Brazilian subsidiary (“Brazil”) has several borrowing facilities with total available borrowings of B$354,000 (equivalent to approximately $63,000 USD).  At September 30, 2020, the outstanding balances totaled B$218,000 (equivalent to approximately $39,000 USD and are included in current portion of long-term debt on the Consolidated Balance Sheet).  At June 30, 2020, the outstanding balances totaled B$250,000 (equivalent to approximately $46,000 USD).  The monthly interest rate on the outstanding balances range from 0.37% to 13.94%.

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12.Severance, Impairment and Other Charges

In the first three months of fiscal 2020, the Company completed the payments on the amounts accrued as part of the reduction in force in the U.S. during fiscal 2019.  

In February 2020, the Company committed to a financial improvement plan that reduced global headcount by approximately 7%. The plan was implemented to re-align the Company’s fixed costs and its near-to-mid-term expectations for the Company’s business. As a result, in the third quarter of fiscal 2020, the Company recorded a charge for severance and related costs of $590,000. At September 30, 2020, the remaining balance of the accruals was $59,000.

The following table reconciles the activity for the Reserves for Restructuring and Other Charges (in thousands):

13.Current Taxes Payable

The tax liabilities represent income and payroll related taxes that are payable in accordance with government authorized installment payment plans.  These installment plans require varying monthly payments through January 2021.

14.Other Long-Term Liabilities

Other long-term liabilities at September 30, 2020 and June 30, 2020 include $443,000 and $449,000, respectively for long-term contractual and statutory severance liabilities acquired as part of the purchase of Coord3 that represent amounts that will be payable to employees upon termination of employment.

15.Stock-Based Compensation

The Company maintains a 2004 Stock Incentive Plan (“2004 Plan”) covering substantially all company employees, non-employee directors and certain other key persons.  The 2004 Plan is administered by a committee of the Company’s Board of Directors: The Management Development, Compensation and Stock Option Committee (“MDCSOC”).

Awards under the 2004 Plan may be in the form of stock options, stock appreciation rights, restricted stock or restricted stock units, performance share awards, director stock purchase rights and deferred stock units, or any combination thereof.  The terms of the awards are determined by the MDCSOC, except as otherwise specified in the 2004 Plan.  

Stock Options

Options outstanding under the 2004 Plan generally become exercisable at 25% or 33.3% per year beginning one year after the date of grant and expire ten years after the date of grant.  Option prices from options granted under these plans must not be less than the fair market value of the Company’s stock on the date of grant.  The Company uses the Black-Scholes model for determining stock option valuations.  The Black-Scholes model requires subjective assumptions, including future stock price volatility and expected time to exercise, which affect the calculated values.  The expected term of option exercises is derived from historical data regarding employee exercises and post-vesting employment termination behavior.  The risk-free rate of return is based on published U.S. Treasury rates in effect for the corresponding expected term.  The expected volatility is based on historical volatility of the Company’s stock price.  These factors could change in the future, which would affect the stock-based compensation expense in future periods.  

The Company recognized operating expense for non-cash stock-based compensation costs related to stock options in the amount of $22,000 and $56,000 in the three months ended September 30, 2020 and 2019, respectively.  As of September 30, 2020, the total remaining unrecognized compensation cost related to non-vested stock options amounted to approximately $29,000.  The Company expects to recognize this cost over a weighted average vesting period of 1.9 years.

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The Company granted no stock options in each of the three months ended September 30, 2020 and 2019, respectively. The Company received zero in cash from option exercises under its share-based payment arrangements in each of the three months ended September 30, 2020 and 2019, respectively.  

Restricted Stock and Restricted Stock Units

The Company’s restricted stock and restricted stock units under the 2004 Plan generally have been awarded by four methods, as follows:

The grant date fair value associated with granted restricted stock is calculated in accordance with ASC 718 “Compensation – Stock Compensation”.  Compensation expense related to restricted stock awards is based on the closing price of the Company’s Common Stock on the grant date authorized by the Company’s MDCSOC, multiplied by the number of restricted stock and restricted stock unit awards expected to be issued and vested and is amortized over the combined performance and service periods.  The non-cash stock-based compensation expense recorded for restricted stock and restricted stock unit awards for the three months ended September 30, 2020 and 2019, was $18,000 and $65,000, respectively. As of September 30, 2020, the total remaining unrecognized compensation cost related to the restricted stock and restricted stock unit awards is approximately $33,000. The Company expects to recognize this cost over a weighted average vesting period of 1.0 years.

A summary of the status of restricted stock and restricted stock unit awards outstanding at September 30, 2020 is presented in the table below.

Performance Stock Units

During the second quarter of fiscal 2020, the Company’s MDCSOC granted certain employees Performance Share Units (“PSUs”) as part of the Fiscal Year 2020 Long-Term Incentive Compensation Plan. The Performance Measures were defined by the Committee as a specific target level of Revenue and Operating Income Before Incentive Compensation for each of the following: fiscal year 2020, fiscal year 2021 and fiscal year 2022. Up to one-third of the PSUs can be earned each year, determined based upon actual performance levels achieved in that year. One half of the award earned each year is based upon the achievement of the two Performance Targets in that year, provided that a minimum level of Operating Income Before Incentive Compensation is achieved for that year. The actual award level for each year can range from 50% to 150% (for Revenue Target) or 75% to 200% (for Operating Income Target) of the target awards depending on actual performance levels achieved in each year compared to that year’s target. If Operating Income Before Incentive Compensation is less than 75% of the targeted Operating Income Before Incentive Compensation for the year, then no PSU’s will vest for that year and the PSU’s vesting that year will expire.  For fiscal year 2020, actual Revenue and Operating Income Before Incentive Compensation did not meet the fiscal year 2020 targets, resulting in the forfeiture of PSU’s vesting in fiscal 2020.

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During the second quarter of fiscal 2019, the Company’s MDCSOC granted certain employees Performance Share Units (“PSUs”) as part of the Fiscal Year 2019 Long-Term Incentive Compensation Plan.  The Performance Measures were defined by the Committee as a specific Target level of Revenue and Operating Income Before Incentive Compensation for each of the following: plan year 2019 (October 1, 2018 to September 30, 2019), fiscal year 2020 and fiscal year 2021.  Up to one-third of the PSUs can be earned each year, determined based upon actual performance levels achieved in that year. One half of the award earned each year is based upon the achievement of the two Performance Targets in that year, provided that a minimum level of Operating Income Before Incentive Compensation is achieved for that year.  The actual award level for each year can range from 50% to 150% (for Revenue Target) or 75% to 200% (for Operating Income Target) of the target awards depending on actual performance levels achieved in each year compared to that year’s target. If Operating Income Before Incentive Compensation is less than 75% of the targeted Operating Income Before Incentive Compensation for the year, then no PSU’s will vest for that year and the PSU’s vesting that year will expire.  For plan year 2019 and fiscal 2020, actual Revenue and Operating Income Before Incentive Compensation did not meet the plan year 2019 and fiscal 2020 targets, resulting in the forfeiture of PSU’s vesting in fiscal 2020.

The non-cash stock-based compensation expense recorded for performance share unit awards for the three months ended September 30, 2020 and 2019, was zero and $51,000, respectively.  As of September 30, 2020, the total remaining unrecognized compensation cost related to performance share unit awards is approximately $125,000. The Company expects to recognize this cost over a weighted average vesting period of 1.1 years.

During the first quarter of fiscal 2020, the MDCSOC granted PSUs to the Company’s interim President and Chief Executive Officer in lieu of a portion of his cash compensation. During the first quarter of fiscal year 2021, the Company recorded expense related to these PSU’s of $33,000.

A summary of the status of the PSUs outstanding at September 30, 2020 is presented in the table below.

Board of Directors Fees

The Company’s Board of Directors’ fees are typically payable in cash on September 1, December 1, March 1, and June 1 of each fiscal year; however, under the Company’s 2004 Plan each director can elect to receive the Company’s stock in lieu of cash on a calendar year election. Each of the Company’s Directors elected a combination of cash and stock for calendar year of 2020.  During the first quarter of fiscal year 2021, the Company issued 11,913 shares to the Company’s directors and recorded expense of $51,000.

16.Earnings Per Share

Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Other obligations, such as stock options and restricted stock awards, are considered to be potentially dilutive common shares.  Diluted EPS assumes the issuance of potential dilutive common shares outstanding during the period and adjusts for any changes in income and the repurchase of common shares that would have occurred from the assumed issuance, unless such effect is anti-dilutive.  The calculation of diluted shares also takes into account the average unrecognized non-cash stock-based compensation expense and additional adjustments for tax benefits related to non-cash stock-based compensation expense. Furthermore, the Company excludes all outstanding options to purchase common stock from the computation of diluted EPS in periods of net losses because the effect is anti-dilutive.

Options to purchase 1,500 and 36,000 shares of common stock outstanding in the three months ended September 30, 2020 and 2019, respectively, were not included in the computation of diluted EPS because the effect would have been anti-dilutive.

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17.Commitments and Contingencies

The Company may, from time to time, be subject to litigation and other claims in the ordinary course of its business. The Company accrues for estimated losses arising from such litigation or claims if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. To estimate whether a loss contingency should be accrued by a charge to income, the Company evaluates, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of the loss. Since the outcome of litigation and claims is subject to significant uncertainty, changes in the factors used in the Company’s evaluation could materially impact its financial position or results of operations.

The Company is currently unaware of any significant pending litigation other than the matters set forth below.

In the third quarter of fiscal 2018, the Canadian Revenue Agency (“CRA”) completed a Goods and Services Tax/Harmonized Sales Tax Returns (GST/HST) audit. Based on this audit, the CRA preliminarily proposed to assess the Company approximately CAD $1,218,000 (equivalent to approximately $923,000) in taxes plus interests and penalties related to sales from 2013 through 2018.  CRA has indicated the Company is entitled to invoice its customers to recover this amount and its customers are required to remit payment.  The Company’s response to the CRA preliminary assessment was delivered in April 2018. In June 2018, the Company received the final assessment, which confirmed the preliminary assessment.  In August 2018, the Company filed a formal appeal request and posted a surety bond as security for this claim.  The Company has not recorded an accrual related to this preliminary audit finding because the Company is disputing several of the CRA’s conclusions and a loss is not probable.  The Company expects to ultimately receive the funds from its customers (excluding any interest or penalties) if the Company is ultimately required to pay CRA, although there may be a timing difference between when the Company must pay the CRA and when the Company collects the funds from its customers.

In the fourth quarter of fiscal 2019, the Company identified a potential concern regarding the residency status of certain U.S. employees as it relates to payroll taxes and withholdings in their country of residency.  The Company estimated the range of correcting this issue, including interest and penalties to range from $0.2 million to $0.3 million.  The Company is not able to reasonably estimate the amount within this range that the Company would be required to pay for this matter.  The reserve balance is $0.3 million as of September 30, 2020.

18.COVID-19 Pandemic

In March of 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. In North America, Europe, Asia and Brazil (the Company’s primary markets), federal, state and local governments have recommended or mandated actions to slow the transmission of COVID-19.  These actions include the implementation of shelter-in-place orders, quarantines, significant restrictions on travel, and restrictions that prohibit non-essential employees from occupying their place of work. There remains considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of governmental and other measures implemented to try to slow the spread of the virus. The COVID-19 pandemic has created significant volatility in the global economy and financial markets, resulting in a significant reduction in both economic activity and employment levels. The COVID-19 pandemic has disrupted the global automotive industry. The Company, along with many of the Company’s customers and suppliers, temporarily closed or limited operations at production facilities. The Company’s revenues have been significantly and negatively affected by the closure of automotive facilities during fiscal year 2020, and into the first quarter of fiscal year 2021. Further, negative financial results, an economic downturn or uncertainty, or a tightening of credit markets caused by COVID-19 or other similar outbreaks could have a material adverse effect on liquidity, ability to effectively meet short- and long-term financial obligations, and accounting estimates. While most automotive operations the Company supports have resumed operations, the extent to which normal purchasing activities by the Company’s customers will return remains uncertain. Any further delays in resumption of activity from customers and any future wave of COVID-19 or other similar outbreaks could further adversely affect the Company’s business. In response, the Company has implemented cost reduction efforts to help mitigate the impact on the business including reducing discretionary spending and various other measures.

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19. Merger Agreement

On September 27, 2020, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Atlas Copco North America LLC, a Delaware limited liability company (“Parent”), and Odyssey Acquisition Corp., a wholly owned subsidiary of Parent (“Merger Subsidiary”), providing for the merger of Merger Subsidiary with and into the Company (the “Merger” and, collectively with the other transactions contemplated by the Merger Agreement, the “Transactions”), with the Company surviving the Merger as a wholly owned subsidiary of Parent.  

At the effective time of the Merger, each issued and outstanding share of common stock of the Company immediately prior to the Effective Time (other than shares owned by the Company) shall be converted into the right to receive $7.00 per share in cash, without interest (the “Merger Consideration”).  Immediately prior to the effective time of the merger, subject to the terms and conditions of the Merger Agreement, each outstanding and unexercised stock option, restricted stock unit, and performance share unit shall automatically and without any required action on the part of the holder thereof, become immediately vested and be cancelled and converted into the right to receive (without interest) from the Company an amount in cash based in part on the options, restricted stock units, or performance share units held immediately prior to the effective date.  

The Board of Directors of the Company (the “Board”) has unanimously determined that the Merger Agreement and the Transactions contemplated thereby, including the Merger, are advisable and in the best interests of the Company and its shareholders and the Board has resolved to recommend to the shareholders of the Company that they vote in favor of the approval of the Merger Agreement and the Merger.

The Merger is subject to customary closing conditions, including shareholder and regulatory approvals.

The Merger Agreement contains certain termination rights for each of the Company and Parent. In addition to their respective termination rights, and subject to certain limitations, the Company or Parent may terminate the Merger Agreement if the Merger is not consummated by June 27, 2021.

Upon termination of the Merger Agreement in accordance with its terms, under specified circumstances, the Company could be required to pay Parent a termination fee of $2,100,000.  

If the Merger is consummated, the Shares will be delisted from The Nasdaq Stock Market LLC (Nasdaq Global Market) and deregistered under the Securities Exchange Act of 1934. 

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