NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1—OUR BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Our Business

 

IEC Electronics Corp. (“IEC” or the “Company”) provides electronic manufacturing services (“EMS”) to advanced technology companies that produce life-saving and mission critical products for the medical, industrial, aerospace and defense sectors. The Company specializes in delivering technical solutions for the custom manufacture of complex full system assemblies by providing on-site analytical testing laboratories, custom design and test engineering services combined with a broad array of manufacturing services encompassing electronics, interconnect solutions, and precision metalworking. As a full service EMS provider, IEC holds all appropriate certifications for the market sectors it supports including ISO 9001:2008, AS9100D, ISO 13485, and Nadcap.  IEC is headquartered in Newark, NY and also has operations in Rochester, NY and Albuquerque, NM.  Additional information about IEC can be found on its web site at www.iec-electronics.com . The contents of this website are not incorporated by reference into this quarterly report.

 

Generally Accepted Accounting Principles

 

IEC’s financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), as set forth in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”).

 

Fiscal Calendar

 

The Company’s fiscal year ends on September 30th and the first three quarters generally end on the Friday closest to the last day of the calendar quarter. For the fiscal year ending September 30, 2018 (“fiscal 2018 ”), the fiscal quarters end on December 29, 2017 , March 30, 2018 and June 29, 2018 . For the fiscal year ended September 30, 2017 (“fiscal 2017 ”), the fiscal quarters ended on December 30, 2016 , March 31, 2017 and June 30, 2017 .

 

Consolidation

 

The consolidated financial statements include the accounts of IEC and its wholly-owned subsidiaries: IEC Electronics Wire and Cable, Inc. (“Wire and Cable”) which merged into IEC on December 28, 2016; IEC Electronics Corp-Albuquerque (“Albuquerque”); IEC Analysis & Testing Laboratory, LLC (“ATL”); and IEC California Holdings, Inc. The Rochester unit, formerly Celmet, operates as a division of IEC. All intercompany transactions and accounts are eliminated in consolidation. 

Unaudited Financial Statements

 

The accompanying unaudited condensed consolidated financial statements for the three and six months ended March 30, 2018 and March 31, 2017 have been prepared without an audit pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and do not include certain of the information the footnotes require by GAAP for complete financial statements.  In the opinion of management, all adjustments, consisting of normal recurring adjustments, required for a fair presentation of the information have been made.  The accompanying financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2017 .

   

Cash

 

The Company’s cash represents deposit accounts with Manufacturers and Traders Trust Company (“M&T Bank”), a banking corporation headquartered in Buffalo, NY. The Company's cash management system provides for the funding of the disbursement accounts on a daily basis as checks are presented for payment. Under this system, outstanding checks in excess of the bank balance create a book overdraft. Book overdrafts are presented in accounts payable in the condensed consolidated balance sheets. Changes in the book overdrafts are presented within net cash flows provided by operating activities within the condensed consolidated statements of cash flows.

 

Allowance for Doubtful Accounts

 

The Company establishes an allowance for doubtful accounts receivable based on the age of outstanding invoices and management’s evaluation of collectability.  Accounts are written off after all reasonable collection efforts have been exhausted and management concludes that the likelihood of collection is remote.

 

Inventory Valuation

 

Inventories are stated at the lower of cost or net realizable value under the first-in, first-out method.  The Company regularly assesses slow-moving, excess and obsolete inventory and maintains balance sheet reserves in amounts required to reduce the recorded value of inventory to the lower of cost or net realizable value.

 

Property, Plant and Equipment

 

Property, plant and equipment (“PP&E”) are stated at cost and are depreciated over various estimated useful lives using the straight-line method.  Maintenance and repairs are charged to expense as incurred, while renewals and improvements are capitalized.  At the time of retirement or other disposition of PP&E, cost and accumulated depreciation are removed from the accounts and any gain or loss is recorded in earnings.

 

Depreciable lives generally used for PP&E are presented in the table below.  Leasehold improvements are amortized over the shorter of the lease term or estimated useful life of the improvement.

   

Reviewing Long-Lived Assets for Potential Impairment

 

ASC 360-10 (Property, Plant and Equipment) (“ASC Topic 360”) requires the Company to test long-lived assets (PP&E and definitive lived assets) for recoverability whenever events or circumstances indicate that the carrying amount may not be recoverable.  If carrying value exceeds undiscounted future cash flows attributable to an asset, it is considered impaired and the excess of carrying value over fair value must be charged to earnings.  No impairment charges were recorded by IEC for long-lived assets during the three and six months ended March 30, 2018 and March 31, 2017 .

 

Leases

 

At the inception of a lease covering equipment or real estate, the lease agreement is evaluated under criteria discussed in ASC 840-10-25 (Leases).  Leases meeting one of four key criteria are accounted for as capital leases and all others are treated as operating leases.  Under a capital lease, the discounted value of future lease payments becomes the basis for recognizing an asset and a borrowing, and lease payments are allocated between debt reduction and interest.  For operating leases, payments are recorded as rent expense.  Criteria for a capital lease include (i) transfer of ownership during the lease term; (ii) existence of a bargain purchase option under terms that make it likely to be exercised; (iii) a lease term equal to 75 percent or more of the economic life of the leased property; and (iv) minimum lease payments that equal or exceed 90 percent of the fair value of the property.

Legal Contingencies

 

When legal proceedings are brought or claims are made against the Company and the outcome is uncertain, ASC 450-10 (Contingencies) requires that the Company determine whether it is probable that an asset has been impaired or a liability has been incurred.  If such impairment or liability is probable and the amount of loss can be reasonably estimated, the loss must be charged to earnings. 

 

When it is considered probable that a loss has been incurred but the amount of loss cannot be estimated, disclosure but not accrual of the probable loss is required.  Disclosure of a loss contingency is also required when it is reasonably possible, but not probable, that a loss has been incurred. 

Legal Expense Accrual

The Company records legal expenses as they are incurred, based on invoices received or estimates provided by legal counsel. Future estimated legal expenses are not recorded until incurred.

Customer Deposits

Customer deposits represent amounts invoiced to customers for which the revenue has not yet been earned and therefore represent a commitment for the Company to deliver goods or services in the future. Deposits are generally short term in nature and are recognized as revenue when earned.

 

Grants from Outside Parties

 

Grants from outside parties are recorded as other long-term liabilities and are amortized over the same period during which the associated property, plant and equipment are depreciated. The Company received grants for certain facility improvements and equipment from state and local agencies in which the Company operates.  These grants reimbursed the Company for a portion of the actual cost or provided in kind services in support of capital projects. 

There were no new deferred grants recorded during either of the three and six months ended March 30, 2018 and March 31, 2017 . The outstanding grant balance was $0.2 million at each of March 30, 2018 and September 30, 2017 .

 

Fair Value Measurements

 

Under ASC 825 (Financial Instruments), the Company is required to disclose the fair value of financial instruments for which it is practicable to estimate value.  The Company’s financial instruments consist of cash, accounts receivable, accounts payable, accrued liabilities and borrowings.  IEC believes that recorded value approximates fair value for all cash, accounts receivable, accounts payable and accrued liabilities. See Note 6—Fair Value of Financial Instruments for a discussion of the fair value of IEC’s borrowings.

 

ASC 820 (Fair Value Measurements and Disclosures) defines fair value, establishes a framework for measurement, and prescribes related disclosures.  ASC 820 defines fair value as the price that would be received upon sale of an asset or would be paid to transfer a liability in an orderly transaction.  Inputs used to measure fair value are categorized under the following hierarchy:

 

Level 1: Quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date.

 

Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs are observable market data.

 

Level 3: Model-derived valuations in which one or more significant inputs are unobservable.

 

The Company deems a transfer between levels of the fair value hierarchy to have occurred at the beginning of the reporting period.  There were no such transfers during each of the three and six months ended March 30, 2018 and March 31, 2017 .

 

Revenue Recognition

 

The Company’s revenue is principally derived from the sale of electronic products built to customer specifications, but also from other value-added support services and repair work.  Revenue from product sales is recognized when (i) goods are shipped or title and risk of ownership have passed, (ii) the price to the buyer is fixed or determinable, and (iii) realization is reasonably assured. Service revenue is generally recognized once the service has been rendered.  For material management arrangements, revenue is generally recognized as services are rendered.  Under such arrangements, some or all of the following services may be provided: design, bid, procurement, testing, storage or other activities relating to materials the customer expects to incorporate into products that it manufactures.  Value-added support services revenue, including material management and repair work revenue, amounted to less than 5% of total revenue in each of the three and six months ended March 30, 2018 and March 31, 2017 .

 

Provisions for discounts, allowances, rebates, estimated returns and other adjustments are recorded in the period the related sales are recognized.

 

Stock-Based Compensation

 

ASC 718 (Stock Compensation) requires that compensation expense be recognized for equity awards based on fair value as of the date of grant.  For stock options, the Company uses the Black-Scholes pricing model to estimate grant date fair value.  Costs associated with stock awards are recorded over requisite service periods, generally the vesting period.  If vesting is contingent on the achievement of performance objectives, fair value is accrued over the period the objectives are expected to be achieved only if it is considered probable that the objectives will be achieved.  The Company also has an employee stock purchase plan (“ESPP”) that provides for the purchase of Company common stock at a discounted stock purchase price.

Income Taxes and Deferred Taxes

 

ASC 740 (Income Taxes) requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns, but not in both.  Deferred tax assets are also established for tax benefits associated with tax loss and tax credit carryforwards.  Such deferred tax balances reflect tax rates that are scheduled to be in effect, based on currently enacted legislation, in the years the book/tax differences reverse and tax loss and tax credit carryforwards are expected to be realized.  An allowance is established for any deferred tax asset for which realization is not likely.

 

ASC 740 also prescribes the manner in which a company measures, recognizes, presents and discloses in its financial statements uncertain tax positions that the Company has taken or expects to take on a tax return.  The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the position will be sustained following examination by taxing authorities, based on technical merits of the position.  The Company believes that it has no material uncertain tax positions.

 

Any interest incurred is reported as interest expense. Any penalties incurred are reported as tax expense. The Company’s income tax filings are subject to audit by various tax jurisdictions and current open years are the fiscal year ended September 30, 2014 through fiscal year ended September 30, 2016. The federal income tax audit for the fiscal year ended September 30, 2013 concluded during fiscal 2017 and resulted in no change to reported tax.

 

Dividends

 

IEC does not pay dividends on its common stock as it is the Company’s current policy to retain earnings for use in the business.  Furthermore, the Company’s Fifth Amended and Restated Credit Facility Agreement, as amended, with M&T Bank includes certain restrictions on paying cash dividends, as more fully described in Note 5—Credit Facilities . 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses and the disclosure of contingent assets and liabilities. Significant items subject to such estimates include: allowance for doubtful accounts, excess and obsolete inventory, warranty reserves and the valuation of deferred income tax assets. Actual results may differ from management’s estimates.

 

Statements of Cash Flows

 

The Company presents operating cash flows using the indirect method of reporting under which non-cash income and expense items are removed from net income/(loss). 

Segments

The Company’s results of operations for the three and six months ended March 30, 2018 and March 31, 2017 represent a single operating and reporting segment, referred to as contract manufacturing within the EMS industry. The Company strategically directs production between its various manufacturing facilities based on a number of considerations to best meet its customers’ requirements. The Company shares resources for sales, marketing, engineering, supply chain, information services, human resources, payroll and corporate accounting functions. Consolidated financial information is available that is evaluated regularly by the chief operating decision maker in assessing performance and allocating resources.  The Company’s operations as a whole reflect the level at which the business is managed and how the Company’s chief operating decision maker assesses performance internally.

 

Recently Issued Accounting Standards Not Yet Adopted

 

FASB Accounting Standard Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“Topic 606”) was issued May 2014 and updates the principles for recognizing revenue. This ASU will supersede most of the existing revenue recognition requirements in GAAP. Under the new standard, revenue will be recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods and services. The standard creates a five-step model that will generally require companies to use more judgment and make more estimates than under current guidance when considering the terms of contracts along with all relevant facts and circumstances. These include the identification of customer contracts and separating performance obligations, the determination of transaction price that potentially includes an estimate of variable consideration, allocating the transaction price to each separate performance obligation, and recognizing revenue in line with the pattern of transfer. Additionally, disclosures required for revenue recognition will include qualitative and quantitative information about contracts with customers, significant judgments and changes in judgments, and assets recognized from costs to obtain or fulfill a contract. Such disclosures are more extensive than what is required under existing GAAP.

The guidance is effective for the Company beginning in the first quarter of the fiscal year ending September 30, 2019 (“fiscal 2019”). The Company has identified key personnel to evaluate the guidance and approve a transition method. The Company has assessed that the impact of the new guidance may result in a change of the Company's revenue recognition model for electronics manufacturing services from "point in time" upon physical delivery to an "over time" model and believes this transition may have a material impact on the Company's consolidated financial statements upon adoption primarily as it recognizes an increase in contract assets for unbilled receivables with a corresponding reduction in inventories. The Company has commenced implementation in accordance with the planned effective date. The new guidance allows for two transition methods in application: (i) retrospective to each prior reporting period presented, or (ii) modified retrospective with the cumulative effect of adoption recognized on October 1, 2018, the first day of the Company's fiscal 2019. The Company will utilize the modified retrospective approach upon adoption of the new guidance.

FASB ASU 2016-02, “Leases” was issued in February 2016. The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. For public entities, the new guidance is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. Early adoption is permitted for all entities. The Company is evaluating the impact this ASU will have on its consolidated financial statements.

 

 

Depreciation expense during the three and six months ended March 30, 2018 and March 31, 2017 follows:

Assets Held For Sale

PP&E is considered held for sale when it meets certain criteria described in ASC Topic 360. As noted in Note 14—Subsequent Events , assets held for sale are comprised of the manufacturing facility located in Rochester, New York.

  ¹ Equipment Line Advances mature on July 26, 2018 and September 29, 2018.

  

M&T Bank Credit Facilities

Effective as of January 26, 2018, the Company and M&T Bank entered into the Fourth Amendment to the Fifth Amended and Restated Credit Facility Agreement, which amended the Fifth Amended and Restated Credit Facility Agreement dated as of December 14, 2015, as amended by various amendments (collectively, the “Credit Facility, as amended”).

The Credit Facility, as amended, established a borrowing base computed using monthly borrowing base reports that, if inaccurate, allow M&T Bank, in its discretion, to suspend the making of or limit Revolving Credit Loans. Further, the Credit Facility, as amended, provides for the Company’s repurchase of its common stock under certain circumstances without M&T Bank’s prior written consent.

The Credit Facility, as amended, is secured by a general security agreement covering the assets of the Company and its subsidiaries, a pledge of the Company’s equity interest in its subsidiaries, a negative pledge on the Company’s real property, and a guarantee by the Company’s subsidiaries, all of which restrict use of these assets to support other financial instruments.

Individual debt facilities provided under the Credit Facility, as amended, are described below:

Borrowing Base

At March 30, 2018 , under the Credit Facility, as amended, the maximum amount the Company can borrow under the Revolver was the lesser of (i) 85% of eligible receivables plus a percentage of eligible inventories (up to a cap of $7.0 million ) or (ii) $16.0 million at March 30, 2018 and September 30, 2017 . Pursuant to a further amendment to the Credit Facility, as amended, the cap on eligible inventories was increased to $8.0 million (see Note 14—Subsequent Events ).

At March 30, 2018 , the upper limit on Revolver borrowings was $16.0 million , with $2.9 million available. This amount was subsequently raised to $22.0 million (see Note 14—Subsequent Events ). At September 30, 2017, the upper limit on Revolver borrowings was $16.0 million with $7.2 million available. Average Revolver balances amounted to $10.6 million during the six months ended March 30, 2018 .

Interest Rates

Under the Credit Facility, as amended, variable rate debt accrues interest at LIBOR plus the applicable marginal interest rate that fluctuates based on the Company’s Fixed Charge Coverage Ratio, as defined below. The applicable marginal interest rate was fixed through the fiscal quarter ending March 30, 2018 as follows: 3.00% for the Revolver and 3.25% for Term Loan B and Equipment Line Advances . At September 30, 2017 , the applicable marginal interest rate was 2.50% for the Revolver and 2.75% for Term Loan B.  Changes to applicable margins and unused fees resulting from the Fixed Charge Coverage Ratio generally become effective mid-way through the subsequent quarter.

The Company incurs quarterly unused commitment fees ranging from 0.250% to 0.375% of the excess of $16.0 million over average borrowings under the Revolver. Fees incurred amounted to $4.6 thousand and $34.4 thousand during the three months ended March 30, 2018 and March 31, 2017 , respectively. Fees incurred amounted to $11.2 thousand and $50.1 thousand during the six months ended March 30, 2018 and March 31, 2017 , respectively. The fee percentage varies based on the Company’s Fixed Charge Coverage Ratio, as defined below.

Financial Covenants

The Credit Facility, as amended, also contains various affirmative and negative covenants including financial covenants. As of September 30, 2017 , the Company had to maintain a Maximum Capital Expenditures requirement and a minimum fixed charge coverage ratio (“Fixed Charge Coverage Ratio”). The Fixed Charge Coverage Ratio compares (i) EBITDAS minus unfinanced capital expenditures minus tax expense, to (ii) the sum of interest expense, principal payments, payments on all capital lease obligations and dividends, if any (fixed charges). “EBITDAS” is defined as earnings before interest, taxes, depreciation, amortization and non-cash stock compensation expense. The Fixed Charge Coverage Ratio which was initially measured for a trailing six months ended September 30, 2017 and was measured for a trailing twelve months ended March 30, 2018 as a minimum of 1.10 times. The Fixed Charge Coverage Ratio was the only covenant in effect at March 30, 2018 .

The Credit Facility, as amended, provides for customary events of default, subject in certain cases to customary cure periods, in which the outstanding balance and any unpaid interest would become due and payable. No Event of Default under the Credit Facility, as amended, occurred as of March 30, 2018 .

⁽¹⁾ Includes final payment of the Celmet Building Term Loan on November 7, 2018 .

⁽²⁾ Includes Revolver balance of $13.1 million at March 30, 2018 .

NOTE 6—FAIR VALUE OF FINANCIAL INSTRUMENTS  

Financial Instruments Carried at Historical Cost

 

The Company’s long-term debt is not quoted.  Fair value was estimated using a discounted cash flow analysis based on Level 2 valuation inputs, including borrowing rates the Company believes are currently available to it for loans with similar terms and maturities.

The Company's debt is carried at historical cost on the condensed consolidated balance sheets. The fair value and carrying value of the Celmet Building Term Loan at March 30, 2018 were both $0.7 million . The fair value and carrying value of the Celmet Building Term Loan as of September 30, 2017 were both $0.8 million .

 

The fair value of the remainder of the Company’s debt approximated carrying value at March 30, 2018 and September 30, 2017 as it is variable rate debt.

NOTE 7—WARRANTY RESERVES  

IEC generally warrants its products and workmanship for up to twelve months from date of sale.  As an offset to warranty claims, the Company is sometimes able to obtain reimbursement from suppliers for warranty-related costs or losses.  Based on historical warranty claims experience and in consideration of sales trends, a reserve is maintained for estimated future warranty costs to be incurred on products and services sold through the balance sheet date. The warranty reserve is included in other accrued expenses on the consolidated balance sheet.

 

A summary of additions to and charges against IEC’s warranty reserves during the period follows: 

 

NOTE 8—STOCK-BASED COMPENSATION  

The 2010 Omnibus Incentive Compensation Plan (“2010 Plan”) was approved by the Company’s stockholders at the January 2011 Annual Meeting.  The Company also has an employee stock purchase plan (“ESPP”), adopted in 2011, that provides for the purchase of Company common stock at a discounted stock purchase price. The 2010 Plan, which is administered by the Compensation Committee of the Board of Directors, provides for the following types of awards: incentive stock options, nonqualified options, stock appreciation rights, restricted shares, restricted stock units, performance compensation awards, cash incentive awards, director stock and other equity-based and equity-related awards.  Awards are generally granted to certain members of management and employees, as well as directors.  Under the 2010 Plan, up to 2,000,000 shares of common stock may be issued over a term of ten years . Under the ESPP, 150,000 shares of common stock may be issued over a term of ten years.

Stock-based compensation expense recorded under the 2010 Plan, totaled $0.1 million and $0.2 million for the three and six months ended March 30, 2018 , respectively. Stock-based compensation expense recorded under the 2010 Plan, totaled $0.1 million and $0.3 million for the three and six months ended March 31, 2017 , respectively.

At March 30, 2018 , there were 263,579 remaining shares available to be issued under the 2010 Plan and 107,330 remaining shares available to be issued under the ESPP.

Expenses relating to stock options that comply with certain U.S. income tax rules are neither deductible by the Company nor taxable to the employee.  Further information regarding awards granted under the 2010 Plan and ESPP is provided below.

 

A summary of stock option activity, together with other related data, follows:

		Six Months Ended
		March 30, 2018							March 31, 2017
Stock Options		Number of Options			Wgtd. Avg. Exercise Price				Number of Options			Wgtd. Avg. Exercise Price
Outstanding, beginning of period		743,045			$	4.27			759,795			$	4.43
Granted		20,000			4.00				50,000			3.60
Exercised		—			—				—			—
Forfeited		(10,000	)		4.25				(30,500	)		5.70
Expired		(10,500	)		5.24				(19,750	)		5.37
Outstanding, end of period		742,545			$	4.25			759,545			$	4.30
For options expected to vest
Number expected to vest		731,316			$	4.25			738,410			$	4.30
Weighted average remaining contractual term, in years		4.2							4.9
Intrinsic value (000s)					$	281						$	11
For exercisable options
Number exercisable		428,008			$	4.30			324,472			$	4.46
Weighted average remaining contractual term, in years		3.8							4.3
Intrinsic value (000s)					$	153						$	—
For non-exercisable options
Expense not yet recognized (000s)					$	319						$	526
Weighted average years to be recognized		1.6							2.3

 

Restricted (Non-vested) Stock

 

Certain holders of IEC restricted stock have voting and dividend rights as of the date of grant, and until vested, the shares may be forfeited and cannot be sold or otherwise transferred.  At the end of the vesting period, which is typically four or five years ( three years in the case of directors), holders have all the rights and privileges of any other common stockholder of the Company.  The fair value of a share of restricted stock is its market value on the date of grant, and that value is recognized as stock compensation expense over the vesting period. 

 

A summary of restricted stock activity, together with related data, follows: