SIGMATRON INTERNATIONAL INC - Quarter Report: 2019 October (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION



Washington, D.C. 20549



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Form 10-Q



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(Mark One)

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES

      EXCHANGE ACT OF 1934



For the quarterly period ended October 31, 2019



OR



☐  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES

     EXCHANGE ACT OF 1934



For the transition period from    to



Commission File Number 0-23248



SIGMATRON INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

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Registrant’s telephone number, including area code:  (847)  956-8000





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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☒   No  ☐

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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files.  Yes  ☒   No  ☐



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of a “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large Accelerated Filer  ☐    Accelerated Filer  ☐



Non-accelerated Filer    ☒        Smaller Reporting Company  ☒



Emerging Growth Company  ☐



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐



Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes  ☐   No  ☒



Indicate the number of shares outstanding of the registrant’s common stock, $0.01 par value, as of December 6,  2019:  4,242,508







 

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SigmaTron International, Inc.



Index



 



 

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SigmaTron International, Inc.

Condensed Consolidated Balance Sheets





























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SigmaTron International, Inc.

Condensed Consolidated Statements of Operations



















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SigmaTron International, Inc.

Condensed Consolidated Statements of Changes in Stockholders’ Equity























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SigmaTron International, Inc.

Condensed Consolidated Statements of Cash Flows







 





 

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Note A - Description of the Business



SigmaTron International, Inc., its subsidiaries, foreign enterprises and international procurement office (collectively, the “Company”) operates in one business segment as an independent provider of electronic manufacturing services (“EMS”), which includes printed circuit board assemblies and completely assembled (box-build) electronic products.  In connection with the production of assembled products, the Company also provides services to its customers, including (1) automatic and manual assembly and testing of products; (2) material sourcing and procurement; (3) manufacturing and test engineering support; (4) design services; (5) warehousing and distribution services; and (6) assistance in obtaining product approval from governmental and other regulatory bodies. 



Note B - Basis of Presentation



The accompanying unaudited condensed consolidated financial statements of SigmaTron International, Inc. (“SigmaTron”), SigmaTron’s wholly-owned subsidiaries Standard Components de Mexico S.A., AbleMex, S.A. de C.V., Digital Appliance Controls de Mexico, S.A. de C.V., Spitfire Controls (Vietnam) Co. Ltd., Spitfire Controls (Cayman) Co. Ltd. and wholly-owned foreign enterprises Wujiang SigmaTron Electronics Co., Ltd. and SigmaTron Electronic Technology Co., Ltd. (“SigmaTron China”) and international procurement office SigmaTron Taiwan branch (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.



Accordingly, the condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Operating results for the three and six month period ended October 31, 2019 is not necessarily indicative of the results that may be expected for the year ending April 30, 2020.  The condensed consolidated balance sheet at April 30, 2019, was derived from audited annual financial statements but does not contain all of the footnotes disclosures from the annual financial statements.  For further information, refer to the  consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 30, 2019. 

 

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Note C - Inventories, net



The components of inventory consist of the following:







 



Note D - Earnings Per Share and Stockholders’ Equity



The following table sets forth the computation of basic and diluted earnings (loss) per share:







Options to purchase 465,232 and 347,318 shares of common stock were outstanding at October 31, 2019 and 2018, respectively.  There were no options granted during the six month periods ended October 31, 2019 and 2018.  There was no stock option expense recognized for the three and six month periods ended October 31, 2019 and 2018.  There was no balance of unrecognized compensation expense related to the Company’s stock option plans at October 31, 2019 and 2018.  For the three month periods ended October 31, 2019 and 2018, 147,706 and 24,459 shares, respectively, were not included in the diluted weighted average common shares outstanding calculation as they were anti-dilutive.    For the six month periods ended October 31, 2019 and 2018, 241,465 and 29,080 shares, respectively, were not included in the diluted weighted average common shares outstanding calculation as they were anti-dilutive. 

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Note E - Long-term Debt



Debt and capital lease obligations consisted of the following at October 31, 2019 and April 30, 2019:







Notes Payable – Banks



On March 31, 2017, the Company entered into a $35,000,000 senior secured credit facility with U.S. Bank, which expires on March 31, 2022.  The credit facility is collateralized by substantially all of the Company’s domestically located assets. The facility allows the Company to choose among interest rates at which it may borrow funds:  the bank fixed rate of five percent or LIBOR plus one and one half percent (effectively 3.44% at October 31, 2019).  Interest is due monthly. 



On July 16, 2018, the Company and U.S. Bank entered into an amendment of the revolving line of credit under the senior secured credit facility.  The amended revolving credit facility allows the Company to borrow up to the lesser of (i) $45,000,000 (the “Revolving Line Cap”) less reserves or (ii) the Borrowing Base, but no more than 90% of the Company’s Revolving Line Cap, except that the 90% limitation will expire if (i) the Company’s actual revolving loans for 90 consecutive days after the amendment’s effective date are less than 80% of the Company’s Borrowing Base and (ii) the Company maintains a Fixed Charge Coverage Ratio of 1.2 to 1.0 for four consecutive quarters.  The amendment also imposes sublimits on categories of inventory equal to $10,500,000 on raw materials, $10,000,000 on finished goods and $28,000,000 on all eligible inventory. 



On December 13, 2018, the Company and U.S. Bank entered into an amendment of the revolving credit facility.  The amendment provides an exception to otherwise ineligible foreign receivables for up to $3,000,000 of receivables paid by certain enumerated account debtors outside of the U.S. and Canada.





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Note E - Long-term Debt - Continued 



On August 26, 2019, the Company and U.S. Bank entered into an amendment of the revolving credit facility.  The amendment allows the Company to borrow up to the lesser of (i) the Revolving Line Cap less reserves or (ii) the Borrowing Base, but no more than 95% of the Company’s Revolving Line Cap until February 26, 2020 and 90% on and after February 26, 2020. 



As of October 31, 2019, there was $29,000,000 outstanding and $11,544,524 of unused availability under the U.S. Bank facility compared to an outstanding balance of $35,727,212 and $6,645,730 of unused availability at April 30, 2019.  At October 31, 2019, the Company was in compliance with its financial covenant and other restrictive covenants under the credit facility.  Deferred financing costs of $40,907 and $46,866 were capitalized during the three and six month periods ended October  31, 2019, respectively, which are amortized over the term of the agreement.  As of October  31, 2019 and April 30, 2019, the unamortized amount offset against outstanding debt was $216,869 and $209,162, respectively.    



On March 15, 2019, the Company’s wholly-owned subsidiary, SigmaTron Electronic Technology Co., Ltd., entered into a credit facility with China Construction Bank.  Under the agreement SigmaTron Electronic Technology Co., Ltd. can borrow up to 5,000,000 Renminbi, approximately $709,000 as of October  31, 2019, and the facility is collateralized by Wujiang SigmaTron Electronic Co., Ltd.’s manufacturing building.  Interest is payable monthly and the facility bears a fixed interest rate of 6.09%.  The term of the facility extends to March 14, 2024.  There was no outstanding balance under the facility at October  31, 2019 and April 30, 2019.



The Company is in compliance with its financial covenant and other restrictive covenants and anticipates that its credit facilities, expected future cash flows from operations and leasing resources are adequate to meet its working capital requirements, and fund capital expenditures for the next 12 months.  In addition, if customers delay orders, future payments are not made timely, the Company desires to expand its operations, its business grows more rapidly than expected, or the current economic climate deteriorates, additional financing resources may be necessary. There is no assurance that the Company will be able to obtain equity or debt financing at acceptable terms, or at all, in the future.  There is no assurance that the Company will be able to retain or renew its credit agreements in the future, or that any retention or renewal will be on the same terms as currently exist.



Notes Payable – Buildings



The Company entered into a mortgage agreement on December 21, 2017, in the amount of $5,200,000, with U.S. Bank to refinance the property that serves as the Company’s corporate headquarters and its Illinois manufacturing facility in Elk Grove Village, Illinois.  The note requires the Company to pay monthly principal payments in the amount of $17,333, bears interest at a fixed rate of 4.0% per year and is payable over a fifty-one month period.  Deferred financing costs of $74,066 were capitalized in fiscal year 2018 which are amortized over the term of the agreement.  As

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Note E - Long-term Debt - Continued 



of October 31, 2019 and April 30, 2019, the unamortized amount included as a reduction to long-term debt was $41,347 and $50,142, respectively.  A final payment of approximately $4,347,778 is due on or before March 31, 2022.  The outstanding balance was $4,836,000 and $4,940,000 at October, 31 2019 and April 30, 2019, respectively.



The Company entered into a mortgage agreement on December 21, 2017, in the amount of $1,800,000, with U.S. Bank to refinance the property that serves as the Company’s engineering and design center in Elgin, Illinois.  The note requires the Company to pay monthly principal payments in the amount of $6,000, bears interest at a fixed rate of 4.0% per year and is payable over a  fifty-one month period.  Deferred financing costs of $65,381 were capitalized in the fiscal year 2018 which are amortized over the term of the agreement.  As of October 31, 2019 and April 30, 2019, the unamortized amount included as a reduction to long-term debt was $36,462 and $44,006, respectively.  A final payment of approximately $1,505,000 is due on or before March 31, 2022.  The outstanding balance was $1,674,000 and $1,710,000 at October, 31 2019 and April 30, 2019, respectively. 



Notes Payable – Equipment



The Company routinely enters into secured note agreements with Engencap Fin S.A. DE C.V. to finance the purchase of equipment. The terms of these secured note agreements extend to November 2021 through May 2023, with quarterly installment payments ranging from $11,045 to $37,941 and at fixed interest rates ranging from 6.65% to 8.00%.



Annual maturities of the Company’s debt, net of deferred financing fees for the remaining periods as of October  31, 2019, are as follows:











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Note E - Long-term Debt - Continued 



Finance Lease and Sales Leaseback Obligations



The Company enters into various finance lease and sales leaseback agreements.  The terms of the lease agreements mature through May 2023, with monthly installment payments ranging from $1,455 to $40,173 and a fixed interest rate ranging from 3.75% to 9.40%.  





Note F - Income Tax



The income tax expense was $316,106 for the three month period ended October 31, 2019 compared to an income tax expense of $1,125,992 for the same period in the prior fiscal year.  The Company’s effective tax rate was 32.35% and 280.06% for the three month period ended October 31, 2019 and 2018, respectively.  The income tax expense was $563,221 for the six month period ended October 31, 2019 compared to an income tax expense of $928,986 for the same period in the prior fiscal year.  The Company’s effective tax rate was 35.52% and (288.9)% for the six month period ended October 31, 2019 and 2018, respectively.  The decrease in income tax expense for both the three month and six month periods ended October 31, 2019 and the decrease in the effective tax rate for the three month period ended October 31, 2019 compared to the same periods in the previous year is due primarily to a discrete income tax expense of $457,011 in the prior year as the result of a valuation allowance established on certain foreign net operating loss carryforwards. The increase in effective tax rate for the six month period in the current year compared to the same period in the previous year is due primarily to an overall loss that was recognized in the prior year compared to income recognized in the current year.



Note G - Commitments and Contingencies



From time to time the Company is involved in legal proceedings, claims or investigations that are incidental to the conduct of the Company’s business. In future periods, the Company could be subjected to cash cost or non-cash charges to earnings if any of these matters are resolved on unfavorable terms. However, although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including management’s assessment of the merits of any particular claim, the Company does not expect that these legal proceedings or claims will have any material adverse impact on its future consolidated financial position, results of operations or cash flows.



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Note H - Critical Accounting Policies



Management Estimates and Uncertainties -  The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates made in preparing the consolidated financial statements include depreciation and amortization periods, the allowance for doubtful accounts, reserves for inventory, contingent consideration, deferred taxes, uncertain tax positions, valuation allowance for deferred taxes and valuation of long-lived assets.  Actual results could materially differ from these estimates.



Revenue Recognition - The following table presents the Company’s revenue disaggregated by the principal end-user markets it serves:







During the three and six month periods ending October 31, 2019, no revenues were recognized from performance obligations satisfied or partially satisfied in previous periods and no amounts were allocated to performance obligations that remain unsatisfied or partially unsatisfied at October 31, 2019.  The Company is electing not to disclose the value of the remaining unsatisfied performance obligation with a duration of one year or less as permitted by the practical expedient in ASU 2014-09, “Revenue from Contracts with Customers.”  The Company had no material remaining unsatisfied performance obligations as of October 31, 2019, with an expected duration of greater than one year.



Income Tax - The Company’s income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated future taxes to be paid.  The Company is subject to income taxes in both the U.S. and several foreign jurisdictions.  Significant judgments and estimates by management are required in determining the consolidated income tax expense assessment.



Deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse.  In evaluating the Company’s ability to recover its deferred tax assets within the jurisdiction from which they arise, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial

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Note H - Critical Accounting Policies - Continued



operations.  In projecting future taxable income, the Company begins with historical results and changes in accounting policies, and incorporates assumptions including the amount of future state, federal and foreign pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies.  These assumptions require significant judgment and estimates by management about the forecasts of future taxable income and are consistent with the plans and estimates the Company uses to manage the underlying businesses.  In evaluating the objective evidence that historical results provide, the Company considers three years of cumulative operating income and/or loss.  Valuation allowances are established when necessary to reduce deferred income tax assets to an amount more likely than not to be realized.    The Company’s valuation allowance was $1,372,643 and $1,294,605 as of October 31, 2019 and April 30, 2019, respectively.



Revisions - Previously reported cash flows from financing activities for the six month period ended October 31, 2018 have been revised to reflect the classification of payments and borrowings under the Company’s revolving line of credit presented in the condensed consolidated statement of cash flows. The revision had no impact on total cash flows from financing activities, net loss or net loss per share, or the condensed consolidated balance sheets or statements of operations or stockholders’ equity. See Note B, “Summary of Significant Accounting Policies” in the Company’s 2019 10-K for additional information on these revisions.



New Accounting Standards:



In February 2016, the FASB issued ASU 2016-02, as amended, Leases (Topic 842), which requires a lessee to record a right-of-use asset and a lease liability for all leases with a term greater than twelve months regardless of whether the lease is classified as an operating lease or a financing lease.



Effective May 1, 2019, the Company adopted the new standard under the modified retrospective approach, applying the current-period adjustment method.  Under the transition guidance of the modified retrospective approach there are a number of optional practical expedients made available to simplify the transition of the new standard. The Company has elected the following:



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Note H - Critical Accounting Policies - Continued



Upon adoption, the Company recorded Right-of-use ("ROU") assets and lease liabilities relating to operating leases of $6,017,771 and $6,290,289, respectively. The changes did not have a material impact on our results of operations or cash flows. The discount rates used to calculate the ROU assets and lease liabilities as of the effective date were based on the remaining lease terms as of the effective date. See Note J - Leases, for the impact on the financial statements and related disclosures from the adoption of this standard.



In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13, as amended by ASU 2019-04 and ASU 2019-05, introduces a new forward-looking approach, based on expected losses, to estimate credit losses on certain types of financial instruments, including trade receivables. The estimate of expected credit losses will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts.  This ASU also expands the disclosure requirements to enable users of financial statements to understand the entity’s assumptions, models and methods for estimating expected credit losses. For small reporting companies, ASU 2016-13 is effective for annual and interim reporting periods beginning after December 15, 2022, and the guidance is to be applied using the modified-retrospective approach. Earlier adoption is permitted for annual and interim reporting periods beginning after December 15, 2018. The Company is currently evaluating the new guidance and has not determined the impact this ASU may have on its consolidated financial statements.



Note I - Related Parties



In March, 2015, two of the Company’s executive officers invested in a start-up customer, Petzila, Inc. (“Petzila”).  The executive officers’ investments constituted less than 2% (individually and in aggregate) of the outstanding beneficial ownership of Petzila, according to information provided by Petzila to the executive officers.  



On April 30, 2018, the Company foreclosed on its security interest and held a public sale of the assets in accordance with the requirements of Article 9 of the California Uniform Commercial Code.  The Company acquired all of the assets of Petzila as the winning bidder at the public sale by a credit bid of $3,500,000, the aggregate amount of Petzila’s liability to the company. Concurrent with the foreclosure sale, the Company entered into an Asset Purchase Agreement with Wagz, Inc. (“Wagz”), an “unrelated party,” whereby the Company sold the assets to Wagz for $350,000 cash, 600,000 shares of Wagz common stock and an earn-out based on sales by Wagz generated from use of the assets through July 31, 2022.  The earn-out is $6.00 per unit of a product specified in the asset purchase agreement and any upgrade to such product.



The fair value of the non-cash consideration consisted of $600,000 for the 600,000 shares of Wagz common stock which is recorded within other assets.  The Company determined the fair value of the equity using the price per common share received by Wagz in a recent financing transaction, a level 3 input.  As of April 30, 2019 and October 31, 2019, the Company did not assign any value to the earn-out because any receipts from the earn-out are highly uncertain and contingent upon Wagz selling the product specified in the asset purchase agreement between the Company and Wagz.



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Note J - Leases



The Company leases office and storage space, vehicles and other equipment under non-cancellable operating leases with initial terms typically ranging from 1 to 5 years.  At contract inception, the Company reviews the facts and circumstances of the arrangement to determine if the contract is or contains a lease.  The Company follows the guidance in Topic 842 to evaluate whether the contract has an identified asset; if the Company has the right to obtain substantially all economic benefits from the asset; and if the Company has the right to direct the use of the underlying asset.  When determining if a contract has an identified asset, the Company considers both explicit and implicit assets, and whether the supplier has the right to substitute the asset.  When determining if the Company has the right to direct the use of an underlying asset, the Company considers if they have the right to direct how and for what purpose the asset is used throughout the period of use and if they control the decision-making rights over the asset.



The Company’s lease terms may include options to extend or terminate the lease.  The Company exercises judgment to determine the term of those leases when extension or termination options are present and include such options in the calculation of the lease term when it is reasonably certain that it will exercise those options.



The Company has elected to include both lease and non-lease components in the determination of lease payments. Payments made to a lessor for items such as taxes, insurance, common area maintenance, or other costs commonly referred to as executory costs, are also included in lease payments if they are fixed. The fixed portion of these payments are included in the calculation of the lease liability, while any variable portion would be recognized as variable lease expenses, when incurred. Variable payments made to third parties for these, or similar costs, such as utilities, are not included in the calculation of lease payments.



At commencement, lease-related assets and liabilities are measured at the present value of future lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, the Company exercises judgment in determining the incremental borrowing rate based on the information available at when the lease commences to measure the present value of future payments.



Operating lease expense is recognized on a straight-line basis over the lease term. Finance lease cost includes amortization, which is recognized on a straight-line basis over the expected life of the leased asset, and interest expense, which is recognized following an effective interest rate method.



Operating leases are included in other assets, current operating lease obligations, and operating lease obligations (less current portion) on the Company’s consolidated balance sheet. Finance leases are included in property, plant and equipment and current and long-term portion of finance lease obligations on the Company’s consolidated balance sheet. Short term leases with an initial term of 12 months or less are not presented on the balance sheet with expense recognized as incurred.

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Note J - Leases - Continued



The following table presents lease assets and liabilities and their balance sheet classification:



The components of lease expense for the three and six month periods ended October 31, 2019, are as follows:







The weighted average lease term and discount rates are as follows:





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Note J - Leases - Continued



Future payments due under leases reconciled to lease liabilities are as follows:







Supplemental disclosures of cash flow information related to leases are as follows:











 

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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.



In addition to historical financial information, this discussion of the business of SigmaTron International, Inc. (“SigmaTron”), its wholly-owned subsidiaries Standard Components de Mexico S.A., AbleMex, S.A. de C.V., Digital Appliance Controls de Mexico, S.A. de C.V., Spitfire Controls (Vietnam) Co. Ltd., Spitfire Controls (Cayman) Co. Ltd., wholly-owned foreign enterprises Wujiang SigmaTron Electronics Co., Ltd. and SigmaTron Electronic Technology Co., Ltd. (collectively, “SigmaTron China”) and international procurement office SigmaTron Taiwan branch (collectively, the “Company”) and other Items in this Quarterly Report on Form 10-Q contain forward-looking statements concerning the Company’s business or results of operations.  Words such as “continue,” “anticipate,” “will,” “expect,” “believe,” “plan,” and similar expressions identify forward-looking statements.  These forward-looking statements are based on the current expectations of the Company.  Because these forward-looking statements involve risks and uncertainties, the Company’s plans, actions and actual results could differ materially.  Such statements should be evaluated in the context of the risks and uncertainties inherent in the Company’s business including, but not necessarily limited to, the Company’s continued dependence on certain significant customers; the continued market acceptance of products and services offered by the Company and its customers; pricing pressures from the Company’s customers, suppliers and the market; the activities of competitors, some of which may have greater financial or other resources than the Company; the variability of the Company’s operating results; the results of long-lived assets impairment testing; the collection of aged account receivables; the variability of the Company’s customers’ requirements; the availability and cost of necessary components and materials; the ability of the Company and its customers to keep current with technological changes within its industries; regulatory compliance, including conflict minerals; the continued availability and sufficiency of the Company’s credit arrangements; the ability to meet the Company’s financial covenant; changes in U.S., Mexican, Chinese, Vietnamese or Taiwanese regulations affecting the Company’s business; the turmoil in the global economy and financial markets; the stability of the U.S., Mexican, Chinese, Vietnamese and Taiwanese economic, labor and political systems and conditions; currency exchange fluctuations; and the ability of the Company to manage its growth.  These and other factors which may affect the Company’s future business and results of operations are identified throughout the Company’s Annual Report on Form 10-K, and as risk factors, may be detailed from time to time in the Company’s filings with the Securities and Exchange Commission.  These statements speak as of the date of such filings, and the Company undertakes no obligation to update such statements in light of future events or otherwise unless otherwise required by law.

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Overview:



The Company operates in one business segment as an independent provider of EMS, which includes printed circuit board assemblies and completely assembled (box-build) electronic products.  In connection with the production of assembled products, the Company also provides services to its customers, including (1) automatic and manual assembly and testing of products; (2) material sourcing and procurement; (3) manufacturing and test engineering support; (4) design services; (5) warehousing and distribution services; and (6) assistance in obtaining product approval from governmental and other regulatory bodies.  The Company provides these manufacturing services through an international network of facilities located in the United States, Mexico, China, Vietnam and Taiwan.



The Company relies on numerous third-party suppliers for components used in the Company’s production process.  Certain of these components are available only from single-sources or a limited number of suppliers.  In addition, a customer’s specifications may require the Company to obtain components from a single-source or a small number of suppliers.  The loss of any such suppliers could have a material impact on the Company’s results of operations.  Further, the Company could operate at a cost disadvantage compared to competitors who have greater direct buying power from suppliers.  The Company does not enter into long-term purchase agreements with major or single-source suppliers.  The Company believes that short-term purchase orders with its suppliers provides flexibility, given that the Company’s orders are based on the changing needs of its customers.



Sales can be a misleading indicator of the Company’s financial performance.  Sales levels can vary considerably among customers and products depending on the type of services (turnkey versus consignment) rendered by the Company and the demand by customers.  Consignment orders require the Company to perform manufacturing services on components and other materials supplied by a customer, and the Company charges only for its labor, overhead and manufacturing costs, plus a profit.  In the case of turnkey orders, the Company provides, in addition to manufacturing services, the components and other materials used in assembly.  Turnkey contracts, in general, have a higher dollar volume of sales for each given assembly, owing to inclusion of the cost of components and other materials in net sales and cost of goods sold.  Variations in the number of turnkey orders compared to consignment orders can lead to significant fluctuations in the Company’s revenue and gross margin levels.  Consignment orders accounted for less than 1% of the Company’s revenues for the three and six month periods ended October 31, 2019 and 2018, respectively. 



The Company’s international footprint provides our customers with flexibility within the Company to manufacture in China, Mexico, Vietnam or the U.S.  We believe this strategy will continue to serve the Company well as its customers continuously evaluate their supply chain strategies.



The Company had a solid second quarter in fiscal year 2020.  As stated in the Company’s press release for the first quarter of fiscal year 2020, it anticipated these results based on the trend going into the second fiscal quarter. These results were driven by higher gross margins, lower operating costs and reduced interest expense resulting from significant reductions in inventory.  The inventory reduction also improved the Company’s liquidity provided under the line of credit.  These positive factors were offset in part by continuing increases in cost of labor and some significant misses in projections by several key customers. Heading into the third quarter of fiscal 2020 the Company is less optimistic and has seen some negative trends in the first part of the third fiscal quarter.  There is no doubt that the China trade war is negatively affecting revenue and operations as the uncertainty and volatility caused by this trade war continues to impact customer sentiment regarding the overall economy.  That, coupled with the usual holiday slowdown and customers managing year-end inventory levels, leads the Company to expect a slower than anticipated November and December in 2019.  However, the

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Company believes the business will bounce back positively in January 2020 and continue at a good level for the balance of the current fiscal year. However, continuing volatility could change those forecasts quickly.  Also, impacting the positive trend from January 2020 forward are several new programs and new customers that will be starting up early in calendar year 2020. 



In terms of our supply chain, the Company has continued to see slight improvements in lead times and some modest cost reductions in several component categories, but those have generally been offset by some increased lead times and price increases in other categories.  The trend is better than it was a year ago but the environment still has the ability to negatively affect margins and production efficiencies.   



Results of Operations:



The following table sets forth selective financial data as a percentage of net sales for the periods indicated.





Net Sales



Net sales decreased for the three month period ended October 31, 2019, to $74,855,312 from $77,001,091 for the three month period ended October 31, 2018.  Net sales increased for the six month period ended October 31, 2019 to $148,865,293 from $148,415,148 for the six month period ended October 31, 2018.  The Company’s sales decreased for the three month period ended October 31, 2019, as compared to the prior year in the consumer electronics and industrial electronics marketplaces.  The decrease in sales dollars for these marketplaces was partially offset by an increase in sales dollars in the medical/life sciences marketplace.  The Company’s sales increased for the six month period ended October 31, 2019, as compared to the prior year in the industrial electronics and medical/life sciences marketplaces.  The increase in sales dollars for these marketplaces was partially offset by a decrease in sales dollars in the consumer electronics marketplace. 



Gross Profit



Gross profit dollars increased during the three month period ended October 31, 2019, to $7,129,486 or 9.5% of net sales compared to $6,694,085 or 8.7% of net sales for the same period in the prior fiscal year.  Gross profit dollars increased during the six month period ended October 31, 2019, to $14,089,818 or 9.5% of net sales compared to $12,483,141 or 8.4% of net sales for the same period in the prior fiscal year.  The increase in gross profit for the three and six month periods ended October 

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31, 2019, was the result of better pricing, lower operating costs and product mix compared to the same period in the prior year. 



Selling and Administrative Expenses



Selling and administrative expenses decreased to $5,700,288 or 7.6% of net sales for the three month period ended October 31, 2019, compared to $5,817,155 or 7.6% of net sales for the same period in the prior fiscal year.  The net decrease in selling and administrative expenses for the three month period ended October 31, 2019, was attributable to sales salaries, financing fees and other professional fees.  The decrease in the foregoing selling and administrative expenses was partially offset by an increase in general insurance, accounting professional fees and bonus expense.  Selling and administrative expenses decreased to $11,527,614 or 7.7% of net sales for the six month period ended October 31, 2019, compared to $11,751,271 or  7.9% of net sales for the same period in the prior fiscal year.  The net decrease in selling and administrative expenses for the six month period ended October 31, 2019, was attributable to sales salaries, financing fees and other professional fees.  The decrease in the foregoing selling and administrative expenses was partially offset by an increase in general insurance, accounting professional fees and bonus expense.



Interest Expense



Interest expense decreased to $462,772 for the three month period ended October 31, 2019, compared to $602,858 for the same period in the prior fiscal year.  Interest expense decreased to $1,054,000 for the six month period ended October 31, 2019, compared to $1,156,348 for the same period in the prior fiscal year.  The decrease in interest expense for the three and six month periods ended October 31, 2019, was due to lower borrowing levels compared to the same period in the prior year.  Interest expense for future quarters may fluctuate depending on interest rates and borrowing levels.



Income Tax Expense



The income tax expense was $316,106 for the three month period ended October 31, 2019, compared to an income tax expense of $1,125,992 for the same period in the prior fiscal year.  The Company’s effective tax rate was 32.35% and 280.06% for the three month period ended October 31, 2019 and 2018, respectively.  The income tax expense was $563,221 for the six month period ended October 31, 2019, compared to an income tax expense of $928,986 for the same period in the prior fiscal year.  The Company’s effective tax rate was 35.52% and (288.9)% for the six month period ended October 31, 2019 and 2018, respectively.  The decrease in income tax expense for both the three month and six month periods ended October 31, 2019 and the decrease in the effective tax rate for the three month period ended October 31, 2019 compared to the same periods in the previous year is due primarily to a discrete income tax expense of $457,011 in the prior year as the result of a valuation allowance established on certain foreign net operating loss carryforwards. The increase in effective tax rate for the six month period in the current year compared to the same period in the previous year is due primarily to an overall loss that was recognized in the prior year compared to income recognized in the current year.



Net Income



Net income increased to $661,183 for the three month period ended October 31, 2019, compared to net loss of $723,941 for the same period in the prior fiscal year.  Net income increased to $1,022,208 for the six month period ended October 31, 2019, compared to net loss of $1,250,548 for the same period in the prior fiscal year.  Basic and diluted earnings per share for the second quarter of fiscal year 2020 

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were $0.16 and $0.15, respectively, compared to basic and diluted loss per share of $0.17 for the same period in the prior fiscal year.  Basic and diluted earnings per share for the six month period ended October 31, 2019 were $0.24, compared to basic and diluted loss per share of $0.30 for the same period in the prior fiscal year.  The increase in net income and earnings per share are due to the results of operations described above, mainly from an increase in gross profit.



Liquidity and Capital Resources:



Operating Activities.



Cash flow provided by operating activities was $11,392,857 for the six months ended October 31, 2019.  During the first six months of fiscal year 2020, cash flow provided by operating activities was primarily the result of net income, a  decrease in inventory of $14,164,330, a decrease in accounts receivable of $1,516,504 and an increase in accrued expenses and wages.   The decrease in inventory is primarily the result of the implementation of an inventory reduction program.  Cash flow provided by operating activities was partially offset by the result of a decrease in accounts payable of $10,673,778.



Cash flow used in operating activities was $3,889,103 for the six months ended October 31, 2018.  During the first six months of fiscal year 2019, cash flow used in operating activities was primarily the result of an increase in accounts receivable in the amount of $7,310,364, an increase in inventory of $2,472,799 and the reported net loss.  The increase in accounts receivable is the result of increased sales.  The increase in inventory is the result of an increase in customer orders and in some cases orders being pushed out.  Further, capacity issues in the component industry made it difficult to obtain some components to complete assemblies for shipping.  Cash flow used in operating activities was partially offset by the result of an increase in accounts payable, accrued expenses and wages excluding the non-cash effects of depreciation and amortization.



Investing Activities.



During the first six months of fiscal year 2020, the Company purchased $588,334 in machinery and equipment to be used in the ordinary course of business.  The Company has received forecasts from current customers for increased business that would require additional investment in capital equipment and facilities.  To the extent that these forecasts come to fruition, the Company anticipates that it will make additional machinery and equipment purchases in fiscal year 2020.  The Company anticipates purchases will be funded by lease transactions.



During the first six months of fiscal year 2019, the Company purchased $1,528,211in machinery and equipment used in the ordinary course of business.  The Company made additional machinery and equipment purchases of $833,418 during the balance of fiscal year 2019.



Financing Activities.



Cash used in financing activities of $8,339,867 for the six months ended October 31, 2019, was primarily the result of net payments under the line of credit.



Cash provided by financing activities of $5,424,834 for the six months ended October 31, 2018, was primarily the result of net borrowings under the line of credit.





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Financing Summary.



Notes Payable – Banks



On March 31, 2017, the Company entered into a $35,000,000 senior secured credit facility with U.S. Bank, which expires on March 31, 2022.  The credit facility is collateralized by substantially all of the Company’s domestically located assets. The facility allows the Company to choose among interest rates at which it may borrow funds:  the bank fixed rate of five percent or LIBOR plus one and one half percent (effectively 3.44% at October 31, 2019).  Interest is due monthly. 



On July 16, 2018, the Company and U.S. Bank entered into an amendment of the revolving line of credit under the senior secured credit facility.  The amended revolving credit facility allows the Company to borrow up to the lesser of (i) $45,000,000 (the “Revolving Line Cap”) less reserves or (ii) the Borrowing Base, but no more than 90% of the Company’s Revolving Line Cap, except that the 90% limitation will expire if (i) the Company’s actual revolving loans for 90 consecutive days after the amendment’s effective date are less than 80% of the Company’s Borrowing Base and (ii) the Company maintains a Fixed Charge Coverage Ratio of 1.2 to 1.0 for four consecutive quarters.  The amendment also imposes sublimits on categories of inventory equal to $10,500,000 on raw materials, $10,000,000 on finished goods and $28,000,000 on all eligible inventory. 



On December 13, 2018, the Company and U.S. Bank entered into an amendment of the revolving credit facility.  The amendment provides an exception to otherwise ineligible foreign receivables for up to $3,000,000 of receivables paid by certain enumerated account debtors outside of the U.S. and Canada.



On August 26, 2019, the Company and U.S. Bank entered into an amendment of the revolving credit facility.  The amendment allows the Company to borrow up to the lesser of (i) the Revolving Line Cap less reserves or (ii) the Borrowing Base, but no more than 95% of the Company’s Revolving Line Cap until February 26, 2020 and 90% on and after February 26, 2020. 



As of October 31, 2019, there was $29,000,000 outstanding and $11,544,524 of unused availability under the U.S. Bank facility compared to an outstanding balance of $35,727,212 and $6,645,730 of unused availability at April 30, 2019.  At October 31, 2019, the Company was in compliance with its financial covenant and other restrictive covenants under the credit facility.  Deferred financing costs of $40,907 and $46,866 were capitalized during the three and six month periods ended October 31, 2019, respectively, which are amortized over the term of the agreement.  As of October 31, 2019 and April 30, 2019, the unamortized amount offset against outstanding debt was $216,869 and $209,162, respectively. 



On March 15, 2019, the Company’s wholly-owned subsidiary, SigmaTron Electronic Technology Co., Ltd., entered into a credit facility with China Construction Bank.  Under the agreement SigmaTron Electronic Technology Co., Ltd. can borrow up to 5,000,000 Renminbi, approximately $709,000 as of October 31, 2019, and the facility is collateralized by Wujiang SigmaTron Electronic Co., Ltd.’s manufacturing building.  Interest is payable monthly and the facility bears a fixed interest rate of 6.09%.  The term of the facility extends to March 14, 2024.  There was no outstanding balance under the facility at October 31, 2019 and April 30, 2019.









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Notes Payable – Buildings



The Company entered into a mortgage agreement on December 21, 2017, in the amount of $5,200,000, with U.S. Bank to refinance the property that serves as the Company’s corporate headquarters and its Illinois manufacturing facility in Elk Grove Village, Illinois.  The note requires the Company to pay monthly principal payments in the amount of $17,333, bears interest at a fixed rate of 4.0% per year and is payable over a fifty-one month period.  Deferred financing costs of $74,066 were capitalized in fiscal year 2018 which are amortized over the term of the agreement.  As of October 31, 2019 and April 30, 2019, the unamortized amount included as a reduction to long-term debt was $41,347 and $50,142, respectively.  A final payment of approximately $4,347,778 is due on or before March 31, 2022.  The outstanding balance was $4,836,000 and $4,940,000 at October, 31 2019 and April 30, 2019, respectively.



The Company entered into a mortgage agreement on December 21, 2017, in the amount of $1,800,000, with U.S. Bank to refinance the property that serves as the Company’s engineering and design center in Elgin, Illinois.  The note requires the Company to pay monthly principal payments in the amount of $6,000, bears interest at a fixed rate of 4.0% per year and is payable over a  fifty-one month period.  Deferred financing costs of $65,381 were capitalized in the fiscal year 2018 which are amortized over the term of the agreement.  As of October 31, 2019 and April 30, 2019,  the unamortized amount included as a reduction to long-term debt was $36,462 and $44,006, respectively.  A final payment of approximately $1,505,000 is due on or before March 31, 2022.  The outstanding balance was $1,674,000 and $1,710,000 at October, 31 2019 and April 30, 2019, respectively. 



Notes Payable – Equipment



The Company routinely enters into secured note agreements with Engencap Fin S.A. DE C.V. to finance the purchase of equipment. The terms of these secured note agreements extend to November 2021 through May 2023, with quarterly installment payments ranging from $11,045 to $37,941 and at fixed interest rates ranging from 6.65% to 8.00%.



Finance Lease and Sales Leaseback Obligations



The Company enters into various finance lease and sales leaseback agreements.  The terms of the lease agreements mature through May 2023, with monthly installment payments ranging from $1,455 to $40,173 and a fixed interest rate ranging from 3.75% to 9.40%.



Other



The Company provides funds for salaries, wages, overhead and capital expenditure items as necessary to operate its wholly-owned Mexican, Vietnam and Chinese subsidiaries and the Taiwan international procurement office.  The Company provides funding, as needed, in U.S. dollars, which are exchanged for Pesos, Dong, Renminbi, and New Taiwan dollars.  The fluctuation of currencies from time to time, without an equal or greater increase in inflation, could have a material impact on the financial results of the Company.    The impact of currency fluctuation for the six month period ended October 31, 2019 resulted in a foreign currency transaction loss of $262,306 compared to a foreign currency transaction loss of approximately $431,975 for the same period in the prior year.  Foreign currency gains or losses are recorded in the cost of products sold.  During the six months of fiscal year 2020, the Company’s U.S. operations paid approximately $26,510,000 to its foreign subsidiaries for services provided.



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Except for the impact of the Tax Act, the Company has not changed its plans to indefinitely reinvest the earnings of the Company’s foreign subsidiaries.  The cumulative amount of unremitted earnings for which U.S. income taxes have not been recorded is $9,199,000 as of October 31, 2019. 



The Company anticipates that its credit facilities, expected future cash flow from operations and leasing resources are adequate to meet its working capital requirements and fund capital expenditures for the next 12 months. However, in the event customers continue to delay orders or future payments are not made timely, the Company desires to expand its operations, its business grows more rapidly than expected, or the current economic climate deteriorates, additional financing resources may be necessary. There is no assurance that the Company will be able to obtain equity or debt financing at acceptable terms, or at all, in the future.  There is no assurance that the Company will be able to retain or renew its credit agreements in the future, or that any retention or renewal will be on the same terms as currently exist.



The impact of inflation on the Company’s net sales, revenues and income from operations for the past two fiscal years has been minimal.



Off-balance Sheet Transactions:



The Company has no off-balance sheet transactions.

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Tabular Disclosure of Contractual Obligations:



As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K under the Exchange Act, the Company is not required to provide the information required by this item.

 

Item 3.Quantitative and Qualitative Disclosures About Market Risks.



As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K under the Exchange Act, the Company is not required to provide the information required by this item.



Item 4.Controls and Procedures.



Disclosure Controls:



The Company’s management, including its President and Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) and 15(d)-15(e)) as of October 31, 2019.  The Company’s disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives and its President and Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of October 31, 2019.



Internal Controls:



There has been no change in the Company’s internal control over financial reporting during the three months ended October 31, 2019, that has materially affected or is reasonably likely to materially affect, its internal control over financial reporting.  The Company’s internal controls over financial reporting are designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with U.S. GAAP.



On May 14, 2013, the Committee of Sponsoring Organizations of the Treasury Commission (“COSO”) issued an updated version of its Internal Control - Integrated Framework (the “2013 Framework”) which officially superseded COSO’s earlier Internal Control-Integrated Framework (1992) (the “1992 Framework”) on December 15, 2014. Originally issued in 1992, the framework helps organizations design, implement and evaluate the effectiveness of internal control concepts and simplify their use and application.  Based on the Company’s evaluation, management concluded that its internal controls over financial reporting were effective at the reasonable assurance level as of October 31, 2019.

 

PART II – OTHER INFORMATION



Item 1.              Legal Proceedings. 



From time to time the Company is involved in legal proceedings, claims, or investigations that are incidental to the Company’s business. In future periods, the Company could be subjected to cash cost or non-cash charges to earnings if any of these matters are resolved on unfavorable terms. However, although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including management’s assessment of the merits of any particular claim, the Company does not expect these legal proceedings or claims will have any material adverse impact on its future consolidated financial position, results of operations or cash flows.

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Item 1A.            Risk Factors.



As a smaller reporting company, as defined in Item 10(f)(1) of Regulation S-K under the Exchange Act, the Company is not required to provide the information required by this item. 



Item 2.              Unregistered Sales of Equity Securities and Use of Proceeds.



None.



Item 3.              Defaults Upon Senior Securities.



None.



Item 4.              Mine Safety Disclosures.



Not applicable.



Item 5.              Other Information.



None.

 

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Item 6.Exhibits.





 

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SIGNATURES:



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



SIGMATRON INTERNATIONAL, INC.







 



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