SIGMATRON INTERNATIONAL INC - Quarter Report: 2021 January (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 January 31, 2021



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





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 March 8,  2021:  4,257,508







 

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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 nine month period ended January 31, 2021 is not necessarily indicative of the results that may be expected for the year ending April 30, 2021.  The condensed consolidated balance sheet at April 30, 2020, 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 condensed consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended April 30, 2020. 



COVID-19 and CARES Act



A pandemic of respiratory disease (abbreviated "COVID-19") began to spread globally, including to the United States, in early 2020. On March 11, 2020, the World Health Organization (WHO) declared COVID-19 to be a public health emergency of international concern. The full impact of the COVID-19 outbreak is inherently uncertain at the time of this report. The COVID-19 outbreak has resulted in travel restrictions and in some cases, prohibitions of non-essential activities, disruption and shutdown of certain businesses and greater uncertainty in global financial markets. The full extent to which COVID-19 impacts the Company’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak within the U.S., China, Mexico, Vietnam and Taiwan, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume.

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Note B - Basis of Presentation - Continued



Even after COVID-19 has subsided, the Company may continue to experience materially adverse impacts to its business as a result of its global economic impact, including any recession that has occurred or may occur in the future. There are no comparable recent events which may provide guidance as to the effect of the spread of COVID-19, and, as a result, the ultimate impact of COVID-19, or a similar health epidemic or pandemic, is highly uncertain and subject to change. The Company has adopted several measures in response to the COVID-19 outbreak.  To date, the Company has been able to continue to meet the needs of its customers.  Although the Company cannot estimate the length or gravity of the impact of the COVID-19 outbreak at this time, if the pandemic continues, it may have a material adverse effect on the Company’s results of future operations, financial position, and liquidity for the remainder of fiscal year 2021 and beyond.



On March 27, 2020, former President Trump signed into law the “Coronavirus Aid, Relief, and Economic Security (CARES) Act.” The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, increased limitations on qualified charitable contributions, and technical corrections to tax depreciation methods for qualified improvement property. It also appropriated funds for the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP Loan”) loans that are forgivable in certain situations to promote continued employment, as well as Economic Injury Disaster Loans to provide liquidity to small businesses harmed by COVID-19.



As further described in Note E, the Company received funds under the PPP Loan in the amount of $6,282,973. The application for these funds required the Company to, in good faith, certify that the current economic uncertainty made the loan request necessary to support the ongoing operations of the Company. This certification further required the Company to take into account its current business activity and its ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The receipt of these funds, and the forgiveness of the loan attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on its adherence to the forgiveness criteria.



Due to the size of the PPP Loan, it is subject to review, which introduces a layer of uncertainty. If, despite the Company’s actions and certification that it satisfied all eligibility requirements for the PPP Loan, it is later determined that it violated applicable laws or was otherwise ineligible to receive the PPP Loan, the Company will be required to repay the PPP Loan in its entirety in a lump sum and may be subject to additional penalties, which could also result in adverse publicity and damage to the Company’s reputation. If these events were to transpire, they could have a material adverse effect on the Company’s business, results of operations, financial condition and liquidity for the remainder of fiscal year 2021 and beyond.





 

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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 513,232 shares of common stock were outstanding at January 31, 2021 and 2020.  There were no options granted during the nine month periods ended January 31, 2021 and 2020.  There was no stock option expense recognized for the three and nine month periods ended January 31, 2021 and 2020.  There was no balance of unrecognized compensation expense related to the Company’s stock option plans at January 31, 2021 and 2020.  For the three month period ended January 31, 2021 and 2020,  143,781 and 151,282 shares, respectively, were not included in the diluted weighted average common shares outstanding calculation as they were anti-dilutive.  For the nine month periods ended January 31, 2021 and 2020,  240,160 and 214,177 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 January 31, 2021 and April 30, 2020:







Notes Payable – Banks



Prior to January 29, 2021, the Company had a senior secured credit facility with U.S. Bank.  The  revolving credit facility allowed 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 80% of the Company’s Revolving Line Cap.  Prior to its payoff and termination, the U.S. Bank senior secured credit facility was due to expire on March 31, 2022.  On January 29, 2021, the Company paid the balance outstanding under the senior secured credit facility in the amount of $25,574,733.  The unamortized deferred financing costs of $158,476 were expensed in the third quarter of fiscal 2021 upon extinguishment of the debt.



On January 29, 2021, the Company entered into a Credit Agreement (the “Agreement”) with JPMorgan Chase Bank, N.A. (“Lender”), pursuant to which Lender has agreed to provide the Company with a secured revolving credit facility of up to $50,000,000 (the “Facility”) maturing on January 29, 2026.    



The Facility allows the Company to choose among interest rates at which it may borrow funds for revolving loans:  “CBFR Loans,” the interest on which is based on (A) the REVLIBOR30 Rate unless the “REVLIBOR30 Rate” (as defined in the agreement) is not available, in which case the interest is generally the rate of interest last quoted by The Wall Street Journal as the “Prime Rate” in the U.S., plus (B) an applicable margin of 2.0% (effectively 2.25% at January 31, 2021),; or “Eurodollar Loans,” the interest on which is based on (X) an interest rate per annum (rounded upwards, if necessary, to the next 1/16 of 1%) equal to the LIBO Rate (as defined in the Agreement) for any



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Note E - Long-term Debt - Continued 



interest period multiplied by the Standard Reserve Rate (as defined in the Agreement) plus (Y) an applicable margin of 2.0%.  Under the  Facility, the Company may borrow up to the lesser of (i) $50,000,000 or (ii) an amount equal to a percentage of the eligible receivable borrowing base plus a percentage of the inventory borrowing base.  The Facility is collateralized by a lien on substantially all of the domestic assets of the Company.  Under the Agreement, a  minimum Fixed Charge Coverage Ratio (“FCCR”) financial covenant of 1.10x is applicable only during an FCCR trigger period which occurs when (i) an event of default (as defined in the Agreement) has occurred and is continuing, and Lender has elected to impose a FCCR trigger period upon notice to the Company or (ii) availability falls below the greater of (i) 10% of the revolving commitment and (ii) the outstanding principal amount of the term loans.  Deferred financing costs of $354,454 were capitalized in the third quarter of fiscal 2021 and will be amortized over the term of the agreement.  As of January  31, 2021, there was $25,584,380 outstanding and $10,390,073 of unused availability under the JPMorgan Chase Bank, N.A. facility compared to an outstanding balance of $26,884,494 and $13,850,575 of unused availability under the U.S. Bank senior secured credit facility at April 30, 2020.  As of January 31, 2021 and April 30, 2020, the unamortized amount offset against outstanding debt was $351,204 and $218,062, respectively. 



On April 23, 2020, the Company received a PPP Loan from U.S. Bank, as lender, pursuant to the CARES Act, as administered by the SBA in the amount of $6,282,973. The PPP Loan, in the form of a promissory note, matures on April 23, 2022.  No additional collateral or guarantees were provided by the Company for the PPP Loan. The PPP Loan provides for customary events of default.  Under the CARES Act, loan forgiveness may be available for the sum of documented payroll costs, rent payments, mortgage interest and covered utilities during the 24-week period beginning on the date of loan disbursement.  The amount of loan forgiveness will be reduced if recipients terminate employees or reduce salaries during the covered period.  The Company will be required to repay any portion of the outstanding principal that is not forgiven, along with accrued interest, and it cannot provide any assurance that it will be eligible for loan forgiveness, or that any amount of the PPP Loan will ultimately be forgiven by the SBA.  All aspects of the PPP Loan are subject to review by the SBA, including without limitation, the Company’s eligibility for and the size of the loan.  The review procedures have not been made public.  The Company cannot predict the outcome of that review nor be assured that all or any part of the PPP Loan will be forgiven.  To the extent that all or part of the PPP Loan is not forgiven, the Company will be required to make payments, including interest accruing at an annual interest rate of 1.0%, beginning on the date of disbursement.



On March 15, 2019, the Company’s wholly-owned subsidiary, SigmaTron Electronic Technology Co., Ltd., entered into a credit facility with China Construction Bank.  On January 26, 2021, the agreement was amended.  Under the agreement SigmaTron Electronic Technology Co., Ltd. can borrow up to 9,000,000 Renminbi, approximately $1,391,000 as of January 31, 2021, and the facility is collateralized by Wujiang SigmaTron Electronics Co., Ltd.’s manufacturing building.  Interest is payable monthly and the facility bears a fixed interest rate of 3.85%.  The term of the facility extends to January 6, 2022.  There was no outstanding balance under the facility at January 31, 2021 compared to an outstanding balance of $304,658 at April 30, 2020.

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Note E - Long-term Debt - Continued 



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 required the Company to pay monthly principal payments in the amount of $17,333, bore interest at a fixed rate of 4.0% per year and was payable over a fifty-one month period.  Deferred financing costs of $74,066 were capitalized in fiscal year 2018 which were amortized over the term of the agreement.  On January 29, 2021, the Company repaid its U.S. Bank mortgage agreement for the remaining amount outstanding of $4,576,000, using proceeds from the JPMorgan Chase Bank, N.A. mortgage agreement.  The Company recorded a prepayment penalty of $120,842 in the third quarter of fiscal 2021.  The remaining deferred financing costs of $21,365 were expensed in the third quarter of fiscal 2021.



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 required the Company to pay monthly principal payments in the amount of $6,000, bore interest at a fixed rate of 4.0% per year and was payable over a fifty-one month period.  Deferred financing costs of $65,381 were capitalized in the fiscal year 2018 which were amortized over the term of the agreement.  On January 29, 2021, the Company repaid its U.S. Bank mortgage agreement for the remaining amount outstanding of $1,584,000, using proceeds from the JPMorgan Chase Bank, N.A. mortgage agreement.  The Company recorded a prepayment penalty of $41,830 in the third quarter of fiscal 2021.    The remaining deferred financing costs of $18,859 were expensed in the third quarter of fiscal 2021.



The Company entered into two term notes on January 29, 2021, in the aggregate amount of $6,500,0000, with JPMorgan Chase Bank, N.A. secured against certain properties owned by the Company.  The notes require the Company to pay monthly aggregate principal payments in the amount of $36,111 and bears interest at (A) the REVLIBOR30 Rate, unless the REVLIBOR30 Rate is not available, in which case the interest is generally the rate of interest last quoted by The Wall Street Journal as the “Prime Rate” in the U.S., plus (B) an applicable margin of 2.0%; (effectively 2.75% at January 31, 2021) and is payable over a sixty month period.  Deferred financing costs of $10,050 were capitalized in the third quarter of fiscal 2021 which are amortized over the term of the agreement.  As of January 31, 2021, the unamortized amount included as a reduction to long-term debt was $10,050.  Final payments of approximately $4,368,444 is due on or before January 31, 2026.  The outstanding balance was $6,500,000 at January 31, 2021.



The Company entered into a mortgage agreement on March 3, 2020, in the amount of $556,000, with The Bank and Trust SSB to purchase the property that serves as the Company’s warehousing and distribution center in Del Rio, Texas.  The note requires the Company to pay monthly installment payments in the amount of $6,103, bears interest at a fixed rate of 5.75% per year and is payable over a 120 month period.  The outstanding balance was $520,859 and $552,561 at January 31, 2021 and April 30, 2020, respectively. 



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Note E - Long-term Debt - Continued



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 mature from November 2021 through May 2023, with quarterly installment payments ranging from $11,045 to $37,941 and a fixed interest rate ranging from 6.65% to 8.00%.



The Company routinely enters into secured note agreements with FGI Equipment Finance LLC to finance the purchase of equipment. The terms of these secured note agreements mature from March 2025 through October 2025, with quarterly installment payments ranging from $10,723 to $69,439 and a fixed interest rate of 8.25%.



Annual maturities of the Company’s debt, net of deferred financing fees for the remaining periods as of January 31, 2021, are as follows:







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 June 2024, with monthly installment payments ranging from $1,455 to $40,173 and a fixed interest rate ranging from 3.75% to 12.73%.  





Note F - Income Tax



The income tax benefit was $25,910 for the three month period ended January 31, 2021 compared to an income tax benefit of $102,731 for the same period in the prior fiscal year.  The Company’s effective tax rate was (11.60)% and 32.13% for the quarters ended January 31, 2021 and 2020, respectively.  The income tax expense was $196,199 for the nine month period ended January 31, 2021 compared to an income tax expense of $460,490 for the same period in the prior fiscal year.  The Company’s effective tax rate was 114.29% and 36.40% for the nine month period ended January 31, 2021 and 2020, respectively.  The decrease in income tax benefit and effective tax rate for the three

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Note F - Income Tax - Continued



month period ended January 31, 2021 compared to the same period in the previous year is due to income recognized in the current quarter compared to a loss in the previous year, and variations in income earned by jurisdiction. The decrease in income tax expense and increase in effective tax rate for the nine month period ended January 31, 2021 compared to the same period in the previous year is due to a decrease in income in the current nine month period compared to the same period in the previous year and variations in income earned by jurisdiction.             



As described in Note E, the Company received a PPP Loan under the CARES Act of $6,282,963. For federal income tax purposes, the CARES Act expressly provides that any forgiveness or cancellation of all or part of such loans will not be treated as income for tax purposes. On January 6, 2021 the IRS issued Revenue Ruling 2021-02 allowing deductions for the payments of eligible expenses when such payments would result in the forgiveness of a loan under the PPP. The ruling supersedes previous IRS guidance stating that such deductions would be disallowed. 



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 $4,705,000 as of January 31, 2021. 



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.



Note H - Significant 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, lower of cost or net realizable value for inventory, deferred income, deferred taxes, uncertain tax positions, valuation

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Note H - Significant Accounting Policies - Continued



allowance for deferred taxes and valuation of long-lived assets.  Actual results could materially differ from these estimates.



The potential impact of future disruptions and continued economic uncertainty over COVID-19 may have a significant adverse impact on the timing of delivery of customer orders and the levels of future customer orders.  It is reasonably possible that these potential adverse impacts may result in the recognition of material impairments of the Company’s long-lived assets or other related charges in future periods.



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





During the three and nine month periods ending January 31, 2021,  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 January 31, 2021.  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 January 31, 2021, 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 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

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Note H - Significant Accounting Policies - Continued



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 $969,149 and $989,194 as of January 31, 2021 and April 30, 2020, respectively.



Investment in Wagz - The Company has recorded an investment in Wagz Inc. (“Wagz”), a privately held company whose equity does not have a readily determinable fair value.  As permitted by ASC 321, Investments - Equity Securities, paragraph 321-35-2, the Company has elected to carry its investment in Wagz equity at its cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or a similar investment of the same issuer until the investment no longer qualifies to be measured under paragraph 321-35-2.  At January 31, 2021 and April 30, 2020, the Company continued to recognize the fair value of the Wagz common stock at $600,000.    



On May 29, 2020, Wagz entered into a Convertible Secured Promissory Note with the Company in the principal sum of up to $4,052,478.  On January 27, 2021, Wagz entered into an additional Convertible Secured Promissory Note with the Company in the principal sum of up to $1,588,328.    The outstanding principal amount of the Notes are due and payable on the earliest to occur of (1) August 31, 2021; (2) upon the closing of a sale of all or substantially all of the assets or common stock of  Wagz; or (3) an event of default (the Maturity Date). Interest is payable at the rate of four percent (4%) per annum and is payable on the Maturity Date. The notes are collateralized against substantially all assets of Wagz.  At January 31, 2021,  $5,539,594 was outstanding under other receivables.



On June 4, 2020, the Company and Wagz announced that they had executed a letter of intent (“LOI”) relating to a proposed business combination.  Subject to the terms and conditions set forth in the LOI, the Company expects to issue approximately 2,443,870 shares of its common stock that would result in the stockholders of Wagz owning in the aggregate approximately one-third of the combined company.  The parties expect the transaction to close by the end of the fourth quarter of fiscal year 2021 and the acquisition remains subject to achievement of certain milestones and satisfaction of conditions by both parties prior to closing such as finalizing a material definitive agreement,  the Company potentially raising additional capital that it projects will be needed for the expanded operations, and the approval by the stockholders of both the Company and Wagz. 



In November 2020, Wagz sought short-term financing for its operations and secured a commitment from Angel Business Credit, LLC (“ABC”) for a loan of $250,000 conditioned on Wagz granting ABC a security interest in its assets and Gary R. Fairhead executing a personal guaranty.  Mr. Fairhead is the Company’s President and CEO; his personal guaranty requires the approval of the Audit Committee of the Company’s Board of Directors.  After consideration, the Audit Committee determined that Mr. Fairhead’s guaranty was in the best interests of the Company and approved the guaranty.  The loan closed on November 12, 2020, and its principal, plus interest equal to $5,000,  were due on the maturity date, December 10, 2020.  The loan was paid in full on December 8, 2020.  As a result, Mr. Fairhead’s guaranty was cancelled and ABC’s security interest was terminated.



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Note H - Significant Accounting Policies – Continued



New Accounting Standards:



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.



In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes”, which intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application of Topic 740. This guidance is effective for fiscal years beginning after December 15, 2020, including interim periods therein, and early adoption is permitted. Adoption of Topic 740 is not expected to have a material effect on the Company’s consolidated financial statements.    If in a future interim reporting period the Company recognizes a year-to-date loss in excess of its forecasted full-year loss in a certain jurisdiction, the adoption of this ASU could affect how much tax benefit is recorded in an interim period related to that loss.  



In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”, which provides optional guidance for a period of time to ease the potential burden in accounting for the transition from reference rates that are expected to be discontinued. Regulators and market participants in various jurisdictions have undertaken efforts to eliminate certain reference rates and introduce new reference rates that are based on a larger and more liquid population of observable transactions. The changes provide optional expedients and exceptions for applying US GAAP to contract, hedging relationships and other transactions affected by reference rate reform. ASU 2020-04 is effective for all entities as of March 12, 2020 and can be adopted no later than December 31, 2022. The Company is currently evaluating the new guidance and has not determined the impact this ASU may have on its consolidated financial statements.







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Note I – 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 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 I – Leases – Continued



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



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Note I – Leases – Continued



The components of lease expense for the three and nine month periods ended January 31, 2021 and 2020, are as follows:







The weighted average lease term and discount rates for the quarter ended January 31, 2021 and 2020, are as follows:





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Note I – Leases – Continued



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







Supplemental disclosures of cash flow information related to leases for the nine months ended January 31, 2021 and 2020 are as follows: