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SGMA > SEC Filings for SGMA > Form 10-K on 26-Jul-2013All Recent SEC Filings

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Form 10-K for SIGMATRON INTERNATIONAL INC


26-Jul-2013

Annual Report


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

In addition to historical financial information, this discussion of the business of SigmaTron International, Inc. ("SigmaTron"), its wholly-owned subsidiaries Standard Components de Mexico S.A., AbleMex, S.A. de C.V., Digital Appliance Controls de Mexico, S.A. de C.V., Spitfire Controls (Vietnam) Co. Ltd., Spitfire Controls (Cayman) Co. Ltd. and SigmaTron International Trading Co., wholly-owned foreign enterprises Wujiang SigmaTron Electronics Co., Ltd. and SigmaTron Electronic Technology Co., Ltd. (collectively, "SigmaTron China") and international procurement office SigmaTron Taiwan branch (collectively, the "Company") and other Items in this Annual Report on Form 10-K contain forward-looking statements concerning the Company's business or results of operations. Words such as "continue," "anticipate," "will," "expect," "believe," "plan," and similar expressions identify forward-looking statements. These forward-looking statements are based on the current expectations of the Company. Because these forward-looking statements involve risks and uncertainties, the Company's plans, actions and actual results could differ materially. Such statements should be evaluated in the context of the risks and uncertainties inherent in the Company's business including, but not necessarily limited to, the Company's continued dependence on certain significant customers; the continued market acceptance of products and services offered by the Company and its customers; pricing pressures from our customers, suppliers and the market; the activities of competitors, some of which may have greater financial or other resources than the Company; the variability of our operating results; the results of long-lived assets and goodwill impairment testing; the variability of our customers' requirements; the availability and cost of necessary components and materials; the ability of the Company and our customers to keep current with technological changes within our industries; regulatory compliance, including conflict minerals; the continued availability and sufficiency of our credit arrangements; changes in U.S., Mexican, Chinese, Vietnamese or Taiwanese regulations affecting the Company's business; the turmoil in the global economy and financial markets; the stability of the U.S., Mexican, Chinese, Vietnamese and Taiwanese economic, labor and political systems and conditions; currency exchange fluctuations; and the ability of the Company to manage its growth, including its integration of the Spitfire operation acquired in May 2012. These and other factors which may affect the Company's future business and results of operations are identified throughout this Annual Report and as risk factors, and may be detailed from time to time in the Company's filings with the Securities and Exchange Commission. These statements speak as of the date of such filings, and the Company undertakes no obligation to update such statements in light of future events or otherwise unless otherwise required by law.


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Overview

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

On May 31, 2012, SigmaTron acquired certain assets and assumed certain liabilities of Spitfire. Spitfire was a privately held Illinois corporation with captive manufacturing sites in Chihuahua, Mexico and suburban Ho Chi Minh City, Vietnam. Both manufacturing sites were among the assets acquired by the Company. Spitfire was an original equipment manufacturer of electronic controls, with a focus on the major appliance (white goods) industry. Although North America is currently its primary market, Spitfire has applications that can be used worldwide. The Company provided manufacturing solutions for Spitfire since 1994, and was a strategic partner to Spitfire as it developed its OEM electronic controls business.

The Company's Spitfire division provides cost effective designs as control solutions for its customers, primarily in high volume applications of domestic cooking ranges, dishwashers, refrigerators, and portable appliances. It is a member of the Association of Home Appliance Manufacturers ("AHAM"), as well as other industry related trade associations and is ISO 9001:2008 certified. The acquisition has enabled the Company to offer design services for the first time in specific markets.

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

Sales can be a misleading indicator of the Company's financial performance. Sales levels can vary considerably among customers and products depending on the type of services (consignment versus turnkey) rendered by the Company and the demand by customers. Consignment orders require the Company to perform manufacturing services on components and other materials supplied by a customer, and the Company charges only for its labor, overhead and manufacturing costs, plus a profit. In the case of turnkey orders, the Company provides, in addition to manufacturing services, the components and other materials used in assembly. Turnkey contracts, in general, have a higher dollar volume of sales for each given assembly, owing to inclusion of the cost of components and other materials in net sales and cost of goods sold. Variations in the number of turnkey orders compared to consignment orders can lead to significant fluctuations in the Company's revenue and gross margin levels. Consignment orders accounted for less than 5% of the Company's revenues for the year ended April 30, 2013.

In an effort to facilitate growth of our China operation, the Company established a new Chinese entity in October 2011 that allows the Company to provide services competitively to the domestic market in China. Nonetheless, in fiscal year 2012 and 2013, the Company continued to see a trend of Chinese costs increasing, thereby making Mexico a more competitive manufacturing location to service North America. Indications suggest that this trend will continue. We feel the Company's international footprint provides our customers with flexibility within the Company to manufacture in China, Mexico or Vietnam. We believe this strategy has continued to serve the Company well during these difficult economic times as its customers continuously evaluate their supply chain strategies.


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In the past, the timing of production and delivery of orders, primarily at the direction of its customers, has caused the Company to experience significant quarterly fluctuations in its revenues and earnings. The Company continued to experience pricing pressures from both its customer and suppliers. The Company expects continuing pressure on margins until the economy achieves a sustained recovery. The Company is hopeful to see that start the second half of calendar 2013. Until that time, the Company will continue to carefully manage its cost structure. The Company continues to add new customers and new programs with existing customers. Some are not launching or transitioning as quickly as initially forecasted by the Company's customers, but the Company believes they will eventually add to its revenue base. We continue to work on integrating Spitfire into SigmaTron, which the Company believes is proceeding on plan and has started to add to our menu of services that we can offer customers.

Due to the acquisition of Spitfire, effective June 1, 2012, the Company discontinued selling to Spitfire and instead began selling directly to Spitfires' customers.

On May 8, 2012, the Company entered into a real estate lease agreement to relocate its Tijuana, Mexico operation to a new facility within Tijuana, Mexico. The relocation was completed in July 2012. As of April 30, 2013, the Company has incurred approximately $424,000 in relocation expenses as a result of the move as of April 30, 2013. All incentives realized under the lease will be recognized over the term of the lease, which is five years.

Critical Accounting Policies:

Management Estimates and Uncertainties - The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. 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 and valuation of long-lived assets. Actual results could materially differ from these estimates.

Revenue Recognition - Revenues from sales of the Company's electronic manufacturing services business are recognized when the finished good product is shipped to the customer. In general, and except for consignment inventory, it is the Company's policy to recognize revenue and related costs when the finished goods have been shipped from its facilities, which is also the same point that title passes under the terms of the purchase order. Finished goods inventory for certain customers is shipped from the Company to an independent warehouse for storage or shipped directly to the customer and stored in a segregated part of the customer's own facility. Upon the customer's request for finished goods inventory, the inventory is shipped to the customer if the inventory was stored off-site, or transferred from the segregated part of the customer's facility for consumption or use by the customer. The Company recognizes revenue upon such shipment or transfer. The Company does not earn a fee for such arrangements. The Company from time to time may ship finished goods from its facilities, which is also the same point that title passes under the terms of the purchase order, and invoice the customer at the end of the calendar month. This is done only in special circumstances to accommodate a specific customer. Further, from time to time customers request the Company hold finished goods after they have been invoiced to consolidate finished goods for shipping purposes. The Company generally provides a 90 day warranty for workmanship only and does not have any installation, acceptance or sales incentives (although the Company has negotiated longer warranty terms in certain instances). The Company assembles and tests assemblies based on customers' specifications. Historically, the amount of returns for workmanship issues has been de minimis under the Company's standard or extended warranties.

Inventories - Inventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out method. In the event of an inventory write-down, the Company records expense to state the inventory at lower of cost or market. The Company establishes inventory reserves for valuation, shrinkage, and excess and obsolete inventory. The Company records provisions for inventory shrinkage based on historical experience to account for unmeasured usage or loss. Actual results differing from these estimates could significantly affect the Company's inventories and cost of products sold. The Company records provisions for excess and obsolete inventories for the difference between the cost of inventory and its estimated realizable value based on assumptions about future product demand and market conditions. Actual product demand or market conditions could be different than that projected by management.


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Goodwill - Goodwill represents the purchase price in excess of the fair value of assets acquired in business combinations. Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 350, "Goodwill and other Intangible Assets," requires the Company to assess goodwill and other indefinite-lived intangible assets for impairment at least annually in the absence of an indicator of possible impairment and immediately upon an indicator of possible impairment. The Company is permitted the option to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the fair value of any reporting unit is less than its corresponding carrying value. If, after assessing the totality of events and circumstances, the Company concludes that it is not more likely than not that the fair value of any reporting unit is less than its corresponding carrying value then the Company is not required to take further action. However, if the Company concludes otherwise, then it is required to perform a quantitative impairment test, including computing the fair value of the reporting unit and comparing that value to its carrying value. If the fair value is less than its carrying value, a second step of the test is required to determine if recorded goodwill is impaired. The Company also has the option to bypass the qualitative assessment for goodwill in any period and proceed directly to performing the quantitative impairment test. The Company will be able to resume performing the qualitative assessment in any subsequent period. The Company performed its annual goodwill impairment test as of February 1, 2013 and determined no impairment existed as of the date of the impairment test.

Impairment of Long-Lived Assets - The Company reviews long-lived assets, including amortizable intangible assets for impairment. Property, machinery and equipment and finite life intangible assets are reviewed whenever events or changes in circumstances occur that indicate possible impairment. If events or changes in circumstances occur that indicate possible impairment, the Company's impairment review is based on an undiscounted cash flow analysis at the lowest level at which cash flows of the long-lived assets are largely independent of other groups of its assets and liabilities. This analysis requires management judgment with respect to changes in technology, the continued success of product lines, and future volume, revenue and expense growth rates. The Company conducts annual reviews for idle and underutilized equipment, and review business plans for possible impairment. Impairment occurs when the carrying value of the assets exceeds the future undiscounted cash flows expected to be earned by the use of the asset group. When impairment is indicated, the estimated future cash flows are then discounted to determine the estimated fair value of the asset or asset group and an impairment charge is recorded for the difference between the carrying value and the estimated fair value.

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 taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense and tax credit carryforwards. In evaluating our ability to recover our 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 adjusted for the results of discontinued operations and changes in accounting policies, and incorporates assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment and estimates by management about the forecasts of future taxable income and are consistent with the plans and estimates the Company uses to manage the underlying businesses. In evaluating the objective evidence that historical results provide, the Company considers three years of cumulative operating income and/or loss.

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on the Company's results of operations, cash flows or financial position.


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A tax benefit from an uncertain tax position may only be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits.

The Company adjusts its tax liabilities when its judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.

New Accounting Standards:

There are no recent accounting standards that had, or are expected to have, a significant effect on the Company's consolidated financial statements.

Results of Operations:

FISCAL YEAR ENDED APRIL 30, 2013 COMPARED

TO FISCAL YEAR ENDED APRIL 30, 2012

The following table sets forth the percentage relationships of expense items to
net sales for the years indicated:



                                                       Fiscal Years
                                                    2013         2012

             Net sales                               100.0 %      100.0 %
             Operating expenses:
             Cost of products sold                    90.0         90.3
             Selling and administrative expenses       9.3          8.0

             Total operating expenses                 99.3         98.3

             Operating income                          0.7 %        1.7 %

Fiscal Year 2013:

Net sales increased 26.7% to $198,439,534 in fiscal year 2013 from $156,635,984 in the prior year. The Company's sales increased in fiscal year 2013 in industrial and consumer electronics, appliance and medical/life sciences marketplaces as compared to the prior year. The increase in sales dollars for these marketplaces was partially offset by a decrease in sales dollars in the fitness, gaming, telecommunications and semiconductor marketplaces. The increase in net sales for the fiscal year 2013 is a result of sales to customers due to the Spitfire acquisition, as well as our existing customers' increased demand for product.

The Company's sales in a particular industry are driven by the fluctuating forecasts and end-market demand of the customers within that industry. Sales to customers are subject to variations from period to period depending on customer order cancellations, the life cycle of customer products and product transition. Sales to the Company's five largest customers accounted for 53% and 57% of net sales for fiscal years 2013 and 2012, respectively.

Gross profit increased to $19,925,646, or 10.0% of net sales, in fiscal year 2013 compared to $15,254,541, or 9.7% of net sales, in the prior fiscal year. The increase in gross profit for fiscal year 2013 was primarily the result of gross profits earned on sales to customers due to the Spitfire acquisition, as well as increased sales revenue from our existing customers. The Company has carefully managed its cost structure and has begun to achieve economies of scale integrating Spitfire into SigmaTron. The increase in gross profit


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in fiscal year 2013 was partially offset by relocation expenses of approximately $399,000 for the Tijuana, Mexico move, and a foreign currency loss of $359,149 compared to a foreign currency gain of $133,979 in the prior fiscal year.

Selling and administrative expenses increased in fiscal year 2013 to $18,358,354, or 9.3% of net sales, compared to $12,611,673, or 8.0% of net sales, in fiscal year 2012 or an increase of $5,746,681. Of the increase noted above, for the fiscal year ended April 30, 2013, $4,469,106 was attributable to salaries and other administrative expenses for the Spitfire operations and $803,006 was transaction costs for the Spitfire Transaction. Other increases in selling and administrative expenses for the fiscal year ended April 30, 2013, were due to increases in commissions, freight out, computer maintenance, insurance and amortization expense. The increase in the foregoing selling and administrative expenses were partially offset by a decrease in bonus expense, depreciation and paper and supply expenses.

Interest expense decreased to $832,126 in fiscal year 2013 compared to $1,025,325 in fiscal year 2012. The interest expense decreased primarily due to the decreased borrowings under the Company's banking arrangements and capital lease obligations. Interest expense for fiscal year 2014 may increase if interest rates or borrowings, or both, increase during fiscal year 2014.

In fiscal year 2013, income tax expense was $321,363 compared to $522,171 in income tax expense in fiscal year 2012. The effective tax rate for the years ended April 30, 2013 and 2012 was 39.5% and 31.5%, respectively. The increase in the effective tax rate for the year ended April 30, 2013 is due to the tax impact of additional profit from the Company's U.S. entities and a dividend payment from its wholly-owned trading company, SigmaTron International Trading Co.

The Company reported net income of $492,961 in fiscal year 2013 compared to a net income of $1,134,324 for fiscal year 2012. Basic and diluted earnings per share for fiscal year 2013 were $0.13 and $0.12, respectively, compared to basic and diluted earnings per share of $0.29 for the year ended April 30, 2012.

Liquidity and Capital Resources:

Operating Activities.

Cash flow provided by operating activities was $3,751,631 for the fiscal year ended April 30, 2013, compared to cash flow provided by operating activities of $9,808,310 for the prior fiscal year. Cash flow provided by operating activities was the result of net income, the non-cash effects of depreciation and amortization, stock-based compensation expense, an increase in trade accounts payable and deferred rent expenses. The increase in accounts payable was due to timing of payments in the ordinary course of business. Net cash provided by operations in fiscal year 2013 was partially offset by an increase of inventories of $5,615,748 and accounts receivable of $5,242,863, primarily related to additional sales volume resulting from the Spitfire acquisition.

Cash flow provided by operating activities was $9,808,310 for the fiscal year ended April 30, 2012. Cash flow provided by operating activities in fiscal year 2012 was primarily the result of net income, the non-cash effects of depreciation and amortization, a decrease in inventory and an increase in accounts payable. The decrease in inventory of $7,147,110 was the result of the improvement of inventory management practices. The increase in accounts payable of $1,402,892 was due to timing of payments in the ordinary course of business. Net cash provided by operations in fiscal year 2012 was partially offset by an increase in accounts receivable. The increase in accounts receivable of $4,381,326 was due to increased sales volume and timing of cash receipts from a significant customer.

Investing Activities.

In fiscal year 2013, the Company purchased approximately $7,200,000 in machinery and equipment to be used in the ordinary course of business. The Company anticipates that it will make additional machinery and equipment purchases in fiscal year 2014 of approximately $13,500,000 to support its anticipated growth. The Company anticipates the purchases will be funded by lease transactions and its bank line of credit. The Company received approximately $1,142,000 in cash in conjunction with the Spitfire purchase. In addition, the Company received $22,000 in cash for proceeds related to the sale of machinery and equipment.


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In fiscal year 2012, the Company purchased approximately $2,300,000 in machinery and equipment used in the ordinary course of business.

Financing Activities.

Cash provided by financing activities was $2,193,615 for the fiscal year ended April 30, 2013, compared to cash used in financing activities of $6,970,338 in fiscal year 2012. Cash provided by financing activities in fiscal year 2013 was primarily the result of increased borrowings of $2,500,000 under the credit facility. The additional borrowings were required to support the purchases of machinery and equipment and the increases in both accounts receivable and inventory.

Cash used in financing activities in fiscal year 2012 was primarily the result of $6,900,000 in payments under the credit facility and for capital lease obligations.

Financing Summary.

The Company has a senior secured credit facility with Wells Fargo with a credit limit up to $30 million and an initial term through September 30, 2013. The facility allows the Company to choose among interest rates at which it may borrow funds. The interest rate is the prime rate plus one half percent (effectively, 3.75% at April 30, 2013) or LIBOR plus two and three quarter percent (effectively, 3.0% at April 30, 2013), which is paid monthly. The credit facility is collateralized by substantially all of the domestically located assets of the Company and requires the Company to be in compliance with several financial covenants. In conjunction with the Spitfire acquisition, two of the financial covenants required by terms of the Company's senior secured credit . . .

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