Exhibit 99.2

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Unaudited Consolidated Financial Report

For the Nine Months Ended September 30, 2018

 

 

Contents

Financial Statements
Unaudited consolidated balance sheets	1-2
Unaudited consolidated statements of operations and comprehensive loss	3
Unaudited consolidated statement of stockholders’ equity	4
Unaudited consolidated statements of cash flows	5-6
Notes to the unaudited consolidated financial statements	7-18

 

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

Consolidated Balance Sheets

 

		September 30, 2018 (Unaudited)				December 31, 2017
Assets
Current Assets
Cash		$	14,350			$	7,210
Accounts receivable, net of allowance for doubtful accounts of 2018 $204,000; 2017 $201,000			24,502,825				22,275,186
Inventories, net			33,446,922				22,635,415
Prepaid expenses and other current assets			2,194,602				1,534,901
Deferred income taxes			-				326,749
Total current assets			60,158,699				46,779,461
Equipment, Building, and Leasehold Improvements
Machinery and equipment			33,114,958				31,952,685
Office and computer equipment			8,355,034				7,966,019
Building leasehold			10,100,000				10,100,000
Leasehold improvements			3,645,307				3,568,179
Vehicles			105,893				105,893
			55,321,192				53,692,776
Less accumulated depreciation and amortization			39,777,298				37,105,821
			15,543,894				16,586,955
Other assets			9,054				9,372
Goodwill			38,547,750				38,547,750
Deposits			813,439				811,408
Total assets		$	115,072,836			$	102,734,946

 

See Notes to Unaudited Consolidated Financial Statements.

 

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

 

Consolidated Balance Sheets (Continued)
		September 30, 2018 (Unaudited)				December 31, 2017
Liabilities and Stockholders’ Equity
Current Liabilities
Current maturities of capital lease obligations		$	1,263,300			$	1,171,629
Accounts payable			25,459,305				13,828,486
Accrued liabilities			6,472,312				4,227,821
Accrued management fees			1,500,000				1,375,000
Customer deposits			833,689				1,011,137
Total current liabilities			35,528,606				21,614,073
Other Liabilities
Line of credit, net of deferred costs 2018 $148,000; 2017 - $207,000			22,673,746				22,560,113
Capital lease obligations, less current maturities			9,136,936				9,851,904
Stockholder subordinated notes			37,603,802				36,485,838
Junior subordinated notes			2,480,452				2,265,733
Deferred income taxes - noncurrent liability			-				326,749
Total liabilities			107,423,542				93,104,410
Commitments and Contingencies
Stockholders’ Equity
Class A common stock – $0.001 par value; 1,940,000 shares authorized, 984,000 issued and outstanding			984				984
Class B common stock – $0.001 par value; 60,000 shares authorized, 27,000 issued and outstanding			27				27
Additional paid-in capital			26,479,536				26,479,536
Accumulated other comprehensive gain (loss)			152,910				(176,645	)
Accumulated deficit			(18,984,163	)			(16,673,366	)
Total stockholders' equity			7,649,294				9,630,536
Total liabilities and stockholders' equity		$	115,072,836			$	102,734,946

 

See Notes to Unaudited Consolidated Financial Statements.

 

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

 

Consolidated Statements of Operations and
Comprehensive Loss		Nine Months Ended
		September 30, 2018 (Unaudited)				September 30, 2017 (Unaudited)
Net Sales		$	111,181,729			$	103,595,096
Cost of Goods Sold			97,764,541				91,212,445
Gross profit			13,417,188				12,382,651
Selling, General and Administrative Expenses			9,274,007				9,020,564
Income from operations			4,143,181				3,362,087
Other Income (Expense)
Interest expense			(6,000,003	)			(5,653,299	)
Other income			27,153				66,295
Other expense			(268,957	)			(532,753	)
			(6,241,807	)			(6,119,757	)
Loss before income taxes			(2,098,626	)			(2,757,670	)
Income Tax Expense			212,171				32,734
Net loss			(2,310,797	)			(2,790,404	)
Other Comprehensive Loss
Net derivatives gain on hedge transactions			329,555				104,681
Comprehensive loss		$	(1,981,242	)		$	(2,685,723	)

 

See Notes to Unaudited Consolidated Financial Statements.

 

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

Consolidated Statement of Stockholders' Equity

(Unaudited)

 

		Class A								Class B								Additional								Accumulated
		Common Stock								Common Stock								Paid-in				Accumulated				Other Comprehensive
		Shares				Amount				Shares				Amount				Capital				Deficit				(Loss) Gain				Total
Balance, December 31, 2017			984,000				984				27,000				27				26,479,536				(16,673,366	)			(176,645	)			9,630,536
Net loss			-				-				-				-				-				(2,310,797	)			-				(2,310,797	)
Other comprehensive gain			-				-				-				-				-				-				329,555				329,555
Balance, September 30, 2018			984,000			$	984				27,000			$	27			$	26,479,536			$	(18,984,163	)		$	152,910			$	7,649,294

 

See Notes to Unaudited Consolidated Financial Statements.

 

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

 

Consolidated Statements of Cash Flows
		Nine Months Ended
		September 30, 2018 (Unaudited)				September 30, 2017 (Unaudited)
Cash Flows From Operating Activities
Net loss		$	(2,310,797	)		$	(2,790,404	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Gain on disposition of equipment and leasehold improvements			(9,841	)			(21,524	)
Depreciation			2,985,784				3,285,799
Amortization of deferred loan costs			58,837				58,837
Interest added to principal on notes payable			1,332,683				1,263,989
Foreign currency hedge gain			329,555				104,661
Changes in working capital components:
Accounts receivable			(2,227,639	)			(241,400	)
Inventories			(10,811,507	)			(1,368,294	)
Prepaid expenses and other current assets			(659,701	)			(36,781	)
Other assets			318				(7,800	)
Accounts payable			11,630,818				664,377
Customer deposits			(177,448	)			(1,154,934	)
Accrued management fees			125,000				-
Accrued liabilities			2,244,492				734,118
Net cash provided by operating activities			2,510,554				490,644
Cash Flows From Investing Activities
Purchases of equipment and leasehold improvements			(1,846,817	)			(1,009,698	)
Proceeds from sale of equipment and leasehold improvements			180,931				25,584
Deposits			(2,031	)			-
Net cash used in investing activities			(1,667,917	)			(984,114	)
Cash Flows From Financing Activities
Net borrowings on line of credit			54,797				1,336,812
Principal payments under capital lease obligations			(890,294	)			(839,884	)
Net cash (used in) provided by financing activities			(835,497	)			496,928

 

(Continued)

 

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

 

Consolidated Statements of Cash Flows (Continued)
		Nine Months Ended
		September 30, 2018 (Unaudited)				September 30, 2017 (Unaudited)
Net increase in cash		$	7,140			$	3,458
Cash
Beginning			7,210				6,668
Ending		$	14,350			$	10,126
Supplemental Disclosures of Cash Flow Information
Cash payments for interest		$	3,409,390			$	4,286,097
Cash payments for income taxes		$	12,011			$	32,734
Supplemental Schedule of Noncash Investing and Financing Activities:
Equipment acquired through capital leases		$	266,996			$	450,278
Accrued interest added to principal balance of stockholder and junior subordinated notes payable		$	1,332,684			$	1,263,989

 

See Notes to Unaudited Consolidated Financial Statements.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 1. Nature of Organization and Significant Accounting Policies

 

Formation and nature of organization: M C Assembly Holdings, Inc. (Holdings) was established on February 27, 2007, for the purpose of acquiring the stock of M C Test Service, Inc. and its subsidiary M.C. Assembly International, LLC. Holdings is located in Melbourne, Florida, and assembles and sells printed circuit boards to customers throughout the United States.

 

On June 18, 2010, MC Assembly LLC (LLC) was formed as a subsidiary of M C Test Service, Inc. On June 30, 2010, LLC purchased substantially all of the assets and assumed certain liabilities of RWA, Inc. (d/b/a Chase EMS). LLC is located in Billerica, Massachusetts and is in the same industry as M C Test Service, Inc., providing contract electronic manufacturing services, including printed circuit board assembly, sub assembly, and fully-tested box build services.

 

Basis of presentation: The consolidated financial statements include the accounts of the Company. Intercompany transactions and accounts with subsidiaries have been eliminated. The interim financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations promulgated by the Securities and Exchange Commission (the SEC). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been omitted pursuant to SEC rules and regulations; nevertheless, management believes the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s consolidated financial statements for the year ended December 31, 2017 included elsewhere in this Form 8K/A. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

The consolidated financial statements reflect all adjustments that, in the opinion of management are both of a normal and recurring nature and necessary for the fair presentation of the results for the interim period presented. The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. As a result, actual results could differ from those estimates.

 

Principles of consolidation: The consolidated financial statements include the accounts of Holdings and its wholly-owned subsidiary, M C Test Service, Inc., and M C Test Service, Inc.’s subsidiaries, M.C. Assembly International, LLC and MC Assembly LLC, which are single-member LLCs (collectively referred to as the Company). All material intercompany amounts and transactions are eliminated in consolidation.

 

Use of estimates: The preparation of 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 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. Accordingly, actual results could differ from those estimates.

 

Customer relationships: As part of the Chase EMS acquisition, the Company identified certain customer relationships as an intangible asset. The customer relationships were amortized on a straight-line basis over 10 years. In 2016, the Company determined the remaining balance for customer relationships was fully impaired as the customer list no longer contained current customers.

 

Goodwill and Other Intangible Assets: The Company’s goodwill was recorded as a result of the Company’s business combinations using the acquisition method of accounting. The Company does not amortize goodwill, but tests it at least annually for recoverability. Other intangible assets include customer lists. Such intangible assets are amortized on a straight-line basis over their estimated useful lives, which are generally two to five years.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 1. Nature of Organization and Significant Accounting Policies (Continued)

 

Impairment of long-lived assets: Finite-lived intangible assets, other than goodwill, are tested for impairment based on undiscounted cash flows at an asset group level and, if impaired, written down by the amount by which the carrying value of the asset group exceeded its fair value, based on either discounted cash flows or market values. However, the carrying amount of a finite-lived asset can never been written down below its fair value.

 

Goodwill is tested annually for impairment, or sooner when circumstances indicate an impairment may exist, using a fair-value approach at the reporting unit level. A reporting unit is the operating segment, or a business which is one level below that operating segment (the “component” level) if discrete financial information is prepared and regularly reviewed by segment management at the component level. Components are aggregated as a single reporting unit if they have similar economic characteristic. The Company may elect to perform a qualitative assessment, based on relevant events and circumstances, to determine whether it is more likely than not that a fair value of the reporting unit is less than its carrying amount. For the nine months ended September 30, 2018 and 2017, management determined that there were no triggering events which required an impairment test to be performed.

 

Income taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

 

The Company may recognize the tax benefit from an uncertain tax position only if it is more-likely-than-not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

 

Shipping and handling: Shipping and handling costs are charged to cost of goods sold as incurred. For the nine months ended September 30, 2018 and September 30, 2017, the costs were approximately $553,000 and $599,000, respectively.

 

Fair value of financial instruments: The estimated fair values of the Company’s short-term financial instruments, including cash, accounts receivable, accounts payable and accrued expenses arising in the ordinary course of business, approximate their individual carrying amounts due to the relatively short period of time between their origination and expected realization. The carrying values of the line of credit approximate fair value as the agreement bears interest at a variable rate and there has been no significant changes in the Company’s credit risk. The estimated fair value of the stockholder and junior subordinated notes are based on the current rates offered to the Company for similar debt of the same remaining maturities.

 

Derivative financial instruments: The Company does not engage in currency speculation, however, we use foreign currency exchange rate derivatives on an ongoing basis to hedge against certain foreign currency-related exposures. Our risk-management objective for undertaking these cash-flow hedges is to mitigate the financial transaction fluctuations associated with the volatility of the U.S. Dollar (USD) compared to the Mexican Peso. The hedging program is structured using a rolling, layering strategy, using monthly hedges at different percentages per quarter. The rolling, layering strategy allows for dollar-cost averaging, reducing the volatility of USD cash flows. These cash-flow hedge contracts qualify for hedge accounting under Accounting Standards Codification (ASC) 815, Derivatives and Hedging. Accordingly, the fair value of these derivative instruments is included in other current assets on the consolidated balance sheet. The changes in the fair value of these derivative contracts are recognized in other comprehensive income in the consolidated statements of operations.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 1. Nature of Organization and Significant Accounting Policies (Continued)

 

Recent accounting pronouncements:

 

Recently adopted pronouncements:

 

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (TCJA) tax reform legislation. This legislation makes significant changes in U.S. tax law including numerous changes to individual tax rules, a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum tax. The legislation reduced the U.S. corporate tax rate from the current rate of 35% to 21%. As a result of the enacted law, the Company was required to revalue deferred tax assets and liability at the enacted rate (see Note 9). The other provisions of the TCJA did not have a material impact on the consolidated financial statements.

 

To be adopted in future periods:

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance for recognizing revenue. ASU 2014-09 updates the guidance on revenue recognition by improving the comparability of revenue practices across entities, industries, jurisdictions and capital markets, and ASU 2015-14 defers the effective date for annual reporting periods beginning after December 15, 2018, with early application permitted for annual periods beginning after December 15, 2016. The Company has not yet evaluated the impact this ASU will have on the consolidated financial statements.

 

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. Under ASU 2015-17, a reporting entity is required to classify deferred tax assets and liabilities as noncurrent in a classified statement of financial position. For non-public business entities, the update is effective for financial statements issued for annual periods beginning after December 15, 2017. Entities may apply the update either prospectively to all deferred tax assets and liabilities, or retrospectively for all periods presented. If an entity applies the update prospectively, the entity shall disclose the nature and reason for the change in accounting principle and disclose that the prior periods were not retrospectively adjusted. If an entity adopts the update retrospectively, the entity shall disclose the nature and reason of the change in accounting principle and disclose the quantitative effects of the accounting change on prior periods. The Company will not early adopt and is currently assessing the impact this ASU will have on future consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The update requires all lessees recognize the assets and liabilities that rise from leases. Elections may be available for those leases with terms of 12 months or less. The amendment still retains the distinction between finance leases and operating leases, with classification affecting the pattern of expense recognition in the consolidated statements of operations. The impact of the adoption of the standard is expected to result in the recognition of all leases with the correspondent assets and liabilities recorded in the consolidated financial statements. Management is currently evaluating the qualitative and quantitative impact of this standard.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the measurement of goodwill impairment by eliminating the requirement that an entity compute the implied fair value of goodwill based on the fair values of its assets and liabilities to measure impairment. Instead, goodwill impairment will be measured as the difference between the fair value of the reporting unit and the carrying value of the reporting unit. The ASU also clarifies the treatment of the income tax effect of tax deductible goodwill when measuring goodwill impairment loss. ASU 2017-04 will be effective for the Company beginning on January 1, 2022. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 1. Nature of Organization and Significant Accounting Policies (Continued)

 

The FASB and other entities issued new, or modifications to, or interpretations of, existing accounting guidance during the nine months ended September 30, 2018. The Company has considered the new pronouncements that altered U.S. GAAP and other than as disclosed in these notes to the unaudited consolidated financial statements, does not believe that any other new or modified principles will have a material impact on the Company’s reported financial position or operations in the near term.

 

Subsequent events: Management has evaluated subsequent events through January 22, 2019 which is the date the consolidated financial statements were available to be issued.

 

Note 2. Goodwill

 

The following table represents the balance and changes in goodwill as of and for the periods ending September 30, 2018 and December 31, 2017:

 

		September 30, 2018				December 31, 2017
Balance as of January 1, 2017		$	38,547,750			$	38,547,750
Accumulated impairment loss			-				-
Balance as of December 31, 2017		$	38,547,750			$	38,547,750
Accumulated impairment loss			-				-
Balance as of September 30, 2018		$	38,547,750			$	38,547,750

 

Note 3. Inventories

 

Inventories consisted of the following as of September 30, 2018 and December 31, 2017:

 

		September 30, 2018				December 31, 2017
Raw materials		$	22,916,556			$	13,617,458
Work in process			9,633,660				8,973,275
Finished goods			3,226,925				2,384,220
			35,777,141				24,974,953
Less allowance			(2,330,257	)			(2,339,538	)
		$	33,446,884			$	22,635,415

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

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Note 4. Line of Credit

 

The Company has a secured revolving line of credit with JPMorgan Chase Bank N.A. (Lender) containing a letter of credit commitment up to $1,500,000 and maximum borrowings of $38,000,000 with a maturity date of August 18, 2020. The amounts available under the line of credit are determined based upon a formula of eligible receivables and inventories. The line of credit is collateralized by a first lien on all assets of the Company. The Company is required to meet a fixed charge coverage ratio, only if the Company’s availability under the line is less than $5 million at the beginning of an interim financial statement reporting period and ending as soon as the Company’s availability remains in excess of $5 million for thirty (30) consecutive days, as long as no event of default has occurred. Interest is payable based upon monthly outstanding balance under the line of credit, at the prime rate as defined in the credit agreement, less 1.00% margin or, at the Company’s option, the Eurodollar Loan Rate plus 1.75% margin. For the nine months ended September 30, 2018 and September 30, 2017, the effective interest rate was 4.25% and 3.06%, respectively. The outstanding balance on the lines of credit as of September 30, 2018 and December 31, 2017, was $22,673,746 and $22,766,738, respectively, net of deferred loan costs of $148,000 and $207,000, respectively. Borrowings under the line of credit are classified as non-current on the balance sheet due to the line of credit having a subjective acceleration clause and a springing lockbox arrangement whereby the Company is required to submit all payments on invoices to the lockbox, but the Lender can only access the lockbox if: (a) commencing on the date the Company fails to maintain availability of less than $5.5 million or upon any event of default occurring and (b) continuing until such time thereafter as no event of default is continuing and availability is greater than $5.5 million for a period of thirty (30) consecutive days.

 

Note 5. Stockholder Subordinated Notes

 

As of September 30, 2018, the Company’s Stockholder Subordinated Notes outstanding balance totaled $37,603,802 compared with the December 31, 2017, balance of $36,485,838. The Stockholder Subordinated Notes are unsecured, bear interest at a rate of 16%, payable quarterly in arrears, and are subordinated to the line of credit (see Note 4). The Stockholder Subordinated Notes mature on September 17, 2020. For the nine months ended September 30, 2018 and September 30, 2017, interest expense related to the Stockholder Subordinated Notes totaled $4,471,859 and $4,295,005, respectively, of which $3,353,894 and $3,221,254, respectively, was paid in cash and $1,117,965 and $1,073,751, respectively, was added to the principal balance.

 

The estimated carrying amount and fair values of the Company’s Stockholder Notes as of September 30, 2018 and December 31, 2017, are as follows:

 

		September 30, 2018								December 31, 2017
		Carrying				Estimated				Carrying				Estimated
		Value				Fair Value				Value				Fair Value
Senior subordinated notes		$	37,603,802			$	39,635,573			$	36,485,838			$	39,080,804

 

Note 6. Junior Subordinated Notes

 

Junior subordinated notes consist of unsecured notes payable to the former stockholder (the Junior Notes). The Junior Notes were entered into in connection with the acquisition of M C Test Service, Inc. and are subordinated to the JPMorgan Chase line of credit (see Note 4) and the Stockholder Subordinated Notes (see Note 5). In conjunction with the line of credit (see Note 4), the Junior Notes were amended to be payable in full on September 17, 2020. The Junior Notes bear interest at 12% per annum payable quarterly in arrears. For the nine months ended September 30, 2018 and 2017, interest expense related to the Junior Notes totaled $214,719 and $190,238, respectively, all of which was added to the principal balance. The outstanding balance of the Junior Notes as of September 30, 2018 and December 31, 2017, was $2,480,452 and $2,265,733, respectively. As of September 30, 2018 and December 31, 2017, the carrying amount of the Junior Notes approximates fair value.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

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Note 7. Capital Lease Obligations

 

The Company leases various equipment and buildings under capital leases. These noncancellable leases have varying expiration dates through March 2030, and are payable in varying monthly installments totaling approximately $174,000 including implied interest at various rates ranging from 3% to 13%. These leases are collateralized by the equipment leased.

 

As of September 30, 2018 and December 31, 2017, equipment held under capital leases reported on the consolidated balance sheet consists of the following:

 

		September 30, 2018				December 31, 2017
Equipment		$	3,787,713			$	3,608,961
Less accumulated depreciation			(2,570,802	)			(2,014,378	)
Equipment under capital leases, net		$	1,216,911			$	1,594,583

 

During 2014, the Company signed a facility lease agreement for a 134,900 square foot facility in Melbourne, Florida, with a commencement date of March 1, 2015, and an expiration date of February 28, 2030. Under the terms of the agreement, the Company began occupancy of the building on December 1, 2014, and was not obligated to make rental payments until March 1, 2015. The lease terms neither transfer title nor contain a bargain purchase option, however the present value of the minimum lease payments under the lease equal 90% or more of the fair value of the leased real estate. Further, the value of the land is less than 25% of the aggregate fair value of the leased property. Under ASC 840-30, Capital Leases, the facility lease qualifies for capital lease treatment and in accordance with ASC 840-10, as the fair value of the land is less than 25% of the fair value of the leased property, the land component is considered immaterial and the lease is accounted for as a single unit for the purposes of the minimum lease payment criterion.

 

As of September 30, 2018 and December 31, 2017, buildings held under capital leases, reported on the consolidated balance sheet, consist of the following:

 

		September 30, 2018				December 31, 2017
Buildings		$	10,100,000			$	10,100,000
Less accumulated depreciation			(2,538,798	)			(2,042,077	)
Buildings under capital leases, net		$	7,561,202			$	8,057,923

 

Future minimum lease payments under the equipment and building capital leases together with the present value of the minimum lease payments as of September 30, 2018, are as follows:

 

2018 (remainder)		$	522,063
2019			2,046,667
2020			1,640,721
2021			1,443,950
2022			1,280,021
Thereafter			8,410,986
Total minimum lease payments			15,344,408
Less amount representing interest			(4,944,172	)
			10,400,236
Less current maturities of capital lease obligations			(1,263,300	)
		$	9,136,936

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 8. Incentive Compensation Plans and Employment Agreement

 

Effective January 13, 2017, the Board of Directors and the Company amended the MC Assembly Holdings, Inc. 2007 Key Employee Stock Option Plan (“2007 Plan”), reducing the shares of Class A Common Stock reserved under the plan from 88,889 shares to 23,778. Simultaneously, the Board of Directors and the Company created the MC Assembly Holdings, Inc. 2017 Employee Stock Option Plan (“2017 Plan”), reserving 111,111 of Class A Common Stock for option awards.

 

Both Plans expire on the tenth anniversary of the Effective Date and the options granted under either Plan expire after twelve years from date of grant. The Effective Date of the 2007 Plan is April 9, 2007, and the effective date of the 2017 Plan is January 13, 2017. The options under the 2007 Plan are fully vested and expire in 1.4 years. Options granted under the 2017 Plan vest ratably over five years and expire in 12 years. Under both Plans, the options become exercisable in ten years from the date of grant or upon a change in control, as defined in the Plan. The Board of Directors of the Company shall administer the Plans and determine the stock option exercise prices.

 

The Company is required to measure and recognize compensation expense at the fair value of stock awards determined at the date of grant. Compensation expense for awards and related tax effects are recognized as they vest.

 

The calculated value of each option award is estimated on the date of grant using an option valuation method that uses the assumptions noted below. The valuation technique incorporates assumptions for the expected volatility of the stock price, the expected term of the option, expected dividends, forfeitures and risk-free interest rate for the expected term of the option. Expected volatility was based on the historical volatility of an appropriate industry sector index. The expected term of the option is based on the average period that the options vest and expire. The risk-free interest rate takes into account the time-value of money. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at time of grant.

 

As the Company’s stock is not traded in an active market, it is unable to determine a volatility estimate specific to the Company. Furthermore, management has not identified a similar company in this line of business listed in the marketplace. Therefore, the Company has used the calculated value method to value options, based on changes in an approximate industry sector index over the expected life of the options to estimate volatility of the Company’s stock price.

 

For the nine months ended September 30, 2018, the Plan’s activity was as follows:

 

						Weighted-Average			Weighted-Average Remaining
2007 Stock Option Plan		Shares Under Option				Exercise Price			Contract Term
Outstanding as of December 31, 2017			88,889			$	29.33
Granted			-				-
Forfeited			-				-
Cancelled			(65,111	)			(28.13	)
Exercised			-				-
Outstanding as of September 30, 2018			23,778			$	32.62		1.4 years
Exercisable as of September 30, 2018			15,278			$	32.62		1.4 years

 

						Weighted-Average			Weighted-Average Remaining
2017 Stock Option Plan		Shares Under Option				Exercise Price			Contract Term
Outstanding as of December 31, 2017			75,000			$	-
Granted			5,500				5.00
Forfeited			-				-
Cancelled			-				-
Exercised			-				-
Outstanding as of September 30, 2018			80,500			$	5.00		10.25 years
Exercisable as of September 30, 2018			-				N/A

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

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Note 8. Incentive Compensation Plans and Employment Agreement (Continued)

 

Under the 2007 Plan, there were no stock options granted during the nine months ended September 30, 2018 and 2017. No compensation expense was recognized for 2007 Plan for the nine months ended September 30, 2018 and 2017.

 

Under the 2017 Plan, 96,111 stock options were granted on January 13, 2017, and 20,000 were forfeited during the nine months ended September 30, 2017. During the nine months ended September 30, 2018, an additional 5,500 shares were granted. No compensation expense was recorded for the nine months ended September 30, 2018 or September 30, 2017. As of September 30, 2018, stock compensation cost for unvested awards under the 2017 Plan totaled $123,725. The weighted-average grant date fair value of the options awarded during 2018 was $2.92.

 

The Company entered into an employment agreement with a key executive (the Executive). The agreement, which was amended in October 2013, terminated on October 31, 2016, unless earlier terminated by the Company for cause, as defined in the agreement and includes automatic renewal periods of one year, unless either party notifies the other in writing not less than ninety (90) days prior to expiration. As of December 31, 2017, neither party has given the other notice of termination of the agreement. If the agreement is terminated by the Company without cause, the Executive shall receive severance pay equal to the Executive’s current annual base salary payable over a twelve-month period.

 

As additional consideration for entering into the employment agreement, the Executive was issued 11,111 shares of restricted stock for $.001 per share. The restricted stock shall be automatically forfeited to the Company and the stock shall be canceled upon termination of the employment agreement or the Executive’s employment with the Company. The risk of forfeiture terminated as of February 27, 2013, at which time the restricted shares became full shares.

 

Note 9. Income Taxes

 

Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the deferred tax assets and liabilities relate to the following as of September 30, 2018 and December 31, 2017:

 

		September 30, 2018				December 31, 2017
Current Asset
Differences related to accrued expenses and allowances		$	-			$	776,057
Less valuation allowance			-				(449,308	)
Net current asset		$	-			$	326,749
Noncurrent Asset
Differences related to accrued expenses and allowances		$	2,655,664			$	707,336
Net operating loss carryforward			3,610,231				4,133,953
			6,265,895				4,841,289
Less valuation allowance			(3,888,347	)			(2,802,926	)
			2,377,548				2,038,363
Noncurrent Liability
Equipment and leasehold improvements, principally due to differences in depreciation			(2,377,548	)			2,365,112
Net noncurrent liability		$	-			$	(326,749	)

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

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Note 9. Income Taxes (Continued)

 

Income tax expense consists of the following for the nine months ended September 30, 2018 and 2017:

 

		September 30, 2018				September 30, 2017
Current income tax expense
Federal		$	-			$	-
Foreign			200,160				-
State			12,011				32,734
			212,171				32,734
Deferred income tax expense
Federal			-				-
State			-				-
Total income tax expense		$	212,171			$	32,734

 

Based on the available objective evidence, including the Company’s recent history of losses, the Company has provided a full valuation allowance against its deferred tax assets as of September 30, 2018 and December 31, 2017. Income tax expense differed from the amounts computed by applying the statutory federal income tax rate to loss before income taxes as a result of the following for the nine months ended September 30, 2018 and 2017.

 

		September 30, 2018				September 30, 2017
Computed expected tax benefit		$	(440,711	)		$	(937,608	)
Nondeductible expenses			(38,343	)			12,745
Effect of state income tax, net of federal benefit			(74,287	)			49,504
Valuation allowance			636,113				(1,165,664	)
Property and equipment			-				2,177,108
Other			129,399				(103,351	)
		$	212,171			$	32,734

 

Note 10. Commitments and Contingencies

 

Accrued liabilities – Accrued liabilities as of September 30, 2018 and December 31, 2017 are as follows:

 

		September 30, 2018				December 31, 2017
Payroll		$	1,856,628			$	1,468,545
Accrued facility rent			1,027,076				963,873
Accrued interest			1,215,103				16,955
Customer-related			559,511				674,237
Accrued employee bonus			391,293				154,393
Accrued commission			311,004				248,067
Other accruals			1,111,697				701,751
		$	6,472,312			$	4,227,821

 

Mexico Operations – The Company, through its wholly-owned subsidiary M.C. Assembly International, LLC, has an Amended and Restated Shelter Services Agreement (the Agreement) with an unrelated third party, Entrada, to provide a workforce, facilities, and allied services in Fresnillo, Zacatecas, Mexico.  The Company pays a monthly fee (Facility Fee) for the use of the manufacturing facility based upon square feet utilized and reimburses Entrada for personnel and related costs plus a fee based on the number of hours worked.  The Company operates in the manufacturing facility that is under lease by Entrada. The Company is obligated to pay the Facility Fee until the earlier of the expiration of the remainder of the lease of the facility, termination of the lease by Entrada, or use of the facility by another customer of Entrada. All inventory and equipment residing in the facility is the property of the Company.  The Company is also responsible for certain common area costs and the cost of insurance.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

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Note 10. Commitments and Contingencies (Continued)

 

Effective March 31, 2017, the Company signed the Third Modification to the Agreement to allow the direct payment of any reimbursable cost as defined by the Agreement to be made directly to Entrada by the Company and paid in Mexican pesos, if such relates to the payment of Mexican payroll or are invoiced in pesos and/or are required to be invoiced in pesos. To mitigate the currency-related exposures, the Company entered into cash flow foreign currency hedges (see Note 13).

 

On December 27, 2017, the Company and Entrada executed the Fourth Modification to the Agreement. This modification was due to the changes in Mexico’s tax laws impacting maquiladoras (Article 183 of Income Tax Law in effect as of January 1, 2014, “Ley del Impresto Sobre la Renta”) and Rule 3.20.6 of the 2017 Mexican Miscellaneous Tax Rules (“MTR”). The Fourth Modification extends the terms of the Agreement for the time necessary to further analyze the impact of these obligations and renegotiate certain terms and conditions of the Agreement. The term of the Agreement is renewed until January 31, 2018, and automatically renewed on a monthly basis thereafter unless either party provides a notice of intent to terminate at least 10 days prior to the end of the month. No such notice has been provided to date by either party to the Agreement.

 

For the nine months ended September 30, 2018 and 2017, payments for the Facility Fee under this Agreement totaled approximately $328,000 and $313,000, respectively.

 

Leases – The Company leases certain buildings and equipment under operating lease agreements. The leases expire at dates to September 2025.

 

In November 2014, the Company signed a facility lease agreement for a 57,990 square foot facility in Billerica, MA, with a commencement date of March 1, 2015 through September 30, 2025. The lease payments for this facility are included in the calculation of future minimum lease commitments shown below.

 

The future minimum lease commitments for these operating leases as of September 30, 2018 are as follows:

 

2018 (remainder)		$	140,917
2019			563,670
2020			561,513
2021			537,787
2022			537,787
Thereafter			1,434,097
		$	3,775,771

 

For the nine months ended September 30, 2018 and 2017, rent expense was approximately $1,068,000 and $1,008,000, respectively.

 

Health Insurance – The Company has a fully self-insured health and medical insurance program. There is a maximum amount of $200,000 per individual for both 2018 and 2017 for which the Company can be responsible. Furthermore, the Company’s total maximum claim liability per policy period was $2,727,000 and $2,763,000 as of September 30, 2018 and December 31, 2017, respectively. Approximately $211,000 and $299,000 is included in accrued liabilities relating to this program as of September 30, 2018 and December 31, 2017, respectively. The total expense recognized under the program, which includes insurance premiums paid, for the nine months ended September 30, 2018 and September 30, 2017, was $2,038,000 and $1,749,000, respectively. A stop-loss insurance policy covers all claims in excess of the above amounts in 2018 and 2017. In May, 2017, the Company received reimbursement for 2016 plan year stop loss claims of $43,000. No stop loss insurance claims were filed for the nine months ended September 30, 2018, for the 2018 plan year.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 10. Commitments and Contingencies (Continued)

 

Litigation - The Company pursues legal proceedings, claims, and litigation against others and is subject to the same arising in the ordinary course of business. As required under the guidance for contingency losses, the Company establishes liabilities when a particular contingency is probable and reasonably estimable. No contingency was established as of September 30, 2018 and December 30, 2017.

 

Note 11. Related Party Transactions

 

The Company entered into a management services agreement on February 2007 with certain stockholders of the Company (the Managers). Under the agreement, the Managers will provide advice and expertise on various corporate matters. The initial term of the agreement was five years, ended March 31, 2012, then automatically renews for successive one-year periods, continuing until the parties agree in writing to terminate with thirty days written notice or the Managers, together with their affiliates, cease to own common stock of MC Assembly Holdings, Inc. or cease to provide indebtedness to the Company and its affiliates. As consideration for the services, the Company pays the Managers $500,000 annually payable quarterly in advance on the first day of each fiscal quarter. Management fee expense for the nine months ended September 30, 2018 and 2017, was accrued $375,000 per year and is included as part of selling, general and administrative expenses in the accompanying consolidated statements of operations. Management fees of $250,000 and $375,000 were paid in cash during the nine months ended September 30, 2018 and 2017, respectively. The accrued balance of management fees as of September 30, 2018 and December 31, 2017, was approximately $1,500,000 and $1,375,000, respectively, and is included in accrued liabilities in the accompanying consolidated balance sheets.

 

Note 12. Receivables Facility

 

In August 2017, the Company began a program of selling current receivables for a single customer to JPMorgan Chase Bank, N.A. (the Receivables Facility). The cash generated from the sale funds the Company’s working capital earlier than the payment would otherwise be received from the customer. The receivables are sold on a non-recourse basis at a discount equal to 1.20% per annum plus the applicable London Interbank Offered Rate (LIBOR) rate. Total receivables sold through September 30, 2018 and December 31, 2017, were $540,677 and $126,677 and proceeds received totaled $535,173 and $125,882, equivalent to a discount rate of 1.02% and 0.63%, respectively. The Company does not plan to expand this program beyond this sole customer.

 

Note 13. Derivative Financial Instruments

 

We do not engage in currency speculation; however, we utilize foreign currency exchange rate derivatives on an ongoing basis to hedge against certain foreign currency-related exposures. Our risk-management objective for undertaking these cash-flow hedges is to mitigate the financial transaction fluctuations associated with the volatility of the USD compared to the Mexican Pesos. MCA purchases Mexican pesos and sells USD to cover forecasted Mexico-site payroll and other expenses. At inception, we designate these hedges as cash-flow hedges and accordingly, gains and losses on the foreign exchange hedge are recorded to the accumulated other comprehensive income (loss) account on the consolidated balance sheet. Gains and losses on the future foreign exchange hedge are not recorded until the hedged transaction is completed.

 

As of September 30, 2018, the notional value of our outstanding foreign currency contracts to hedge certain foreign exchanged-related operating exposures was approximately $3,750,000 or fifty-percent (50%) of our projected annual spend, based on prior-year actuals and current-year forecast. These contracts range nominally in value from $333,333 to $133,333 and range in maturity up to twelve months from year end. The fair value of these foreign exchange contracts, reported in other current assets was $152,911 and ($176,644), as of September 30, 2018 and December 31, 2017, respectively. The amount of gain recognized on these derivatives was $329,955 and $104,681, for the periods ended September 30, 2018 and 2017, respectively.

 

M C Assembly Holdings, Inc. and Subsidiary

(d/b/a M.C. Assembly)

 

Notes to Unaudited Consolidated Financial Statements

---

 

Note 14. Significant Customers

 

The following summarizes the Company’s significant customer concentration for the nine months ended September 30, 2018 and 2017:

 

		Nine months ended September 30,
		2018														2017
						% of Total			Account				% of Total							% of Total			Account				% of Total
Customer		Revenues				Rev			Receivable				AR			Revenues				Rev			Receivable				AR
Customer A		$	38,249,007			34%			$	6,030,234			25%			$	35,534,677			34%			$	5,326,164			29%

 

Note 15. Subsequent Events

 

On November 9, 2018, SMTC Corporation (NASDAQ: SMTX) acquired all of the outstanding shares of MC Assembly Holdings, Inc. SMTC believes the acquisition will result in a stronger company with an expanded market presence, a diversified customer base since there is no customer overlap or customer concentration, and greater financial resources. The combined company will operate under the name SMTC Corporation and currently plans to continue to operate and maintain the existing facilities operated by each Company.

 

The purchase price at closing was $65 million, subject to certain adjustments. Further, the sellers are eligible to earn up to an additional $5 million of consideration, contingent upon the performance of MC Assembly for the twelve calendar months ending March 31, 2019. As part of the acquisition, all existing debt of MC Assembly Holdings, Inc., excluding capital leases, was paid in full in connection with the sale.

 

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