NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Business
Key Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs) and also manufactures keyboards and other input devices. The Company’s headquarters are located in Spokane Valley, Washington with manufacturing operations in Oakdale, Minnesota; Fayetteville, Arkansas; Corinth, Mississippi; and foreign manufacturing operations in Juarez, Mexico; and Shanghai, China.
Principles of Consolidation
The consolidated financial statements include the Company and its wholly owned subsidiaries in the United States, Mexico and China. Intercompany balances and transactions have been eliminated during consolidation.
Reclassifications
Certain prior period reclassifications were made to conform with the current period presentation. These reclassifications had no effect on reported income, comprehensive income (loss), cash flows, total assets, or shareholders' equity as previously reported.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable inventories, deferred tax assets and liabilities, uncertain tax positions, valuation of goodwill, impairment of long-lived assets, medical self-funded insurance liability, long-term incentive compensation accrual, the provision for warranty costs, the fair value of stock appreciation rights granted under the Company’s share-based compensation plan and purchase price allocation of acquired businesses. Due to uncertainties with respect to the assumptions and estimates, actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value. The Company may have cash and cash equivalents at financial institutions that are in excess of federally insured limits from time to time.
Allowance for Doubtful Accounts
The Company evaluates the collectability of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount that management reasonably estimates will be collected. A specific allowance is recorded against receivables considered to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the allowance, the Company considers several factors including the aging of the receivables, the current business environment and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the allowance.
Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is determined principally using the first-in, first-out (FIFO) method. Customer orders are based upon forecasted quantities of product manufactured for shipment over defined periods. Raw material inventories are purchased to fulfill these customer requirements. Within these arrangements, customer demands for products frequently change, sometimes creating excess and obsolete inventories. The Company regularly reviews raw material inventories by customer for both excess and obsolete quantities. Wherever possible, the Company attempts to recover its full cost of excess and obsolete inventories from customers or, in some cases, through other markets. When it is determined that the Company’s carrying cost of such excess and obsolete inventories cannot be recovered in full, a charge is taken against income for the difference between the carrying cost and the estimated realizable amount. We also reserve for inventory related to specific customers covered by lead-time assurance agreements when those customers are experiencing financial difficulties or reimbursement is not reasonably assured.
Property, Plant and Equipment
Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives of the assets. Repairs and maintenance costs are expensed as incurred.
Business Combinations
The Company recognizes the assets acquired and liabilities assumed in business combinations on the basis of their fair values at the date of acquisition. We assess the fair value of assets, including intangible assets, using a variety of methods and each asset is measured at fair value from the perspective of a market participant. The method used to estimate the fair values of intangible assets incorporates significant assumptions regarding the estimates a market participant would make in order to evaluate an asset, including a market participant’s use of the asset and the appropriate discount rates for a market participant. Assets recorded from the perspective of a market participant that are determined to not have economic use for us are expensed immediately. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. Transaction costs and restructuring costs associated with a business combination are expensed as incurred.
Impairment of Goodwill
The Company records intangible assets that are acquired individually or with a group of other assets in the financial statements at acquisition. In accordance with ASC 350,
Goodwill and Other Intangible Assets
, 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 Company tests goodwill by first performing a qualitative analysis (“Step 0”) to determine if it is more likely than not that the fair value of the reporting unit is greater than its carrying value. If the Company determines that it is not more likely than not that the fair value of the reporting unit is greater than its carrying value, the Company calculates the fair value of the reporting unit and compares the fair value of the reporting unit to its carrying value (“Step 1”). If the carrying value of the reporting unit exceeds the fair value, goodwill is potentially impaired and the second step (“Step 2”) of the impairment test must be performed. In the second step, the Company compares the implied fair value of the goodwill, as defined by ASC 350, to the carrying amount to determine the impairment loss, if any.
The Company performed its annual qualitative Step 0 analysis as of April 2, 2017 and determined a Step 1 analysis was necessary due to market conditions. Based on the results of the Step 1 analysis, the Company concluded that the fair value of the reporting unit was greater than the carrying value of the reporting unit based on a methodology that utilized both an income approach and a market approach. We considered valuation factors including the Company's market capitalization, future discounted cash flows and an estimated control premium based upon a review of comparable market transactions. Our consideration of discounted future cash included assumptions regarding growth rates and margins based on our historical trends. In addition, we applied a market discount rate calculated based upon an analysis of companies similar in size. The estimated fair value of the reporting unit exceeded the carrying value by approximately 20%. We will continue to monitor our market capitalization and impairment indicators.
Impairment of Long-lived Assets
The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value.
Accrued Warranty
An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns.
Self-funded Insurance
The Company self-funds its domestic employee health plans. The Company contracts with a separate administrative service company to supervise and administer the programs and act as its representative. The Company reduces its risk under this self-funded platform by purchasing stop-loss insurance coverage for high dollar individual claims. In addition, if the aggregate annual claims amount to more than
125 percent
of expected claims for the plan year this insurance will also pay those claims amounts exceeding that level.
The Company estimates its exposure for claims incurred but not paid at the end of each reporting period and uses historical claims data supplied by the Company’s broker to estimate its self-funded insurance liability. This liability is subject to a total limitation that varies based on employee enrollment and factors that are established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. Costs related to the administration of the plan and related claims are expensed as incurred.
Revenue Recognition
Sales revenue from manufacturing is recognized upon shipment of the manufactured product per contractual terms. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. The price to the buyer is fixed or determinable and recoverability is reasonably assured. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements or further obligations related to the manufacturing services; if any such requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated returns of manufactured product based on management’s analysis of historical returns.
Revenues and associated costs from engineering design, development services and tooling, which are performed under contract of short term durations, are recognized only after the completed performance of the service. Revenue from engineering design, development services and tooling represented approximately
2.1 percent
,
1.7 percent
and
2.5 percent
of total revenue in fiscal years
2017
,
2016
, and
2015
, respectively.
Shipping and Handling Fees
The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and handling fees are reported as revenue.
Research, Development and Engineering
Research, development and engineering expenses include unreimbursed EMS costs as well as design and engineering costs associated with the production of EMS programs. Research, development and engineering costs are expensed as incurred.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.
We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than
50%
likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments based on new assessments and changes in estimates and which may not accurately forecast actual outcomes. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax provision. To date, we have not incurred charges for interest or penalties in relation to the underpayment of income taxes. The tax years 1997 through the present remain open to examination by the major U.S. taxing jurisdictions to which we are subject. Refer to Note 6 for further discussions.
Derivative Instruments and Hedging Activities
The Company has entered into foreign currency forward contracts and an interest rate swap which are accounted for as cash flow hedges in accordance with ASC 815,
Derivatives and Hedging
. The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (AOCI) and is reclassified into earnings in the same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item.
The Company uses derivatives to manage the variability of foreign currency fluctuations of expenses in our Mexico facilities and interest rate risk associated with certain borrowings under the Company’s debt arrangement. The foreign currency forward contracts and interest rate swaps have terms that are matched to the underlying transactions being hedged. As a result, these transactions fully offset the hedged risk and no ineffectiveness has been recorded.
The Company’s foreign currency forward contracts and interest rate swaps potentially expose the Company to credit risk to the extent the counterparties may be unable to meet the terms of the agreement. The Company minimizes such risk by seeking high quality counterparties. The Company’s counterparties to the foreign currency forward contracts and interest rate swaps are major banking institutions. These institutions do not require collateral for the contracts, and the Company believes that the risk of the counterparties failing to meet their contractual obligations is remote. The Company does not enter into derivative instruments for trading or speculative purposes.
Earnings Per Common Share
Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing net income by the combination of other potentially dilutive weighted average common shares and the weighted average number of common shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per common share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on earnings per share.
Foreign Currency Transactions
The functional currency of the Company’s subsidiaries in Mexico and China is the U.S. dollar. Realized foreign currency transaction gains and losses for local currency denominated assets and liabilities are included in cost of goods sold.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, accounts receivable and current liabilities reflected on the balance sheets at
July 1, 2017
and
July 2, 2016
, reasonably approximate their fair value. The Company had an outstanding balance on the line of credit of
$18.3 million
as of
July 1, 2017
and
$18.1 million
as of
July 2, 2016
, with a carrying value that reasonably approximates the fair value. The Company had an outstanding balance on the term loan of
$21.3 million
as of
July 1, 2017
and
$26.3 million
as of
July 2, 2016
, with a carrying value that reasonably approximates the fair value. The equipment term loan is estimated to be
$3.5 million
as of
July 1, 2017
, with a carrying value that reasonably approximates the fair value. As of
July 2, 2016
, the Company did not have a balance under the equipment term loan.
Share-based Compensation
The Company’s incentive plan may provide for equity and liability awards to employees in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is included in cost of goods sold, research, development and engineering, and selling, general, and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations.
Restructuring
Periodically the Company may consolidate excess facilities in order to maximize efficiencies and reduce its costs. In connection with these activities, we recognize restructuring charges for employee termination costs, exit costs and long-lived asset impairment when applicable.
The recognition of these restructuring charges require that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit activity. To the extent our actual results differ from our estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the recognition of additional restructuring charges or the reduction of liabilities already recognized. Such changes to previously estimated amounts may be material to the consolidated financial statements. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans.
Newly Adopted and Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09 (ASU 2014-09),
Revenue from Contracts with Customers
. The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. This may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. 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. In August 2015, the FASB issued an amendment to defer the effective date of ASU 2014-09 for all entities by one year. This Update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company has assessed that the impact of the new guidance will 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 will recognize an increase in contract assets for unbilled receivables with a corresponding reduction in finished goods and work-in-progress inventory. The Company has commenced implementation in accordance with the planned effective date and such efforts are ongoing. Companies have the option of using either a full or modified retrospective approach in applying this standard. The Company has not yet concluded upon its selection of the transition method.
In July 2015, the FASB issued final guidance that simplifies the subsequent measurement of inventory for which cost is determined by methods other than last-in first-out (“LIFO”) and the retail inventory method. For inventory within the scope of the new guidance, entities will be required to compare the cost of inventory to only one measure, its net realizable value, and not the three measures required by the existing guidance. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The new guidance should not change how entities initially measure the cost of inventory. The guidance will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Company adopted this guidance during the second quarter of fiscal year 2017 and it had no impact on our financial statements.
In February 2016, the FASB issued Accounting Standards Update 2016-02 (ASU 2016-02),
Leases
which supersedes ASC 840
Leases
and creates a new topic, ASC 842
Leases
. This update requires lessees to recognize a lease asset and a lease liability for all leases, including operating leases, with a term greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with earlier adoption permitted. This update will be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Upon initial evaluation, the Company believes the new guidance will have a material impact on its consolidated balance sheets when adopted. The Company is currently assessing the timing of adoption.
In March 2016, the FASB issued Accounting Standards Update 2016-09 (ASU 2016-09),
Improvements to Employee Share-Based Payment Accounting
. This update simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This update is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with earlier adoption permitted. The Company prospectively adopted this ASU during the first quarter of fiscal year 2017. As a result, excess tax benefits are recorded in income tax expense instead of a component of shareholders’ equity and excess tax benefits are no longer broken out on the consolidated statement of cash flows beginning in fiscal year 2017.
In August 2016, the FASB issued Accounting Standards Update 2016-15 (ASU 2016-15),
Classification of Certain Cash Receipts and Cash Payments
. This update provides guidance on how to record eight specific cash flow issues. This update is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted and a retrospective transition method to each period should be presented. The Company early adopted this guidance during the second quarter of fiscal year 2017 and it had no impact on our consolidated financial statements.
In January 2017, the FASB issued Accounting Standards Update 2017-04,
Simplifying the Test for Goodwill Impairment
. Under the new standard, goodwill impairment would be measured as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying value of goodwill. This ASU eliminates existing guidance that requires an entity to determine goodwill impairment by calculating the implied fair value of goodwill by hypothetically assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. This update is effective prospectively to impairment tests beginning June 28, 2020, with early adoption permitted. The Company would apply this guidance to applicable impairment tests after the adoption date. The Company is currently evaluating the effect of this update on its consolidated financial statements.
In May 2017, the FASB issued Accounting Standards Update 2017-09,
Compensation - Stock Compensation
. This update provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. This update is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted. The Company is currently evaluating the effect of this update on its consolidated financial statements.
Fiscal Year
The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years
2017
,
2016
, and
2015
, ended on
July 1, 2017
,
July 2, 2016
, and
June 27, 2015
, respectively. Fiscal year 2017 and 2015 were 52 week years whereas fiscal year 2016 was a 53 week year.
2. INVENTORIES
The components of inventories consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
Finished goods
|
$
|
12,244
|
|
|
$
|
13,384
|
|
|
Work-in-process
|
20,596
|
|
|
18,988
|
|
|
Raw materials and supplies
|
68,750
|
|
|
74,634
|
|
|
|
$
|
101,590
|
|
|
$
|
107,006
|
|
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
|
|
July 1, 2017
|
|
July 2, 2016
|
|
|
(in years)
|
|
(in thousands)
|
|
Land
|
—
|
|
$
|
2,940
|
|
|
$
|
2,940
|
|
|
Buildings and improvements
|
3 to 30
|
|
23,158
|
|
|
23,737
|
|
|
Equipment
|
1 to 10
|
|
57,848
|
|
|
53,095
|
|
|
Furniture and fixtures
|
3 to 5
|
|
3,512
|
|
|
2,924
|
|
|
|
|
|
87,458
|
|
|
82,696
|
|
|
Accumulated depreciation
|
|
|
(56,962
|
)
|
|
(54,771
|
)
|
|
|
|
|
$
|
30,496
|
|
|
$
|
27,925
|
|
4. LONG-TERM DEBT
On September 3, 2014, the Company entered into a five-year term loan in the amount of
$35.0 million
used to acquire all of the outstanding shares of CDR Manufacturing, Inc. (dba Ayrshire Electronics). The term loan requires quarterly payments of
$1.25 million
through June 15, 2019, with a final payment of the remaining outstanding balance on August 31, 2019. The Company had an outstanding balance of
$21.3 million
and
$26.3 million
under the term loan as of
July 1, 2017
and
July 2, 2016
, respectively.
On August 6, 2015, the Company entered into a First Amendment to the amended and restated credit agreement extending the limit on our line of credit facility to
$45.0 million
as evidenced by the Second Replacement Revolving Note. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and general corporate purposes. The line of credit is secured by substantially all of the assets of the Company and matures on August 31, 2019 at which time all outstanding balances are payable. As of
July 1, 2017
, the Company had an outstanding balance under the credit facility of
$18.3 million
,
$0.4 million
in outstanding letters of credit and
$26.3 million
available for future borrowings. As of
July 2, 2016
, the Company had an outstanding balance under the credit facility of
$18.1 million
,
$0.4 million
in outstanding letters of credit and
$26.5 million
available for future borrowings.
On December 28, 2016, the Company entered into an equipment term loan agreement in the amount of
$3.9 million
in order to further invest in production equipment. The equipment term loan is collateralized by production equipment. Under this loan agreement, equal quarterly payments of approximately
$0.2 million
commenced on March 31, 2017 and will continue through the maturity of the equipment term loan on June 30, 2021. Amortization of the debt issuance costs is reported as interest expense on the consolidated income statement. As of
July 1, 2017
, the Company had an outstanding balance of
$3.5 million
. The Company did not have a balance as of
July 2, 2016
. The Company has available an additional
$2.1 million
which can be borrowed in the future under this agreement.
Borrowings under the revolving line of credit, term loan and equipment term loan bear interest at either a “Base Rate” or a “Fixed Rate,” as elected by the Company. The base rate is the higher of the Wells Fargo Bank prime rate, daily one month London Interbank Offered Rate (LIBOR) plus
1.5%
, or the Federal Funds rate plus
1.5%
. The fixed rate is LIBOR plus
1.75%
, LIBOR plus
2.0%
or LIBOR plus
2.25%
depending on the level of the Company’s trailing four quarters Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). The interest rates on the outstanding debt as of
July 1, 2017
range from
3.22%
-
4.25%
compared to
2.45%
-
3.50%
as of
July 2, 2016
.
Debt maturities as of
July 1, 2017
for the next five years and thereafter are as follows (in thousands):
|
|
|
|
|
|
|
|
Fiscal Years Ending
|
Amount
|
|
2018
|
$
|
5,871
|
|
|
2019
|
5,871
|
|
|
2020
|
30,455
|
|
|
2021
|
871
|
|
|
2022
|
—
|
|
|
Total debt
|
$
|
43,068
|
|
|
Unamortized debt issuance costs
|
$
|
(119
|
)
|
|
Long-term debt, net of debt issuance costs
|
$
|
42,949
|
|
The Company must comply with certain financial covenants, including a cash flow leverage ratio, an asset coverage ratio and a fixed charge coverage ratio. The credit agreement requires the Company to maintain a minimum profit threshold, limits the maximum capital lease expenditures and restricts the Company from declaring or paying dividends in cash or stock without prior bank approval. The Company is in compliance with all financial covenants for all periods presented.
5. TRADE ACCOUNTS RECEIVABLE PURCHASE PROGRAMS
Sale Programs
The Company utilizes an Account Purchase Agreement with Wells Fargo Bank, N.A. ("WFB") which allows the Company to sell and assign to WFB and WFB may purchase from Company the accounts receivable of certain Company customers in a maximum aggregate amount outstanding of
$20.0 million
. This agreement may be cancelled at any time by either party. The Company also has an Account Purchase Agreement with Orbian Financial Services (“Orbian”). This agreement allows the Company to sell accounts receivable of certain customers to Orbian and the agreement may be cancelled at any time by either party.
Total accounts receivables sold during the twelve months ended
July 1, 2017
and
July 2, 2016
was approximately
$86.5 million
and
$78.0 million
, respectively. Accounts receivables sold and not yet collected was approximately
$1.6 million
and
$1.7 million
as of
July 1, 2017
and
July 2, 2016
, respectively. The receivables that were sold were removed from the consolidated balance sheets and the cash received is reflected as cash provided by operating activities in the consolidated statements of cash flows.
6. INCOME TAXES
Income tax provision consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
June 27, 2015
|
|
|
(in thousands)
|
|
Current income tax provision:
|
|
|
|
|
|
|
United States
|
$
|
1,231
|
|
|
$
|
1,014
|
|
|
$
|
1,701
|
|
|
Foreign
|
1,206
|
|
|
1,960
|
|
|
975
|
|
|
|
2,437
|
|
|
2,974
|
|
|
2,676
|
|
|
Deferred income tax benefit:
|
|
|
|
|
|
|
United States
|
(539
|
)
|
|
(1,285
|
)
|
|
(1,486
|
)
|
|
Foreign
|
(259
|
)
|
|
(71
|
)
|
|
(194
|
)
|
|
|
(798
|
)
|
|
(1,356
|
)
|
|
(1,680
|
)
|
|
Total income tax provision
|
$
|
1,639
|
|
|
$
|
1,618
|
|
|
$
|
996
|
|
The Company has gross tax credit carryforwards of approximately
$8.2 million
at
July 1, 2017
. Included in total tax credits carryforwards is approximately
$7.4 million
in research and development (R&D) tax credits.
Management also has reviewed its other deferred tax assets for purposes of determining whether or not a valuation allowance may be required. A valuation allowance against these deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Based on the Company’s profitability and estimated future repatriations from foreign subsidiaries, it has been determined that it is more likely than not that the deferred tax assets will be realized.
Management has reviewed and updated as necessary estimates of future repatriations of the undistributed earnings of its foreign subsidiaries. Based on this analysis, management expects to repatriate a portion of the foreign undistributed earnings based on increased sales growth driving additional U.S. capital requirements, cash requirements for potential acquisitions and to potentially implement certain tax strategies. No foreign earnings were repatriated from either foreign subsidiary during fiscal
2017
or
2016
. The Company currently estimates that future repatriations from foreign subsidiaries will approximate
$13.4 million
. As such, as earnings are recognized in the United States, the Company would be subject to U.S. federal and state income taxes and potential withholding taxes are estimated to be approximately
$6.6 million
. Both the domestic tax and estimated withholding tax have been recorded as part of deferred taxes as of
July 1, 2017
. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed asset purchases in foreign locations.
The Company has not provided for U.S. income taxes or foreign withholding taxes on approximately
$15.0 million
of earnings from foreign subsidiaries which are permanently reinvested outside the U.S. The unrecognized net tax provision, after netting U.S. federal and state income tax and any related foreign tax credits, would be approximately
$2.3 million
associated with these earnings.
During the second quarter of fiscal year 2017, the Company signed a unilateral advance pricing agreement (APA) with the Large Taxpayer Division of Mexico’s Servicio de Administración Tributaria (SAT) under an elective framework that has been agreed to by the U.S. and Mexican authorities. The APA is part of a larger program affecting hundreds of U.S. companies with maquiladora operations in Mexico. The general impact of the APA is to increase margins between the maquiladora and U.S. parent company, shifting profits to Mexico from the U.S.
As a result of the APA, the Company recognized an increased tax liability in Mexico of approximately
$0.4 million
related to the calendar years 2014-2016. However, the increased costs to the U.S. resulted in a reduced tax liability of approximately
$0.4 million
in the U.S. during fiscal year 2017. The overall net impact of the APA is therefore estimated to not be material to the Company’s consolidated financial results. The estimated increased liabilities in Mexico and related offsetting tax benefit in the U.S. were recorded during the second quarter of fiscal year 2017. The APA was finalized during the fourth quarter of fiscal year 2017.
Further, the resulting impact of the APA resulted in approximately
$1.8 million
of additional earnings being recognized in Mexico. The Company has reevaluated its repatriation assumptions and based on new customer growth in Mexico and related required capital expenditures, it is assumed that
50%
of the additional
$1.8 million
in earnings will be permanently reinvested in Mexico.
The Company’s effective tax rate differs from the federal tax rate as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
June 27, 2015
|
|
|
(in thousands)
|
|
Federal income tax provision at statutory rates
|
$
|
2,467
|
|
|
$
|
2,771
|
|
|
$
|
1,802
|
|
|
State income taxes, net of federal tax effect
|
175
|
|
|
250
|
|
|
133
|
|
|
Foreign tax rate differences
|
(156
|
)
|
|
(442
|
)
|
|
(80
|
)
|
|
Effect of income tax credits
|
(738
|
)
|
|
(1,254
|
)
|
|
(1,085
|
)
|
|
Effect of repatriation of foreign earnings, net
|
199
|
|
|
(161
|
)
|
|
(80
|
)
|
|
Other
|
(308
|
)
|
|
454
|
|
|
124
|
|
|
Transaction costs
|
—
|
|
|
—
|
|
|
182
|
|
|
Income tax provision
|
$
|
1,639
|
|
|
$
|
1,618
|
|
|
$
|
996
|
|
The domestic and foreign components of income before income taxes were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
June 27, 2015
|
|
|
(in thousands)
|
|
Domestic
|
$
|
3,553
|
|
|
$
|
2,228
|
|
|
$
|
3,395
|
|
|
Foreign
|
3,703
|
|
|
5,923
|
|
|
1,905
|
|
|
Income before income taxes
|
$
|
7,256
|
|
|
$
|
8,151
|
|
|
$
|
5,300
|
|
Deferred income tax assets and liabilities consist of the following at:
|
|
|
|
|
|
|
|
|
|
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
|
(in thousands)
|
|
Deferred tax assets:
|
|
|
|
|
Tax credit carryforwards, net
|
$
|
4,164
|
|
|
$
|
4,056
|
|
|
Foreign subsidiaries - future tax credits
|
840
|
|
|
840
|
|
|
Inventory
|
840
|
|
|
508
|
|
|
Accruals
|
4,020
|
|
|
4,270
|
|
|
Mark-to-market adjustments
|
1,443
|
|
|
4,043
|
|
|
Other
|
28
|
|
|
86
|
|
|
Deferred income tax assets
|
$
|
11,335
|
|
|
$
|
13,803
|
|
|
Deferred tax liabilities:
|
|
|
|
|
Foreign subsidiaries – unremitted earnings
|
(2,288
|
)
|
|
(2,098
|
)
|
|
Fixed assets
|
(456
|
)
|
|
(1,025
|
)
|
|
Identifiable intangibles
|
(1,308
|
)
|
|
(1,613
|
)
|
|
Other
|
(302
|
)
|
|
(85
|
)
|
|
Deferred income tax liabilities
|
$
|
(4,354
|
)
|
|
$
|
(4,821
|
)
|
|
Net deferred income tax assets
|
$
|
6,981
|
|
|
$
|
8,982
|
|
|
Balance sheet caption reported in:
|
|
|
|
|
Long-term deferred income tax asset
|
$
|
6,981
|
|
|
$
|
8,982
|
|
|
Net deferred income tax asset
|
$
|
6,981
|
|
|
$
|
8,982
|
|
Uncertain Tax Positions
The Company has R&D tax credits that approximate
$7.4 million
that have
20
year carryforwards before expiring. The Company’s R&D tax credits expire in various fiscal years from 2021 to 2036. The Company also has alternative minimum tax credits, which do not expire, approximating
$726,000
.
As of
July 1, 2017
, the Company had unrecognized tax benefits of
$3.9 million
related to its gross R&D tax credits. The unrecognized tax benefits relate to certain R&D tax credits generated from 1999 to 2016.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
June 27, 2015
|
|
|
(in thousands)
|
|
Beginning Balance
|
$
|
3,760
|
|
|
$
|
3,446
|
|
|
$
|
3,072
|
|
|
Additions based on tax positions related to the current year
|
187
|
|
|
314
|
|
|
374
|
|
|
Ending Balance
|
$
|
3,947
|
|
|
$
|
3,760
|
|
|
$
|
3,446
|
|
The increase from the prior year is due to additional R&D credits that were recorded in
2017
as discussed above. Management does not anticipate any material changes to this amount during the next 12 months.
The Company recognizes interest accrued related to unrecognized tax benefits and penalties in its income tax provision. The Company has not recognized any interest or penalties in the fiscal years presented in these financial statements. The Company is subject to income tax in the U.S. federal jurisdiction, various state jurisdictions, Mexico and China. Certain years remain subject to examination but there are currently no ongoing exams in any taxing jurisdictions.
7. EARNINGS PER SHARE
Basic earnings per share (EPS) is calculated by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of shares outstanding and any dilutive common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share awards that were not included in the diluted earnings per share calculation. These antidilutive securities occur when equity awards outstanding have an option price greater than the average market price for the period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
(in thousands, except per share information)
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
June 27, 2015
|
|
Net income
|
$
|
5,617
|
|
|
$
|
6,533
|
|
|
$
|
4,304
|
|
|
Weighted average shares outstanding– basic
|
10,756
|
|
|
10,710
|
|
|
10,572
|
|
|
Effect of dilutive common stock awards
|
161
|
|
|
568
|
|
|
714
|
|
|
Weighted average shares outstanding – diluted
|
10,917
|
|
|
11,278
|
|
|
11,286
|
|
|
Earnings per share – basic
|
$
|
0.52
|
|
|
$
|
0.61
|
|
|
$
|
0.41
|
|
|
Earnings per share – diluted
|
$
|
0.51
|
|
|
$
|
0.58
|
|
|
$
|
0.38
|
|
|
Antidilutive SARs not included in diluted earnings per share
|
892
|
|
|
442
|
|
|
208
|
|
8. STOCK OPTION AND BENEFIT PLANS
The Company’s incentive plan provides for equity and liability awards to employees and non-employee directors in the form of stock options, stock appreciation rights (SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is recorded as employee compensation expense in cost of goods sold, research, development and engineering, and selling, general and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations.
In addition to service conditions, these SARs contain a performance condition. The additional performance condition is based upon the achievement of Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are measured over the vesting period and are charged to compensation expense over the requisite service period based on the number of shares expected to vest. The SARs cliff vest after a three-year period from date of grant and expire five years from date of grant.
On October 28, 2016, the Company granted
10,000
SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of
$8.04
and a grant date fair value of
$2.30
, as of
July 1, 2017
,
10,000
remain outstanding. The grant date fair value for the awards granted during fiscal year
2017
, were estimated using the Black Scholes option valuation method with the following weighted average assumptions as of October 28, 2016:
|
|
|
|
|
|
|
Fiscal Year 2017
|
|
|
October 28, 2016
|
|
Expected dividend yield
|
—%
|
|
Risk – free interest rate
|
1.63%
|
|
Expected volatility
|
33.43%
|
|
Expected life
|
4.00
|
On July 26, 2016, the Company granted
242,500
SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of
$8.18
and a grant date fair value of
$2.42
, as of
July 1, 2017
,
242,500
remain outstanding. The grant date fair value for the awards granted during fiscal year
2017
, were estimated using the Black Scholes option valuation method with the following weighted average assumptions as of July 26, 2016:
|
|
|
|
|
|
|
Fiscal Year 2017
|
|
|
July 26, 2016
|
|
Expected dividend yield
|
—%
|
|
Risk – free interest rate
|
0.93%
|
|
Expected volatility
|
36.13%
|
|
Expected life
|
4.00
|
On July 29, 2015, the Company granted
248,166
SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of
$10.26
and a grant date fair value of
$3.65
, as of
July 1, 2017
,
233,333
remain outstanding. The grant date fair value for the awards granted during fiscal year 2016, were estimated using the Black Scholes option valuation method with the following weighted average assumptions as of July 29, 2015:
|
|
|
|
|
|
|
Fiscal Year 2016
|
|
|
July 29, 2015
|
|
Expected dividend yield
|
—%
|
|
Risk – free interest rate
|
1.39%
|
|
Expected volatility
|
43.66%
|
|
Expected life
|
4.00
|
On October 31, 2014, the Company granted
213,166
SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of
$8.22
and a grant date fair value of
$3.04
, as of
July 1, 2017
,
205,833
remain outstanding. The grant date fair value for the awards granted during fiscal year 2016, were estimated using the Black Scholes option valuation method with the following weighted average assumptions as of October 31, 2014:
|
|
|
|
|
|
|
Fiscal Year 2015
|
|
|
October 31, 2014
|
|
Expected dividend yield
|
—%
|
|
Risk – free interest rate
|
1.39%
|
|
Expected volatility
|
45.67%
|
|
Expected life
|
4.00
|
Subsequent to
July 1, 2017
, the Company granted
272,500
SARs with a strike price of
$7.26
and a grant date fair value of
$1.89
.
Share-based compensation expense is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. This forfeiture rate will be revised, if necessary, in subsequent periods if actual forfeitures differ from the amount estimated. Share-based compensation expense for fiscal years ended
July 1, 2017
,
July 2, 2016
and
June 27, 2015
was
$0.7 million
,
$0.8 million
and
$0.7 million
, respectively.
The Black-Scholes option valuation model is used by the Company for estimating the fair value of SARs. Option valuation models require the input of highly subjective assumptions, particularly for the expected term and expected stock price volatility. Changes in these assumptions can materially affect the fair value estimates.
The intrinsic value for stock options and SARs exercised in fiscal years
2017
,
2016
and
2015
was
$0.4 million
,
$0.2 million
and
$1.9 million
, respectively.
As of
July 1, 2017
, total unrecognized compensation expense related to nonvested share-based compensation arrangements was approximately
$0.8 million
. This expense is expected to be recognized over a weighted-average period of
1.54 years
.
The following table summarizes the Company’s Options and SARs activity for all plans from June 28, 2014 through
July 1, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SARs
Available
For Grant
|
|
SARs
Outstanding
|
|
Aggregate
Intrinsic
Value (in
thousands)
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Life (in
years)
|
|
Balances, June 28, 2014
|
69,002
|
|
|
1,065,928
|
|
|
$
|
4,096
|
|
|
$
|
7.01
|
|
|
1.8
|
|
Shares authorized
|
1,000,000
|
|
|
|
|
|
|
—
|
|
|
|
|
SARs granted
|
(213,166
|
)
|
|
213,166
|
|
|
|
|
8.22
|
|
|
|
|
SARs forfeited
|
—
|
|
|
—
|
|
|
|
|
—
|
|
|
|
|
Options/SARs exercised
|
—
|
|
|
(465,263
|
)
|
|
1,877
|
|
|
5.84
|
|
|
|
|
Balances, June 27, 2015
|
855,836
|
|
|
813,831
|
|
|
$
|
2,312
|
|
|
$
|
7.99
|
|
|
2.5
|
|
Shares authorized
|
—
|
|
|
|
|
|
|
|
|
|
|
SARs granted
|
(248,166
|
)
|
|
248,166
|
|
|
|
|
10.26
|
|
|
|
|
SARs forfeited
|
26,999
|
|
|
(26,999
|
)
|
|
|
|
9.48
|
|
|
|
|
SARs exercised
|
—
|
|
|
(63,333
|
)
|
|
165
|
|
|
4.56
|
|
|
|
|
Balances, July 2, 2016
|
634,669
|
|
|
971,665
|
|
|
$
|
339
|
|
|
$
|
8.75
|
|
|
2.4
|
|
Shares authorized
|
—
|
|
|
|
|
|
|
|
|
|
|
SARs granted
|
(252,500
|
)
|
|
252,500
|
|
|
|
|
8.17
|
|
|
|
|
SARs forfeited
|
12,166
|
|
|
(12,166
|
)
|
|
|
|
8.60
|
|
|
|
|
SARs exercised
|
—
|
|
|
(127,000
|
)
|
|
385
|
|
|
4.77
|
|
|
|
|
Balances, July 1, 2017
|
394,335
|
|
|
1,084,999
|
|
|
$
|
—
|
|
|
$
|
9.09
|
|
|
2.3
|
|
Exercisable at July 1, 2017
|
|
|
393,333
|
|
|
$
|
—
|
|
|
$
|
9.43
|
|
|
0.6
|
Additional information regarding SARs outstanding and exercisable as of
July 1, 2017
, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range of
Exercise Prices
|
|
Number Outstanding
|
|
Weighted Avg.
Remaining
Contractual Life (yrs.)
|
|
Weighted Avg.
Exercise Price
|
|
Number
Exercisable
|
|
Weighted
Avg. Exercise
Price
|
|
$4.40 – $7.90
|
|
192,500
|
|
|
0.1
|
|
$
|
7.44
|
|
|
192,500
|
|
|
$
|
7.44
|
|
|
7.91 – 9.91
|
|
458,333
|
|
|
3.3
|
|
8.19
|
|
|
—
|
|
|
—
|
|
|
9.92 – 11.34
|
|
434,166
|
|
|
2.2
|
|
10.76
|
|
|
200,833
|
|
|
11.34
|
|
|
$4.40 to $11.34
|
|
1,084,999
|
|
|
2.3
|
|
$
|
9.09
|
|
|
393,333
|
|
|
$
|
9.43
|
|
The Company has defined contribution plans available to U.S. employees who have attained age 21. Company contributions to the plans were approximately
$0.6 million
,
$0.6 million
, and
$0.6 million
during fiscal years
2017
,
2016
and
2015
, respectively.
9. COMMITMENTS AND CONTINGENCIES
Leases
: As of
July 1, 2017
,
July 2, 2016
and
June 27, 2015
, the Company did not have any property and equipment financed under capital leases. As of
July 1, 2017
, the Company has operating leases for certain equipment and production facilities, which expire at various dates during the next
eight years
.
Future minimum payments under non-cancelable operating leases at
July 1, 2017
, are summarized as follows (in thousands):
|
|
|
|
|
|
|
|
|
Fiscal Years Ending
|
Operating Leases
|
|
2018
|
$
|
6,747
|
|
|
2019
|
3,979
|
|
|
2020
|
1,873
|
|
|
2021
|
1,114
|
|
|
2022
|
325
|
|
|
Thereafter
|
854
|
|
|
Total minimum lease payments
|
$
|
14,892
|
|
Rental expense under operating leases was approximately
$7.8 million
,
$6.6 million
, and
$3.8 million
during fiscal years
2017
,
2016
and
2015
, respectively.
Warranty Costs
: The Company provides warranties on certain product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. As of
July 1, 2017
and
July 2, 2016
, the reserve for warranty costs was approximately
$32,000
and
$30,000
, respectively.
If actual return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be required in future periods. Warranty expense for fiscal years
2017
,
2016
and
2015
was related to workmanship claims on keyboards and certain EMS products.
Litigation
: During the second quarter of fiscal year 2017, the Company commenced the arbitration process with a former customer related to approximately
$9 million
in inventory purchased, cancellation fees, and other carrying costs we believe should be reimbursed by this former customer based on the terms of the manufacturing agreement. The Company is actively working through the arbitration process and expects further clarity on the resolution of this matter, whether through negotiations or a scheduled hearing by the end of the calendar year. The Company has not accrued for any potential gains or losses related to this claim and legal costs are being expensed as incurred. The ultimate disposition of these matters could have a material effect on our consolidated financial position, results of operations or cash flows.
Indemnification Rights
: Under the Company’s bylaws, the Company’s directors and officers have certain rights to indemnification by the Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors in certain circumstances.
10. FAIR VALUE MEASUREMENTS
The Company has adopted ASC 820,
Fair Value Measurements,
which defines fair value, establishes a framework for assets and liabilities being measured and reported at fair value and expands disclosures about fair value measurements. There are three levels of fair value hierarchy inputs used to value assets and liabilities which include: Level 1 – inputs are quoted market prices for identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3 – inputs are unobservable inputs for the asset or liability. There have been no changes in the fair value methodologies used at
July 1, 2017
and
July 2, 2016
.
The following table summarizes the fair value of assets (liabilities) of the Company’s derivatives that are required to be measured on a recurring basis as of
July 1, 2017
and
July 2, 2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July 1, 2017
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
Fair Value
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
Foreign currency forward contracts & swaps
|
$
|
—
|
|
|
$
|
1,010
|
|
|
$
|
—
|
|
|
$
|
1,010
|
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
$
|
—
|
|
|
$
|
(103
|
)
|
|
$
|
—
|
|
|
$
|
(103
|
)
|
|
Foreign currency forward contracts & swaps
|
$
|
—
|
|
|
$
|
(5,112
|
)
|
|
$
|
—
|
|
|
$
|
(5,112
|
)
|
|
|
|
|
|
|
|
|
|
|
|
July 2, 2016
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
Fair Value
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
Foreign currency forward contracts
|
—
|
|
|
136
|
|
|
—
|
|
|
$
|
136
|
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
$
|
—
|
|
|
$
|
(498
|
)
|
|
$
|
—
|
|
|
$
|
(498
|
)
|
|
Foreign currency forward contracts & swaps
|
$
|
—
|
|
|
$
|
(11,112
|
)
|
|
$
|
—
|
|
|
$
|
(11,112
|
)
|
The Company currently has forward contracts and swaps to hedge known future cash outflows for expenses denominated in the Mexican peso and an interest rate swap to mitigate risk associated with certain borrowings under the Company’s debt arrangement. These contracts are measured on a recurring basis based on the foreign currency spot rates and forward rates quoted by banks or foreign currency dealers. These contracts are marked to market using level 2 input criteria every period with the unrealized gain or loss, net of tax, reported as a component of shareholders’ equity in accumulated other comprehensive income (loss), as they qualify for hedge accounting.
The carrying values of cash and cash equivalents, accounts receivable and current liabilities reflected on the balance sheets at
July 1, 2017
and
July 2, 2016
, reasonably approximate their fair value. The Company’s long-term debt primarily consists of a revolving line of credit, a term loan and an equipment term loan. These borrowings bear interest at either a “Base Rate” or a “Fixed Rate,” as elected by the Company. Each of these rates is a variable floating rate dependent upon current market conditions and the Company’s current credit risk as discussed in footnote 4.
As a result of the determinable market rate for our revolving line of credit, term loan and equipment term, they are classified within Level 2 of the fair value hierarchy. The discounted cash flow of the revolving line of credit is estimated to be
$18.3 million
as of
July 1, 2017
and
$18.1 million
as of
July 2, 2016
, with a carrying value that reasonably approximates the fair value. The discounted cash flow of the term loan is estimated to be
$21.3 million
as of
July 1, 2017
and
$26.3 million
as of
July 2, 2016
, with a carrying value that reasonably approximates the fair value. The discounted cash flow of the equipment term loan is estimated to be
$3.5 million
as of
July 1, 2017
, with a carrying value that reasonably approximates the fair value. As of
July 2, 2016
, the Company did not have a balance under the equipment term loan.
11. DERIVATIVE FINANCIAL INSTRUMENTS
As of
July 1, 2017
, the Company had outstanding foreign currency forward contracts and swaps with a total notional amount of
$55.7 million
. The maturity dates for these contracts and swaps extend through
September 2019
. As of
July 1, 2017
, the net amount of unrealized loss expected to be reclassified into earnings within the next 12 months is approximately
$2.8 million
. During the fiscal year ended
July 1, 2017
, the Company entered into
$6.7 million
of foreign currency forward contracts and settled
$20.5 million
of such contracts. During the fiscal year ended
July 2, 2016
, the Company entered into
$25.9 million
of foreign currency forward contracts and settled
$21.5 million
of such contracts. During the fiscal year ended
June 27, 2015
, the Company entered into
$23.1 million
of foreign currency forward contracts and settled
$20.5 million
of such contracts.
As of
July 1, 2017
, the aggregate notional amount of the Company’s outstanding foreign currency contracts and swaps along with their unrealized gains (losses) are expected to mature as summarized below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ending
|
|
Notional Contracts and Swaps in MXN
|
|
Notional Contracts and Swaps in USD
|
|
Estimated Fair Value
|
|
September 30, 2017
|
|
$
|
76,192
|
|
|
$
|
5,395
|
|
|
$
|
(1,218
|
)
|
|
December 30, 2017
|
|
$
|
88,558
|
|
|
$
|
6,162
|
|
|
$
|
(1,370
|
)
|
|
March 31, 2018
|
|
$
|
90,812
|
|
|
$
|
5,713
|
|
|
$
|
(864
|
)
|
|
June 30, 2018
|
|
$
|
95,500
|
|
|
$
|
5,811
|
|
|
$
|
(774
|
)
|
|
September 29, 2018
|
|
$
|
90,443
|
|
|
$
|
5,301
|
|
|
$
|
(588
|
)
|
|
December 29, 2018
|
|
$
|
125,328
|
|
|
$
|
6,746
|
|
|
$
|
(298
|
)
|
|
March 30, 2019
|
|
$
|
137,944
|
|
|
$
|
6,979
|
|
|
$
|
33
|
|
|
June 29, 2019
|
|
$
|
142,947
|
|
|
$
|
6,828
|
|
|
$
|
350
|
|
|
September 28, 2019
|
|
$
|
148,468
|
|
|
$
|
6,740
|
|
|
$
|
627
|
|
On October 1, 2014, the Company entered into an interest rate swap contract with an effective date of September 1, 2015 and a termination date of September 3, 2019, with a notional amount of
$25.0 million
related to the borrowings outstanding under the term loan. The interest rate swap pays the Company variable interest at the one month LIBOR rate, and the Company pays the counter party a fixed interest rate. The fixed interest rate for the contract is
1.97%
that replaces the one month LIBOR rate component of our contractual interest to be paid to WFB as part of our term loan. Based on the terms of the interest rate swap contract and the underlying borrowings outstanding under the term loan, the interest rate contract was determined to be effective, and thus qualifies as a cash flow hedge. As of
July 1, 2017
and
July 2, 2016
, the remaining notional balance of this swap was
$14.5 million
and
$20.5 million
, respectively.
The following table summarizes the fair value of derivative instruments in the Consolidated Balance Sheets as of
July 1, 2017
and
July 2, 2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July 1, 2017
|
|
July 2, 2016
|
|
Derivatives Designated as Hedging Instruments
|
|
Balance Sheet Location
|
|
Fair Value
|
|
Fair Value
|
|
Foreign currency forward contracts & swaps
|
|
Other long-term assets
|
|
$
|
1,010
|
|
|
$
|
136
|
|
|
Foreign currency forward contracts & swaps
|
|
Other current liabilities
|
|
$
|
(4,226
|
)
|
|
$
|
(4,670
|
)
|
|
Foreign currency forward contracts & swaps
|
|
Other long-term liabilities
|
|
$
|
(886
|
)
|
|
$
|
(6,442
|
)
|
|
Interest rate swaps
|
|
Other long-term assets
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Interest rate swaps
|
|
Other current liabilities
|
|
$
|
(81
|
)
|
|
$
|
(264
|
)
|
|
Interest rate swaps
|
|
Other long-term liabilities
|
|
$
|
(22
|
)
|
|
$
|
(234
|
)
|
The following table summarizes the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the fiscal year
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives Designated as Hedging Instruments
|
Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
|
|
AOCI Balance
as of
July 2, 2016
|
|
Effective
Portion
Recorded In
AOCI
|
|
Effective Portion
Reclassified From
AOCI Into Income
|
|
AOCI Balance
as of
July 1, 2017
|
|
Forward contracts & swaps
|
Cost of sales
|
|
$
|
(7,245
|
)
|
|
$
|
(600
|
)
|
|
$
|
5,138
|
|
|
$
|
(2,707
|
)
|
|
Interest rate swap
|
Interest expense
|
|
(328
|
)
|
|
14
|
|
|
246
|
|
|
(68
|
)
|
|
Total
|
|
|
$
|
(7,573
|
)
|
|
$
|
(586
|
)
|
|
$
|
5,384
|
|
|
$
|
(2,775
|
)
|
The following table summarizes the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the fiscal year
2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives Designated as Hedging Instruments
|
Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
|
|
AOCI Balance
as of
June 27, 2015
|
|
Effective
Portion
Recorded In
AOCI
|
|
Effective Portion
Reclassified From
AOCI Into Income
|
|
AOCI Balance
as of
July 2, 2016
|
|
Forward contracts & swaps
|
Cost of sales
|
|
$
|
(4,487
|
)
|
|
$
|
(6,939
|
)
|
|
$
|
4,181
|
|
|
$
|
(7,245
|
)
|
|
Interest rate swap
|
Interest expense
|
|
(276
|
)
|
|
(348
|
)
|
|
296
|
|
|
(328
|
)
|
|
Total
|
|
|
$
|
(4,763
|
)
|
|
$
|
(7,287
|
)
|
|
$
|
4,477
|
|
|
$
|
(7,573
|
)
|
The following table summarizes the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the fiscal year
2015
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives Designated as Hedging Instruments
|
Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
|
|
AOCI Balance
as of
June 28, 2014
|
|
Effective
Portion
Recorded In
AOCI
|
|
Effective Portion
Reclassified From
AOCI Into Income
|
|
AOCI Balance
as of
June 27, 2015
|
|
Forward contracts
|
Cost of sales
|
|
$
|
2,403
|
|
|
$
|
(7,208
|
)
|
|
$
|
318
|
|
|
$
|
(4,487
|
)
|
|
Interest rate swap
|
Interest expense
|
|
—
|
|
|
(276
|
)
|
|
—
|
|
|
(276
|
)
|
|
Total
|
|
|
$
|
2,403
|
|
|
$
|
(7,484
|
)
|
|
$
|
318
|
|
|
$
|
(4,763
|
)
|
As of
July 1, 2017
, the Company does not have any foreign exchange contracts with credit-risk-related contingent features. The Company is subject to the risk of fluctuating interest rates from our line of credit and foreign currency risk resulting from our China operations. The Company does not currently manage these risk exposures by using derivative instruments.
12. ENTERPRISE-WIDE DISCLOSURES
Operating segments are defined in ASC Topic 280,
Segment Reporting
as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. As of
July 1, 2017
, the Company operates and internally manages a single operating segment, Electronics Manufacturing Services as this is the only discrete financial information that is regularly reviewed by the chief operating decision maker. This segment provides integrated electronic and mechanical engineering, assembly, sourcing and procurement, logistics, and new product testing for our customers.
Products and Services
Of the revenues for the years ended
July 1, 2017
,
July 2, 2016
, and
June 27, 2015
, EMS sales and services were
$466.6 million
,
$483.3 million
and
$432.1 million
, respectively. Keyboard sales for the years ended
July 1, 2017
,
July 2, 2016
, and
June 27, 2015
were
$1.2 million
,
$1.7 million
and
$1.9 million
, respectively.
Geographic Areas
Net sales and long-lived assets (property, plant, and equipment) by geographic area for the years ended and as of
July 1, 2017
,
July 2, 2016
and
June 27, 2015
are summarized in the following table. Net sales set forth below are based on the shipping destination. Long-lived assets information is based on the physical location of the asset.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
(in thousands)
|
|
|
2017
|
|
2016
|
|
2015
|
|
Geographic net sales:
|
|
|
|
|
|
|
Domestic (U.S.)
|
$
|
361,886
|
|
|
$
|
347,552
|
|
|
$
|
301,891
|
|
|
Foreign
|
105,911
|
|
|
137,413
|
|
|
132,106
|
|
|
Total
|
$
|
467,797
|
|
|
$
|
484,965
|
|
|
$
|
433,997
|
|
|
|
|
|
|
|
|
|
Long-lived assets:
|
|
|
|
|
|
|
United States
|
$
|
8,988
|
|
|
$
|
11,406
|
|
|
$
|
8,969
|
|
|
Mexico
|
20,878
|
|
|
15,756
|
|
|
17,156
|
|
|
China
|
630
|
|
|
763
|
|
|
849
|
|
|
Total
|
$
|
30,496
|
|
|
$
|
27,925
|
|
|
$
|
26,974
|
|
Percentage of net sales made to customers located in the following countries:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
2017
|
|
2016
|
|
2015
|
|
United States
|
77%
|
|
72%
|
|
70%
|
|
Canada
|
1
|
|
7
|
|
10
|
|
Other foreign countries
(a)
|
22
|
|
21
|
|
20
|
|
Total
|
100%
|
|
100%
|
|
100%
|
(a) No other individual foreign country accounted for 10% or more of the foreign sales in fiscal years 2017, 2016 or 2015.
Significant Customers
The percentage of net sales to and trade accounts receivables from significant customers were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of Net
Sales Fiscal Year
|
|
Percentage of
Trade Accounts Receivable
Fiscal Year
|
|
|
2017
|
|
2016
|
|
2015
|
|
2017
|
|
2016
|
|
Customer A
|
18%
|
|
18%
|
|
17%
|
|
30%
|
|
24%
|
13. QUARTERLY FINANCIAL DATA (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended July 1, 2017
|
|
|
First
Quarter
|
|
Second
Quarter
|
|
Third
Quarter
|
|
Fourth
Quarter
|
|
|
(in thousands, except per share amounts)
|
|
Net sales
|
$
|
117,135
|
|
|
$
|
118,517
|
|
|
$
|
113,601
|
|
|
$
|
118,544
|
|
|
Gross profit
|
9,709
|
|
|
9,612
|
|
|
9,139
|
|
|
9,840
|
|
|
Income before income taxes
|
2,201
|
|
|
1,995
|
|
|
1,283
|
|
|
1,777
|
|
|
Net income
|
1,792
|
|
|
1,528
|
|
|
961
|
|
|
1,336
|
|
|
Earnings per common share-basic
|
$
|
0.17
|
|
|
$
|
0.14
|
|
|
$
|
0.09
|
|
|
$
|
0.12
|
|
|
Earnings per common share-diluted
|
$
|
0.16
|
|
|
$
|
0.14
|
|
|
$
|
0.09
|
|
|
$
|
0.12
|
|
|
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
Basic
|
10,748
|
|
|
10,758
|
|
|
10,759
|
|
|
10,760
|
|
|
Diluted
|
10,922
|
|
|
10,968
|
|
|
10,957
|
|
|
10,856
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended July 2, 2016
|
|
|
First
Quarter
|
|
Second
Quarter
|
|
Third
Quarter
|
|
Fourth
Quarter
|
|
|
(in thousands, except per share amounts)
|
|
Net sales
|
$
|
126,209
|
|
|
$
|
116,403
|
|
|
$
|
118,448
|
|
|
$
|
123,905
|
|
|
Gross profit
|
8,919
|
|
|
9,110
|
|
|
9,955
|
|
|
10,841
|
|
|
Income before income taxes
|
1,247
|
|
|
1,882
|
|
|
2,137
|
|
|
2,885
|
|
|
Net income
|
817
|
|
|
1,787
|
|
|
1,783
|
|
|
2,146
|
|
|
Earnings per common share-basic
|
$
|
0.08
|
|
|
$
|
0.17
|
|
|
$
|
0.17
|
|
|
$
|
0.20
|
|
|
Earnings per common share-diluted
|
$
|
0.07
|
|
|
$
|
0.16
|
|
|
$
|
0.16
|
|
|
$
|
0.20
|
|
|
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
Basic
|
10,706
|
|
|
10,710
|
|
|
10,711
|
|
|
10,714
|
|
|
Diluted
|
11,391
|
|
|
11,418
|
|
|
11,068
|
|
|
10,966
|
|
14. ACQUISITION
On September 3, 2014, the Company acquired all of the outstanding stock of Ayrshire, resulting in Ayrshire becoming a wholly owned subsidiary of the Company. Ayrshire provides printed circuit board assembly and other electronic manufacturing services to a diversified customer base through manufacturing facilities operated by Ayrshire or its subsidiaries in Minnesota, Arkansas, Mississippi, and Kentucky and through a sheltered maquiladora facility in Reynosa, Mexico. The Reynosa, Mexico operations were moved to the Company's existing facility in Juarez, Mexico shortly after acquisition. During the second quarter of fiscal year 2017, the Company closed the Harrodsburg, Kentucky facility in order to improve operating efficiencies. The remaining programs from the Kentucky facility were transferred to other facilities. This acquisition expanded our printed circuit board assembly capacity, total revenue, and added to and diversified our customer base with the addition of many new multi-national companies. The total cash payment of approximately
$48.0 million
was funded through borrowings on our term loan, revolving line of credit, and cash on hand. The Company incurred approximately
$775,000
of costs related to due diligence.
The following table summarizes the purchase price paid for Ayrshire and the fair value of the assets acquired and liabilities assumed as of the date of acquisition (in thousands):
|
|
|
|
|
|
|
|
|
Estimated Fair Values
|
|
|
At September 3, 2014
|
|
Purchase Price Paid
|
$
|
48,010
|
|
|
Cash Acquired
|
(46
|
)
|
|
Purchase Price, Net of Cash Received
|
$
|
47,964
|
|
|
|
|
|
Cash
|
$
|
46
|
|
|
Accounts Receivable
|
21,211
|
|
|
Inventories
|
21,772
|
|
|
Other Current Assets
|
1,013
|
|
|
Property, Plant and Equipment
|
7,823
|
|
|
Favorable Leases
|
2,941
|
|
|
Customer Relationships
|
2,833
|
|
|
Non-Compete Agreements
|
196
|
|
|
Goodwill
|
8,217
|
|
|
Other Assets
|
42
|
|
|
Accounts Payable
|
(11,070
|
)
|
|
Accrued Salaries and Wages
|
(2,188
|
)
|
|
Other Current Liabilities
|
(2,408
|
)
|
|
Deferred Tax Liability
|
(2,418
|
)
|
|
Fair Value of Assets Acquired
|
$
|
48,010
|
|
The Ayrshire acquisition was accounted for using the acquisition method of accounting whereby the total purchase price is allocated to tangible and intangible assets and liabilities based on their fair values on the date of acquisition. The Company determined the purchase price allocations on the acquisition based on estimates of the fair values of the assets acquired and liabilities assumed.
The following summary pro forma condensed consolidated financial information reflects the Ayrshire acquisition as if it had occurred on June 30, 2013 for purposes of the statements of income. This summary pro forma information is not necessarily representative of what the Company’s results of operations would have been had this acquisition in fact occurred on June 30, 2013 and is not intended to project the Company’s results of operations for any future period.
Pro forma condensed consolidated financial information for the year ended June 27, 2015 (in thousands):
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|
|
|
|
|
|
|
|
|
|
Fiscal Year Ended
|
|
|
|
(unaudited)
|
|
|
|
June 27, 2015
|
|
Net sales
|
|
$
|
457,475
|
|
|
Net income
|
|
$
|
4,136
|
|
It is impracticable to determine the revenue and net income related to the Ayrshire acquisition as certain customer programs have been transferred to the Company’s Juarez facilities.
15. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company recorded goodwill in connection with the Ayrshire and Sabre acquisitions resulting primarily from the synergies that resulted from the Company's acquisitions and the assembled workforce. The goodwill is not amortized for financial accounting purposes. The goodwill from the acquisitions is not deductible for tax purposes. As of
July 1, 2017
and
July 2, 2016
, goodwill was recorded at
$10.0 million
.
The components of acquired intangible assets are as follows (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July 1, 2017
|
|
|
Amortization Period
in Years
|
|
Gross Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Carrying
Amount
|
|
Other intangible assets:
|
|
|
|
|
|
|
|
|
Non-Compete Agreements
|
3 - 5
|
|
$
|
568
|
|
|
$
|
(483
|
)
|
|
$
|
85
|
|
|
Customer Relationships
|
10
|
|
4,803
|
|
|
(1,590
|
)
|
|
3,213
|
|
|
Favorable Lease Agreements
|
4 - 7
|
|
2,941
|
|
|
(1,439
|
)
|
|
1,502
|
|
|
Total
|
|
|
$
|
8,312
|
|
|
$
|
(3,512
|
)
|
|
$
|
4,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
July 2, 2016
|
|
|
Amortization Period
in Years
|
|
Gross Carrying
Amount
|
|
Accumulated
Amortization
|
|
Net Carrying
Amount
|
|
Other intangible assets:
|
|
|
|
|
|
|
|
|
Non-Compete Agreements
|
3 - 5
|
|
$
|
568
|
|
|
$
|
(343
|
)
|
|
$
|
225
|
|
|
Customer Relationships
|
10
|
|
4,803
|
|
|
(1,110
|
)
|
|
3,693
|
|
|
Favorable Lease Agreements
|
4 - 7
|
|
2,941
|
|
|
(931
|
)
|
|
2,010
|
|
|
Total
|
|
|
$
|
8,312
|
|
|
$
|
(2,384
|
)
|
|
$
|
5,928
|
|
Amortization expense related to intangible assets was approximately
$1.1 million
for the years ended
July 1, 2017
and
July 2, 2016
, respectively.
Aggregate amortization expense related to existing intangible assets by fiscal year is currently estimated to be as follows (in thousands):
|
|
|
|
|
|
|
|
|
Fiscal Years Ending
|
|
Amount
|
|
2018
|
|
$
|
1,073
|
|
|
2019
|
|
818
|
|
|
2020
|
|
783
|
|
|
2021
|
|
784
|
|
|
2022
|
|
531
|
|
|
Thereafter
|
|
811
|
|
|
Total amortization expense
|
|
$
|
4,800
|
|