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IEC > SEC Filings for IEC > Form 10-K on 26-Nov-2012All Recent SEC Filings

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Form 10-K for IEC ELECTRONICS CORP


26-Nov-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information in this Management's Discussion & Analysis should be read in conjunction with the accompanying Consolidated Financial Statements, the related Notes and the five-year summary of Selected Consolidated Financial Data. Forward-looking statements in this Management's Discussion and Analysis are qualified by the cautionary statement preceding Item 1 of this Form 10-K and the risk factors identified in Item 1A.

Overview

Since 2004, we have focused our efforts on developing relationships with customers who manufacture advanced technology products and who are unlikely to utilize offshore suppliers due to the proprietary nature of their products, governmental restrictions or volume considerations. We have continued to expand our business by adding new customers and markets, and our customer base is stronger and more diverse as a result. We proactively invest in areas we view as important for our continued growth. IEC is ISO 9001:2008 certified. Four of our units (IEC in Newark, NY; Wire and Cable in Victor, NY; Albuquerque in NM; and SCB in Bell Gardens, CA) are AS9100 certified to serve the military and commercial aerospace market sector, and are ITAR registered. In addition, the Company's locations in Newark, NY and Albuquerque, NM are Nadcap accredited for electronics manufacturing to support the most stringent quality requirements of the aerospace industry and the Newark, NY and Victor, NY locations are ISO 13485 certified to serve the medical market sector. Our Newark, NY location is also an NSA approved supplier under the COMSEC standard and its environmental systems are ISO 14001:2004 certified. DRTL is ISO 17025 accredited, which is the international standard covering testing and calibration laboratories. Albuquerque and SCB also perform work per NASA-STD-8739 and J-STD-001ES space standards.

We evaluate emerging technologies on an ongoing basis to maintain a technology roadmap so that relevant processes and advances in new equipment are available to our customers when commercial and design factors warrant. The current generation of interconnection technologies includes chip-scale packaging and ball-grid-array ("BGA") assembly techniques. We have placed millions of plastic and ceramic BGA's since 1994. Future advances will be directed by our Technology Center, which combines Prototype and Pilot Build Services with the capabilities of our Advanced Materials Technology Laboratory and our Design Engineering Group.

The technical expertise of our experienced workforce enables us to build some of the most advanced electronic, wire & cable, and precision metal systems sought by original equipment manufacturers ("OEMs").

Fourth Quarter Results



A summary of selected income statement amounts for the fourth quarters of fiscal
2012 and 2011 follows:



                                                       Three Months Ended
                                                 September 30,       September 30,
             Income Statement Data                        2012                2011
                                                           (thousands)

    Net sales                                  $        37,062     $        34,941
    Gross profit                                         6,799               7,024
    Selling and administrative expenses                  3,579               4,544
    Interest and financing expense                         297                 387
    Other (income)/expense                                   1              (1,162 )
    Income before provision for income taxes             2,922               3,255
    Provision for income taxes                             921                 624
    Net income                                 $         2,001     $         2,631

Revenue increased in the fourth quarter of fiscal 2012 by $2.1 million or 6.1% as compared to the fourth quarter of the prior fiscal year. Revenue growth during the quarter was primarily attributable to a $2.3 million increase in the industrial market sector and a $1.6 million increase in the military/aerospace sector, partially offset by a $1.2 million decrease in the medical market sector. Increased volume from two existing customers in the industrial market sector provided the majority of the increase. Four of our operating locations comprise the majority of our military/aerospace revenue. At one location military revenue increased compared to the fourth quarter of the prior fiscal year, partially offset by a decrease in aerospace revenue. One of our aerospace customers represented the majority of the decrease as they discontinued outsourcing a product to us and began to manufacture it in house. The customer made the decision to bring production in house because of available capacity due to decreased demand for some of their other products. The decrease in the medical market sector is due to changes in customer demand for our products, partially offset by new customers.

Our fourth fiscal quarter gross profit decreased by $0.2 million, or 3.2% from the fourth quarter of the prior fiscal year. The gross profit as a percentage of sales decreased from 20.1% of revenue in the fourth quarter of the prior fiscal year to 18.3% in the fourth fiscal quarter of this year. The decrease was primarily due to increased revenue, offset by unfavorable changes in product mix compared to the same quarter in the prior fiscal year.

Selling and administrative ("S&A") expenses decreased $1.0 million to 9.7% of revenue in the fourth fiscal quarter of 2012, as compared to 13.0% in the same fiscal quarter of the prior year. The decrease is primarily due to decreased payroll and bonus costs.

Interest expense decreased to $0.3 million in the quarter ended September 30, 2012 from $0.4 million in the same quarter of the prior fiscal year. The decrease is primarily the result of a $11.2 million decrease in average borrowings. Borrowings were significantly higher in the fourth quarter of the prior fiscal year due to incremental borrowing of $20.0 million to fund the SCB acquisition in December 2010. Interest rates on the majority of our debt are variable based on the ratio of debt to EBITDARS (earnings before interest, taxes, depreciation, amortization, rent payments and non-cash stock compensation expense). The weighted average interest rate on IEC's debt decreased from 3.47% for the quarter ended September 30, 2011 to 3.19% for the quarter ended September 30, 2012 due to improvement in this ratio. With respect to ongoing operations, we are committed to our goals of managing working capital, maximizing positive cash flow and reducing the level of debt and corresponding interest expense. Detailed information regarding our borrowings is provided in Note 9 - Credit Facilities to the consolidated financial statements included in this Annual Report.

The other (income)/expense category of IEC's income statement reflects non-operating items. Compared to the prior year's fourth fiscal quarter, net other income decreased by $1.2 million due to a gain on contingent consideration recorded in the prior fiscal year.

Income tax expense increased by $0.3 million, or 47.6% for the fiscal quarter ended September 30, 2012, and increased 12.3% to 31.5% of pre-tax net income compared to the same quarter in the prior fiscal year.

With respect to tax payments, in the near term IEC expects to be sheltered by sizable net operating loss carryforwards for federal and New York state income tax purposes. At the end of fiscal 2012, the carryforwards amounted to approximately $11.9 million and $0.4 million for federal and New York State, respectively. The carryforwards expire in varying amounts between 2020 and 2025 unless utilized prior to these dates. They are not available to offset state taxable income earned by IEC's operations in New Mexico and California.

Full-Year Results



A summary of selected income statement amounts for the fiscal years ended
September 30, 2012 and 2011 follows:



                                                           Years Ended
                                                 September 30,       September 30,
             Income Statement Data                        2012                2011
                                                           (thousands)

    Net sales                                  $       144,963     $       133,296
    Gross profit                                        27,956              25,757
    Selling and administrative expenses                 15,765              15,368
    Interest and financing expense                       1,227               1,601
    Other (income)/expense                              (1,050 )            (1,028 )
    Income before provision for income taxes            12,014               9,816
    Provision for income taxes                           4,254               3,056
    Net income                                 $         7,760     $         6,760

Revenue increased for this fiscal year compared to the prior fiscal year by $11.7 million or 8.8%. Our SCB acquisition accounted for approximately $3.3 million of the increase, while continuing operations increased $8.4 million or 7.4%. IEC's organic sales increase resulted primarily from the industrial, medical, communications and other market sectors partially offset by a decrease in the military/aerospace market sector. Revenue from the industrial market sector increased $19.3 million or 11.9% compared to the prior fiscal year. One of our existing customers provided the majority of the increase in the industrial sector. The two primary reasons for increased revenue from this customer were the award of a new contract for introductory period previously held by a competitor, and increased volume from existing contracts. The increase in revenue over the prior fiscal year for the medical sector was $2.5 million or 8.7% and is due primarily to new customers. The communications and other market sector increased $1.9 million or 15.0% over the prior fiscal year, primarily due to new contracts from existing customers. These increases were partially offset by a decrease of $12.0 million or 13.0% in the military/aerospace market caused by delays in military funding. Such delays continued to impact two of our locations in particular, where revenue decreased from the prior fiscal year, however another of our locations began to experience some strengthening in the military/aerospace market. At this location, military revenue increased compared to the prior fiscal year, partially offset by a decrease in aerospace revenue.

Gross profit increased by 8.5% to $28.0 million for the current fiscal year from $25.8 million for the prior fiscal year. The increase was primarily due to increased revenue compared to the prior fiscal year as well as changes in product mix and improvements in purchasing and inventory management.

S&A expense increased $0.4 million to $15.8 million or 10.9% of revenue in the current fiscal year compared to $15.4 million or 11.5% of revenue in the prior fiscal year. The majority of this is due to experiencing a full year of S&A expense for SCB, as well as the higher cost structure SCB experiences. In addition, there were several insignificant offsetting changes in various other expenses. These included the impact of changes made to realign administrative positions within the Company, such as adding, removing and adjusting positions in the organization.

Interest expense decreased $0.4 million in the fiscal year ended September 30, 2012 from the prior fiscal year. The decrease is the result of a decrease in average borrowings as well as lower average interest rates. Average borrowings for the fiscal year ending September 30, 2012 were approximately $12.6 million lower than for the prior fiscal year. This reduction is primarily due to repayment of debt including the revolving credit facility, which was made possible by increased operating cash flow. The prior fiscal year included incremental borrowing of $20.0 million to fund the SCB acquisition. Interest rates on the majority of our debt are variable based on the ratio of debt to EBITDARS. The weighted average interest rate on IEC's debt decreased from 4.85% in the fiscal year ended September 30, 2011 to 3.25% in the fiscal year ending September 30, 2012 due to improvement in this ratio. With respect to ongoing operations, we are committed to our goals of managing working capital, maximizing positive cash flow and reducing the level of debt and corresponding interest expense. Detailed information regarding our borrowings is provided in Note 9 - Credit Facilities to the consolidated financial statements included in this Annual Report.

The other (income)/expense category of IEC's income statement reflects non-operating items. In the fiscal year ending September 30, 2012, $1.1 million of additional income was recorded for contingent consideration owed to IEC by the sellers of Southern California Braiding Company, Inc. The income is the result of a shortfall in SCB's calendar-year 2011 sales and backlog as compared to a target specified in the acquisition agreement. Combined with a $1.1 million estimate recorded in the fiscal year ended September 30, 2011, the total gain related to the contingent consideration is $2.2 million. We received payment in the form of cash and common stock during the third fiscal quarter of 2012 through settlement of the escrow account established at the time of the SCB acquisition.

Income tax expense increased by $1.2 million for the twelve months ended September 30, 2012, and increased 4.2% to 35.4% of pre-tax net income compared to the same period in the prior fiscal year.

With respect to tax payments, in the near term IEC expects to be sheltered by sizable net operating loss carryforwards for federal and New York state income tax purposes. At the end of fiscal 2012, the carryforwards amounted to approximately $11.9 million and $24.9 million for federal and New York State, respectively. The carryforwards expire in varying amounts between 2020 and 2025 unless utilized prior to these dates. They are not available to offset state taxable income earned by IEC's operations in New Mexico and California.

Liquidity and Capital Resources

Cash flow from operations, before considering changes in IEC's working capital accounts, amounted to $17.7 million in the fiscal year ended September 30, 2012, compared to $13.4 million in fiscal 2011. The increase was driven by a $1.0 million increase in net income as well as higher add-backs for non-cash expenses such as depreciation, contingent consideration and deferred taxes. The net change in current asset and liability accounts used $4.8 million and $0.5 million of cash in fiscal 2012 and 2011, respectively.

Investing activities utilized $3.0 million of cash flow in fiscal 2012, compared to $29.3 million in fiscal 2011. In December 2010, we acquired SCB for cash of $24.5 million plus common stock. Equipment added in fiscal 2012 to enhance productivity and facilitate growth amounted to $3.1 million, compared to $4.9 million in fiscal 2011.

For the fiscal year ended September 30, 2012, cash was used by financing activities to pay term loans, mortgage loans and the revolving credit facility. Bank funding for acquisitions, through term loans, a mortgage loan and the revolving credit facility, represented most of the cash generated from financing activities the during the fiscal year ended September 30, 2011. In addition to satisfying scheduled debt service requirements, favorable operating cash flows enabled us to repay borrowings of $7.5 million in fiscal 2012 and $4.6 million in fiscal 2011.

As of September 30, 2012, borrowings under the revolving credit facility amounted to $6.6 million, and the maximum available was $20.0 million. The Company believes that its liquidity is sufficient to satisfy anticipated operating requirements during the next twelve months.

The Company's primary borrowing arrangement is contained in the Third Amended and Restated Credit Facility Agreement ("Credit Agreement") entered into with Manufacturers and Traders Trust Company ("M&T") in December 2010, as amended and supplemented to date. The Credit Agreement contains a borrowing base as well as various affirmative and negative covenants, including financial covenants. We are required to maintain (i) a minimum level of quarterly EBITDARS, (ii) a ratio of debt to twelve-month EBITDARS that is below a specified limit, and (iii) a minimum fixed charge coverage ratio. The Company was in compliance with each of the covenants on September 30, 2012 and September 30, 2011, as summarized in a table below. EBITDARS, a non-GAAP financial measure, is reconciled to net income, the most directly comparable GAAP financial measure in "Note 9 - Credit Facilities" to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

                                                                     Calculated Amount At
                                                              September 30,         September 30,
             Debt Covenant                     Limit              2012                  2011
Quarterly EBITDARS (000s)                  Minimum $1,500    $         4,658       $         4,906
Total debt to EBITDARS                     Maximum 3.25x                1.51 x                2.08 x
Fixed charge coverage ratio (a)            Minimum 1.25x                1.82 x                2.07 x

(a) The ratio compares (i) 12-month EBITDA plus non-cash stock compensation expense minus unfinanced capital expenditures minus cash taxes paid, to (ii) the sum of interest expense, principal payments, sale-leaseback payments and dividends, if any (fixed charges).

A reconciliation of EBITDARS to net income follows:

                                                      Three Months Ended
                                              September 30,        September 30,
                                                  2012                 2011
                                                         (thousands)
     Net Income                              $         2,001      $         2,631
     Provision for Income Tax                            921                  624
     Depreciation and Amortization Expense             1,119                1,054
     Net Interest Expense                                297                  387
     Rent Expense (M&T Sale-leaseback)                    97                   65
     Non-cash Stock Compensation                         223                  145
     EBITDARS                                $         4,658      $         4,906

EBITDARS is a non-GAAP financial measure. It should not be considered in isolation or as a measure of the Company's profitability or liquidity; it is in addition to, and is not a substitute for, financial measures under GAAP. EBITDARS may be different from non-GAAP financial measures used by other companies, and may not be comparable to similarly titled measures reported by other companies. Non-GAAP financial measures have limitations since they do not reflect all of the amounts associated with the Company's results of operations as determined in accordance with GAAP.

The Company defines EBITDARS as earnings before interest, taxes, depreciation, amortization, rent expense and non-cash stock compensation. EBITDARS does not take into account working capital requirements, capital expenditures, debt service requirements and other commitments, and accordingly, EBITDARS is not necessarily indicative of amounts that may be available for discretionary use. The Company presents EBITDARS because certain covenants in the Company's credit facilities are tied to that measure. The Company also views EBITDARS as a useful measure of operating performance given the Company's strong operating margins and large net operating loss carryforward and because, as a supplemental measure: (i) it is a basis upon which the Company assesses its liquidity position and performance and (ii) the Company believes that investors will find the data useful in assessing its ability to service and/or incur indebtedness. The Company believes that EBITDARS, when considered with both the Company's GAAP results and the reconciliation to operating income, provides a more complete understanding of the Company's business than could be obtained absent this disclosure.

Off-Balance Sheet Arrangements

IEC is not a party to any material off-balance sheet arrangements.

Critical Accounting Policies and Use of Estimates

IEC's financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America, as presented in the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC). In preparing financial statements, management is required to (i) determine the manner in which accounting principles are applied and (ii) make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. A discussion of the Company's critical accounting policies follows.

Revenue recognition: Under FASB ASC 605-10 (Revenue Recognition), revenue from 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 revenues are generally recognized as services are rendered or, in the case of material management contracts, in proportion to materials procured to date. Provisions for discounts and rebates to customers, estimated returns and allowances and other adjustments are recorded in the period the related sales are recognized.

Doubtful accounts: FASB ASC 310-10-35 (Receivables) requires us to establish an allowance for doubtful accounts when it is probable that losses have been incurred in the collection of accounts receivable and the amount of loss can reasonably be estimated. If losses are probable and estimable, they are to be accrued even though the particular customer accounts on which losses will be incurred cannot yet be identified.

Inventory reserves: FASB ASC 330-10-35 (Inventory) requires us to reduce the carrying value of inventory when there is evidence that the utility of goods will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels or other causes. Inventory balances are generally reduced to the lower of cost or market value by establishing offsetting balance sheet reserves.

Intangible assets: FASB ASC 805-20 (Business Combinations) requires corporate acquirers to recognize, separately from goodwill, intangible assets that meet either a separability or contractual-legal criterion. Establishing the initial value for such intangible assets typically involves estimating cash flows to be derived from the assets and discounting the cash flows back to the acquisition date. Significant judgment is required in estimating future cash flows, selecting discount rates and determining useful lives over which to amortize the assets. In connection with recent corporate acquisitions, IEC has established intangible assets for customer relationships, a property-tax abatement, and a non-compete agreement.

Goodwill: Goodwill represents the excess of cost over fair value of net assets acquired in a corporate acquisition. Under ASC 350, goodwill is not amortized but is required to be reviewed for impairment at least annually or when events or circumstances indicate that carrying value may exceed fair value. The review process entails comparing the overall fair value of the unit to which goodwill relates to carrying value. If fair value exceeds carrying value, no goodwill write-down is required. If fair value of the unit is less than carrying value, a valuation of the unit's individual assets and liabilities is required to determine whether or not goodwill is impaired. Quantitative evaluations of goodwill may be avoided if qualitative assessments indicate a greater-than-50 percent likelihood that fair value of the corresponding unit exceeds its carrying value.

Impairment of long-lived assets: FASB ASC 360-10 (Property, Plant and Equipment) and 350-30 (Intangibles) require the Company to test long-lived assets (PP&E and amortizing intangible 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 carrying amount must be reduced to fair value.

Legal contingencies: When legal proceedings are brought or claims are made against us and the outcome is uncertain, FASB ASC 450-10 (Contingencies) requires that we accrue an estimated loss if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. Any such accruals are charged to earnings.

Disclosure of a contingency is required if there is at least a reasonable possibility that a loss will be incurred. In determining whether to accrue or disclose a loss, we evaluate, among other factors, the probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount. Changes in these factors may materially affect our financial position or results of operations.

Income taxes: FASB ASC 740 (Income Taxes) describes the manner in which income taxes are to be provided for in the Company's financial statements. We are required to recognize (i) the amount of taxes payable or refundable for the current period and (ii) deferred tax assets and liabilities for the future tax consequences of events that have been reported in IEC's financial statements or tax returns. With respect to uncertain positions that may be taken on a tax return, we recognize related tax benefits only if it is more likely than not that the position will be sustained under examination based on the technical merits of the position. The determination of income tax balances for financial statement purposes requires significant judgment, and actual outcomes may vary from the amounts recorded.

Recently Issued Accounting Standards

Information with respect to recently issued accounting standards is provided in the Accounting Policies note to the consolidated financial statements included in Item 8 of this Form 10-K.

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