SMTC CORPORATION Where we say "we", "us", "our", the "Company" or "SMTC", we mean
You should read this Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MD&A") in combination with the accompanying
unaudited interim consolidated financial statements and related notes as well as
the audited consolidated financial statements and the accompanying notes to the
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP") included within
the Company's Annual Report on Form 10-K filed on March 13, 2020 .
The forward-looking statements in this discussion and elsewhere in this
quarterly report, including those regarding the electronics manufacturing
services industry, market conditions, our expectations regarding our future
performance, liquidity and capital resources, the impact of accounting standards
not yet adopted, compliance with financial covenants under our Credit
Facilities, future response to and effects of the COVID-19 pandemic, including
on our employees, continued operations, customers suppliers, logistics
providers, implementation of protective measures, public policy response to the
COVID-19 pandemic including legislation or restrictions, our expectations
regarding customer concentration, our expectations regarding timing and
mitigation of the identified material weakness in internal control over
financial reporting, and other non-historical statements include numerous risks
and uncertainties, some of which are as described in the "Risk Factors" section
in the Annual Report on Form 10-K filed on March 13, 2020 , as updated by Item 1A
in Part II of this quarterly report. Certain statements in this MD&A contain
words such as "could", "expects", "may", "anticipates", "believes", "intends",
"estimates", "plans", "envisions", "seeks" and other similar language and are
considered forward looking statements or information under applicable securities
laws. These statements are based on our current expectations, estimates,
forecasts and projections about the operating environment, economies and markets
in which we operate. These statements are subject to important assumptions,
risks and uncertainties, which are difficult to predict and the actual outcome
may be materially different. Except as required by applicable law, we do not
intend to update these forward-looking statements after the date of this
quarterly report, even though our situation may change in the future. All
forward-looking statements attributable to us are expressly qualified by these
cautionary statements.
This MD&A contains discussion in
Background
We are a provider of end-to-end electronics manufacturing services ("EMS"),
including product design and engineering services, printed circuit board
assembly ("PCBA"), production, enclosure, cable assembly, precision metal
fabrication, systems integration and comprehensive testing services,
configuration to order ("CTO"), build to order ("BTO") and direct order
fulfillment ("DOF"). We operate more than 50 manufacturing and assembly lines in
over 555,000 square feet of production space worldwide at strategically located
facilities in the United States and Mexico , that provide local support,
flexibility, fast turn around and delivery times, and low-cost, volume
manufacturing capabilities, as well as new product integration ("NPI") services,
to our global customers. Our services extend over the entire electronic product
life cycle from new product development and NPI through to growth, maturity and
end of life phases. As of September 27, 2020 , we had 3,207 employees of which
2,616 were full time and contract employees.
COVID-19 Update
We continue to monitor the global pandemic and spread of COVID-19 and take steps to mitigate the potential risks to us posed by its spread and related circumstances and impacts. While our business operations have generally performed as expected during the first nine months of 2020, the COVID-19 pandemic continues to represent significant uncertainty for the remainder of the year and into fiscal 2021, and has the potential to negatively impact the results of our operations, cash flows and financial position.
Workplace Safety
The health and safety of our employees is a top priority for us. All of our facilities remain in operation and we have progressively implemented measures to safeguard our employees from COVID-19 infection and exposure, in accordance with guidelines established by theCenters for Disease Control , other governmental requirements, and our own safety standards. These consist of policies, procedures, protocols, and guidance related to, among other things, COVID-19 symptom awareness, effective hygiene practices, travel restrictions, visitor restrictions, social distancing, face covering expectations, temperature and health screening, work-from-home requirements, employee infection assessments, close contact tracing, enhanced workplace cleaning, and large-scale decontamination. These efforts will continue as requirements change, new risks are identified, and infections impact us. We anticipate incurring higher direct labor charges in the fourth quarter of 2020 as a result of the continuation of these efforts. 22
-------------------------------------------------------------------------------- In addition, in all geographies in which we operate, regulatory authorities at some point have imposed restrictions regarding the conduct of business and people movement to safeguard its citizens. To address these requirements, we are in continuous communication with our employees and union representatives, in addition to government and state representatives where our manufacturing facilities reside. If one or more of our manufacturing facilities were temporarily closed or had their operations limited, or customers pushed out demand due to the pandemic, this would have a material impact on our operations.
Supply Chain
Our suppliers may face challenges in maintaining an adequate workforce or securing materials from their own suppliers as a result of the COVID-19 pandemic. As a result, we may experience an inability to procure certain components and materials on a timely basis, or increased shipping costs or lead times. We continue to take steps to coordinate with our suppliers and validate our suppliers' ability to deliver to us on time, which may also be affected by the impact of the COVID-19 pandemic on their own financial condition. Despite these efforts it is possible that an extended pandemic could disrupt the operation of our supply chain.
Customers
We are also in close contact with our customers to understand the impact of the COVID-19 pandemic on their businesses and the resulting potential impact on our business. The COVID-19 pandemic has introduced volatility and uncertainty to all of our customers, which has required us to react and respond. Although many of the products we manufacture for our customers are deemed essential, the COVID-19 pandemic may impact demand for our customers' products, which could impact our production schedules. While the COVID-19 pandemic has negatively impacted some of our customers and, therefore, our business with them, we have experienced opportunities with new and existing customers, to manufacture products that may be used in the effort to combat the effects of COVID-19.
Liquidity
We incurred an additional$1.3 million in COVID-19 related expenses in the third quarter primarily due to the retention of temporary replacement labor, additional sanitation, cleaning and disinfection of facilities, personal protective equipment and related supplies, costs related to facilitating social distancing and logistics costs associated with expediting inventory purchases from existing and new sources. With respect to liquidity, we continue to evaluate and take actions to reduce costs and spending across our Company, including pausing all non-essential new hiring and new programs and reducing our capital expenditures. While we are unable to determine or predict the nature, duration or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity or capital resources, we continue to actively monitor the situation and may take further actions that alter our business operations to comply with requirements by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers, and stockholders. As atSeptember 27, 2020 , we had$30.5 million available to borrow under our PNC Facility (as described and defined below) after deducting the current borrowing base conditions and subject to debt covenants. .
Results of Operations
The unaudited interim consolidated financial statements of SMTC are prepared in
accordance with
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Quarter ended
The following table sets forth summarized operating results in millions of US$ for the periods indicated:
Three months ended Three months ended Change
September 27, 2020 September 29, 2019 2019 to 2020
$ % $ % $ %
Revenue 99.5 100.0 88.7 100.0 10.8 12.2
Cost of sales 88.4 88.8 79.8 90.0 8.6 10.8
Gross profit 11.1 11.2 8.9 10.0 2.2 24.7
Selling, general and
administrative expenses 6.7 6.7 6.6 7.4 0.1 1.5
Restructuring charges 0.9 0.9 6.4 7.2 (5.5 ) (85.9 )
Operating income (loss) 3.5 3.5 (4.1 ) (4.6 ) 7.6 185.4
Fair value measurement loss
(gain) on warrant
liability 0.1 0.1 (0.9 ) (1.0 ) 1.0 111.1
Interest expense 2.0 2.0 2.7 3.0 (0.7 ) (25.9 )
Income (loss) before income
taxes 1.4 1.4 (5.9 ) (6.7 ) 7.3 123.7
Income tax expense (recovery)
Current 0.3 0.3 (0.1 ) (0.1 ) 0.4 400.0
Deferred (0.1 ) (0.1 ) (0.1 ) (0.1 ) - -
0.2 0.2 (0.2 ) (0.2 ) 0.4 200.0
Net income (loss) 1.2 1.2 (5.7 ) (6.4 ) 6.9 121.9
Revenue by Industry Sector
Three months ended Three months ended
September 27, 2020 September 29, 2019 Change
Industry Sector $ % $ % $ %
Test and Measurement 8.1 8.1 8.8 9.9 (0.7 ) (8.0 )
Retail and Payment Systems 10.3 10.4 10.6 12.0 (0.3 ) (2.8 )
Telecom, Networking and
Communications 4.8 4.8 9.6 10.8 (4.8 ) (50.0 )
Medical and Safety 11.3 11.4 10.5 11.8 0.8 7.6
Industrial IoT, Power and Clean
Technology 37.0 37.2 36.7 41.4 0.3 0.8
Semiconductors 16.0 16.1 7.3 8.2 8.7 119.2
Avionics, Aerospace and Defense 12.0 12.1 5.2 5.9 6.8 130.8
Total 99.5 100.0 88.7 100.0 10.8 12.2
Certain customers were reclassified from the Test and Measurement sector to the
Industrial IoT, Power and Clean Technology sector and Semiconductors sector,
Avionics, Aerospace and Defense sector to Medical and Safety sector during the
three months ended September 27, 2020 . The comparative three period has been
adjusted to conform to this classification.
Total revenue increased $10.8 million to $99.5 million for the third quarter of
2020 from $88.7 million in the same period in the prior year due to increased
demand in the commercial avionics, test and measurement and semiconductor
programs, among others, offset by customer disengagement in China due to the
Dongguan facility closure in the third quarter of 2020, along with order
rescheduling from other North America customers in the latter part of the third
quarter of 2020. We believe this resulted in part from the COVID-19 pandemic and
our customers modifying their requirements in response to shifting demand of
their respective end customers.
Revenue decreased $0.7 million in the test and measurement sector compared to
the third quarter of 2019, primarily due to reduced volumes from one customer,
offset by increased volumes from one customer, all serviced in the U.S. Revenue decreased
Revenue decreased$4.8 million in the telecom, networking and communications sector compared to the third quarter of 2019, primarily due to one customer serviced in theMexico experiencing reduced volumes due to the customer's program transitioning to end-of-life, and two customers disengaging inChina due to theDongguan facility closure. 24 --------------------------------------------------------------------------------
Revenue increased
Revenue increased$0.3 million in the industrial IoT, power and clean technology sector compared to the third quarter of 2019, primarily due to increased volume from one customer serviced inMexico , offset by decreased volumes from two customers serviced in theU.S. and two customers serviced inMexico .
Revenue increased
Revenue increased$6.8 million in the avionics, aerospace and defense sector compared to the third quarter of 2019, due to the addition of one new customer, volume increases with three customers, offset by volume decreases with another customer, all serviced in theU.S.
Revenue by Geography
During the third quarter of 2020, 61.8% of our revenue was attributable to production from our operations inMexico and 38.2% of our revenue was attributable to production from our operations in theU.S. During the third quarter of 2019, 64.0% of our revenue was attributable to production from our operations inMexico , 30.9% of our revenue was attributable to production from our operations in theU.S. and 5.1% of our revenue was attributable to production from our operations inChina . Following the closure of ourDongguan manufacturing facility inChina , manufacturing of certain products previously manufactured at that facility has been transferred to the Company's other manufacturing facilities..
Additional Revenue Information
We recorded approximately$4.8 million and$3.6 million of revenue from sales of raw materials inventory to customers during the third quarter of 2020 and the third quarter of 2019, respectively. The Company purchases raw materials based on customer purchase orders. When a customer requires an order to be altered or changed, the customer is generally obligated to purchase the original on-order raw material at cost, to the extent the materials are not consumed within a specified period. The Company's ten largest customers represented 60.3% of revenue during the third quarter of 2020, compared with 53.1% in the third quarter of 2019. Revenue from the two largest customers during the third quarter of 2020 was$11.6 million representing 11.7% and$11.0 million representing 11.1% of total revenue. This compares with revenue from the largest customer during the third quarter of 2019 of$10.9 million representing 12.3 % of total revenue. No other customers represented more than 10% of revenue in either period.
Gross Profit
Gross profit for the third quarter of 2020 increased by$2.2 million to$11.1 million or 11.2% of revenue compared with$8.9 million or 10.0% of revenue for the same period in 2019. When excluding unrealized foreign exchange gain on unsettled forward contracts ,amortization of intangible assets and COVID-19 related expenses, the adjusted gross profit was$12.5 million or 12.6% of revenue for the third quarter of 2020 compared with$10.8 million or 12.1% of revenue for the third quarter of 2019. The increase in gross profit percentage is primarily due to headcount reductions, resulting in labor efficiencies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to
Restructuring Charges
During the third quarter of 2020, we recorded restructuring expenses of$1.2 million primarily related to the reduction of 307 full-time equivalents ("FTEs"), at ourZacatecas, Mexico facility, partially offset by restructuring provision reversals of$0.3 million previously included for theDongguan facility. During the third quarter of 2019, we accrued restructuring charges of$5.5 million related to the Company's previously announced closure of business operations inDongguan, China , in addition to$0.9 million related to the reduction of 19 FTEs in theU.S , 4 FTEs inCanada and 89 FTEs and contract employees inMexico . The restructuring charges related to theDongguan facility included$1.4 million of severance charges related to the reduction of 137 FTEs and other facility closure activities, accrued tax and duties of$0.2 million , and equipment decommissioning and facility charges of$0.4 million . In 25 --------------------------------------------------------------------------------
addition, the restructuring charges included a
As atSeptember 27, 2020 , the Company had$0.4 million of accrued restructuring charges remaining related toDongguan for employee severance, and legal fees andU.S. employee severance to be paid by the end of the fourth quarter of 2020.
Interest Expense
Interest expense decreased to$2.0 million in the third quarter of 2020 compared to$2.7 million in the same period in 2019, respectively. The decrease primarily resulted from the pay down of the Term Loan B Facility in addition to lower average debt balance in the third quarter of 2020 compared to the same period in 2019. The weighted average interest rates with respect to the debt on our PNC and TCW Facilities was 6.94%. The weighted average interest rates for the same period in the prior year was 12.2%.
Income Tax Expense
The Company recorded current income tax expense of$0.3 million and$0.1 million for the third quarters of 2020 and 2019, in connection withU.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax benefit of$0.1 million in the third quarter of 2020 and 2019, in connection with temporary differences related to the Mexican operations.
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance withU.S. GAAP, we use the following non-GAAP financial measures: Adjusted Gross Profit, EBITDA, Adjusted EBITDA and Adjusted Net Income (collectively the "Non-GAAP Financial Measures"). We believe that these Non-GAAP Financial Measures, when used in conjunction with GAAP financial measures, provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to the key metrics we use in our financial and operational decision making, as they exclude the effects of items that may not be indicative of, or are unrelated to, our underlying operating results, such as expenses related to the COVID-19 pandemic. The Company's management believes that adjusting for the additional temporary costs attributable to the COVID-19 pandemic allows for a better comparison of the Company's performance to prior periods, which is consistent with our recent amendments to the financial covenants in our financing agreements. These non-GAAP measures are used by the Company's management to manage and monitor the Company's performance, and also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance withU.S. GAAP, and they should not be construed as an inference that our future results will be unaffected by any items adjusted for in these non-GAAP measures. In evaluating these non-GAAP measures, you should be aware that in the future we may incur expenses that are the same as or similar to some of those adjusted in this presentation. The Non-GAAP Financial Measures that we use are not necessarily comparable to similarly titled measures used by other companies due to different methods of calculation.
Net Income and Adjusted Net Income Reconciliation
Adjusted Net Income, a non-GAAP financial measure, is defined as Net Income
before amortization of intangible assets, restructuring charges, stock-based
compensation, fair value adjustment of warrant liability, merger and acquisition
related expenses and unrealized foreign exchange gains and losses on unsettled
forward foreign exchange contracts and COVID-19 related expenses. Management
presents Adjusted Net Income, as it is believed the information is useful to
investors in understanding and evaluating our operating results as it aligns the
net income (loss) with those adjustments made to EBITDA and gross profit.
26
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Below is the reconciliation of Net Income to Adjusted Net Income (in thousands):
September 27, September 29,
2020 2019
Net income (loss) $ 1,243 $ (5,734 )
Add:
Amortization of intangible assets 354 1,844
Restructuring charges 871 6,454
Stock based compensation 158 353
Fair value adjustment of warrant liability 133 (858 )
Merger and acquisitions related expenses - 68
COVID-19 related expenses (1) 1,348 -
Unrealized foreign exchange gain on unsettled forward
foreign exchange contracts (261 ) - Adjusted net income $ 3,846 $ 2,127
(1) Includes costs attributable to the COVID-19 pandemic, including retention of
temporary replacement labor, additional sanitation, cleaning and disinfection
of facilities, personal protective equipment and related supplies, costs
associated with facilitating social distancing and logistics costs associated
with expediting inventory purchases from existing and new sources.
Net income increased to $1.2 million from a $5.7 million loss in the third
quarter of 2020 and 2019, respectively. This was due to increased gross profit,
partially driven by an unrealized foreign exchange gain on unsettled forward
contracts and a reduction in amortization of intangible assets and headcount
reductions. Also contributing was a decrease in interest expense and decreased
restructuring cost recorded in the third quarter of 2020 over the same period in
the prior year. The net income in the third quarter of 2020 was partially offset
by $1.3 million of COVID-19 related expenses not incurred for the same period in
the prior year. When excluding the items in the reconciliation above, Adjusted
Net Income increased $1.7 million in the third quarter of 2020 over the same
period in the prior year.
Gross Profit and Adjusted Gross Profit Reconciliation
Adjusted Gross Profit, a non-GAAP financial measure, is defined as gross profit exclusive of unrealized foreign exchange gains or losses on unsettled forward foreign exchange contracts and the amortization of intangible assets. The Company calculates an adjusted gross profit amount as we consider gross profit exclusive of such unrealized foreign exchange gains or losses on unsettled forward foreign exchange contracts to be a meaningful measure as it is non-cash and management does not consider the mark-to-market valuation reflective of operating performance in the current period. Management also excludes the impact of intangible assets amortization as these charges are non-cash in nature and are not believed to be reflective of operating performance. Management also excludes COVID-19 related expenses as it believes these costs are not reflective of normal operations due to pandemic. We also believe adjusted gross profit provides useful information to investors in understanding and evaluating our operating results in the same manner as management.
Below is the reconciliation from the financial statement presentation of gross profit to the non-GAAP measure of adjusted gross profit (in thousands):
Three Three
months months
ended ended
September 27, September 29,
2020 2019
Gross profit $ 11,102 $ 8,906
Add:Unrealized foreign exchange gain on unsettled
forward exchange contracts (261 )
-
Amortization of intangible assets 354 1,844 COVID-19 related expenses (1) 1,348 - Adjusted gross profit$ 12,543 $ 10,750 Adjusted gross profit percentage 12.6 % 12.1 %
(1) Includes costs attributable to the COVID-19 pandemic, including retention of
temporary replacement labor, additional sanitation, cleaning and disinfection
of facilities, personal protective equipment and related supplies, costs
associated with facilitating social distancing and logistics costs associated
with expediting inventory purchases from existing and new sources.
27
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EBITDA and Adjusted EBITDA Reconciliation
EBITDA and Adjusted EBITDA, non-GAAP financial measures, are defined as earnings before interest, taxes, depreciation and amortization, with Adjusted EBITDA also excluding restructuring charges, stock-based compensation, unrealized foreign exchange gains and losses on unsettled forward foreign exchange contracts, fair value adjustment of warrant liability and merger and acquisition related expenses and COVID-19 related expenses. Management presents EBITDA and Adjusted EBITDA, as they are utilized by management to monitor performance against budget as well as compliance with bank covenants. We also believe EBITDA and Adjusted EBITDA provide useful information to investors in understanding and evaluating our operating results in the same manner as management.
Below is the reconciliation of net income (loss), the closest GAAP measure, to EBITDA and Adjusted EBITDA (in thousands).
Three Three
months months
ended ended
September 27, September 29,
2020 2019
Net income (loss) $ 1,243 $ (5,734 )
Add:
Depreciation of property, plant and equipment 1,545 1,649
Amortization of intangible assets 354
1,844
Interest 1,941
2,679
Income taxes expense (recovery) 204 (184 ) EBITDA $ 5,287 $ 254 Add: Restructuring charges 871 6,454 Stock based compensation 158 353 Fair value adjustment of warrant liability 133 (858 ) Merger and acquisition related expenses -
68
COVID-19 related expenses (1) 1,348
-
Unrealized foreign exchange gain on unsettled
forward exchange contracts (261 ) - Adjusted EBITDA $ 7,536 $ 6,271
(1) Includes costs attributable to the COVID-19 pandemic, including retention of
temporary replacement labor, additional sanitation, cleaning and disinfection
of facilities, personal protective equipment and related supplies, costs
associated with facilitating social distancing and logistics costs associated
with expediting inventory purchases from existing and new sources.
Adjusted EBITDA for three months ended
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Nine months ended
The following table sets forth summarized operating results in millions of US$ for the periods indicated:
Nine months ended Nine months ended Change
September 27, 2020 September 29, 2019 2019 to 2020
$ % $ % $ %
Revenue 285.1 100.0 282.3 100.0 2.8 1.0
Cost of sales 253.7 89.0 255.7 90.6 (2.0 ) (0.8 )
Gross profit 31.4 11.0 26.6 9.4 4.8 18.0
Selling, general and
administrative expenses 21.0 7.4 19.9 7.0 1.1 5.5
Change in fair value of
contingent consideration 0.0 0.0 (3.0 ) (1.1 ) 3.0 100.0
Restructuring charges 0.5 0.2 8.6 3.0 (8.1 ) (94.2 )
Operating income 9.9 3.4 1.1 0.4 8.8 800.0
Fair value measurement loss
(gain) on warrant
liability 0.0 0.0 (0.9 ) (0.3 ) 0.9 100.0
Interest expense 6.0 2.1 8.4 3.0 (2.4 ) (28.6 )
Income (loss) before income
taxes 3.9 1.3 (6.4 ) (2.3 ) 10.3 160.9
Income tax expense
Current 0.9 0.3 0.6 0.2 0.3 50.0
Deferred 0.0 0.0 0.0 0.0 - -
0.9 0.3 0.6 0.2 0.3 50.0
Net income (loss) 3.0 1.0 (7.0 ) (2.5 ) 10.0 142.9
Revenue by Industry Sector
Nine months ended Nine months ended
September 27, 2020 September 29, 2019 Change
Industry Sector $ % $ % $ %
Test and Measurement 25.4 8.9 33.9 12.0 (8.5 ) (25.1 )
Retail and Payment Systems 29.4 10.3 35.6 12.6 (6.2 ) (17.4 )
Telecom, Networking and
Communications 17.3 6.1 28.4 10.1 (11.1 ) (39.1 )
Medical and Safety 33.3 11.7 34.2 12.1 (0.9 ) (2.6 )
Industrial IoT, Power and Clean
Technology 111.4 39.1 112.8 40.0 (1.4 ) (1.2 )
Semiconductors 37.4 13.1 20.4 7.2 17.0 83.3
Avionics, Aerospace and Defense 30.9 10.8 17.0 6.0 13.9 81.8
Total 285.1 100.0 282.3 100.0 2.8 1.0
Certain customers were reclassified from the Test and Measurement sector to the
Industrial IoT, Power and Clean Technology sector and Semiconductors sector,
Avionics, Aerospace and Defense sector to Medical and Safety sector during the
three months ended September 27, 2020 and six months ended June 28, 2020 . The
comparative three and nine month periods have been adjusted to conform to this
classification.
Total revenue increased $2.8 million to $285.1 million for the first nine months
of 2020 from $282.3 million in the same period in the prior year primarily due
to some demand gains from commercial avionics and test and measurement programs,
among others, and customer disengagement in China due to the Dongguan facility
closure in the third quarter of 2019, along with order rescheduling from other
North America customers in the latter part of the third quarter of 2020. We
believe this resulted in part from the COVID-19 pandemic and our customers
modifying their requirements in response to shifting demand of their respective
end customers.
Revenue decreased $8.5 million in the test and measurement sector compared to
the first nine months of 2019, primarily due to reduced volume from one customer
serviced in the U.S.
Revenue decreased $6.2 million in the retail and payment systems sector compared
to the first nine months of 2019, primarily due to decreased volume from two
customers, offset by increased volume from one customer, all serviced in Mexico .
Revenue decreased $11.1 million in the telecom, networking and communications
sector compared to the first nine months of 2019, primarily due to two customers
disengaging in China due to the Dongguan facility closure, one customer serviced
in Mexico experiencing reduced volumes due to the customer's program
transitioning to end-of-life, and one customer serviced in Mexico with reduced
volume, partially offset by one new customer serviced in the U.S.
29
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Revenue decreased $0.9 million in the medical and safety sector compared to the
first nine months of 2019, primarily due to one customer serviced in the U.S.
experiencing reduced volumes due to the customer's program transitioning to
end-of-life, decreased volume from two customers, partially offset by one new
customer serviced in Mexico and two new customers serviced in the U.S.
Revenue decreased $1.4 million in the industrial IoT, power and clean technology
sector compared to the first nine months of 2019, primarily due to decreased
volume from four customers (two serviced in Mexico ; two serviced in the U.S. ),
partially offset by increased volume from two customers serviced in Mexico .
Revenue increased $17.0 million in the semiconductors sector compared to the
first nine months of 2019, due to increased volume from three customers serviced
in Mexico and one new customer serviced in the U.S.
Revenue increased $13.9 million in the avionics, aerospace and defense sector
compared to the first nine months of 2019, due to volumes increases with two
customers, as well as one new customer, offset by volume decreases with one
customer, all serviced in the U.S. Revenue by Geography
During the first nine months of 2020, 63.5% of our revenue was attributable to production from our operations inMexico , 36.2% of our revenue was attributable to production from our operations in theU.S. and 0.3% of our revenue was attributable to production from our operations inChina . During the first nine months of 2019, 64.2% of our revenue was attributable to production from our operations inMexico , 30.6% of our revenue was attributable to production from our operations in theU.S. and 5.3% of our revenue was attributable to production from our operations inChina . Following the closure of ourDongguan manufacturing facility inChina , manufacturing of certain products previously manufactured at that facility has been transferred to the Company's other manufacturing facilities.
Additional Revenue Information
We recorded approximately$8.8 million and$8.0 million of revenue from sales of raw materials inventory to customers during the first nine months of 2020 and the first nine months of 2019. The Company purchases raw materials based on customer purchase orders. When a customer requires an order to be altered or changed, the customer is generally obligated to purchase the original on-order raw material at cost, to the extent the materials are not consumed within a specified period. The Company's ten largest customers represented 55.5% of revenue during the first nine months of 2020, compared with 54.0% in the first nine months of 2019. Revenue from the largest customer during the first nine months of 2020 was$38.2 million representing 13.4% of total revenue. This compares with revenue from the largest customer during the first nine months of 2019 of$36.7 million representing 13.0% of total revenue. No other customers represented more than 10% of revenue in either period.
Gross Profit
Gross profit for the first nine months of 2020 increased by$4.8 million to$31.4 million or 11.0% of revenue compared with$26.6 million or 9.4% of revenue for the same period in 2019. When excluding unrealized foreign exchange gain on unsettled forward contracts, amortization of intangible assets and COVID-19 related expenses, the adjusted gross profit was$36.0 million or 12.6% of revenue for the first nine months of 2020 compared with$32.1 million or 11.4% of revenue for the first nine months of 2019. This was due primarily to higher gross profit due to product mix and lower variable manufacturing expenses in addition to headcount reductions resulting in labor efficiencies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to$21.0 million in the first nine months of 2020 from$19.9 million in the same period in 2019, mainly due to increased professional services rendered related to additional compliance obligations under the Sarbanes-Oxley Act of 2002, as well as new headcount hired in the first nine months of 2020. 30 --------------------------------------------------------------------------------
Change in fair value of contingent consideration
During the first nine months of 2019, it was determined that there was no fair value of the contingent consideration liability, and that no obligation existed resulting in a recognized gain of$3.1 million . The contingent consideration liability was initially recognized at fair value in the fourth quarter of 2018 and relates to a contingent earn-out payment associated with the acquisition ofMC Assembly . The fair value estimate under purchase accounting of$3.1 million was derived from a multiple of earnings based onMC Assembly's forecasted twelve-month earnings for the period endedSeptember 29, 2019 . Based on actual earnings, the contingent consideration liability was considered resolved and no longer payable as atSeptember 29, 2019 . No contingent consideration existed as atSeptember 27, 2020 . Restructuring Charges During the first nine months of 2020, we recorded restructuring expenses of$1.3 million primarily related to the reduction of 307 FTEs, offset by restructuring recoveries of$0.8 million included in theDongguan facility. During the first nine months of 2019,$8.6 million of restructuring charges were incurred related to the reduction of 137 FTEs inChina , 28 FTEs inU.S. , 4 FTEs inCanada and 459 FTEs and contract employees inMexico . The majority of the charges were incurred during the three months endedSeptember 29, 2019 as it related to the closure of theDongguan manufacturing facility. During the three months endedSeptember 29, 2019 , restructuring charges of$5.5 million were incurred related to theDongguan facility exit, in addition to$0.9 million incurred related to the reduction of 19 FTEs in theU.S , 4 FTEs inCanada and 89 FTEs and contract employees inMexico . The restructuring charges related to theDongguan facility included$1.4 million of severance charges related to the reduction of 137 FTEs and other facility closure activities, accrued tax and duties of$0.2 million and equipment decommissioning and facility charges of$0.4 million . In addition, the restructuring charges included is a$1.7 million write down of accounts receivable, a$1.5 million write down of inventory and$0.3 million write down of property, plant and equipment.
As at
Interest Expense
Interest expense decreased to$6.0 million in the first nine months of 2020 compared to$8.3 million in the same period in 2019. The decrease was primarily the result of the pay down of the Term Loan B Facility in addition to lower average debt balance in the first nine months of 2020 compared to the same period in 2019. The weighted average interest rates with respect to the debt on our PNC and TCW Facilities was 7.3%. The weighted average interest rates for the same period in the prior year was 10.5%.
Income Tax Expense
The Company recorded current income tax expense of$0.9 million and$0.6 million for the first nine months of 2020 and 2019, in connection withU.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax benefit of$15 thousand and expense of$14 thousand in the first nine months of 2020 and 2019, in connection with temporary differences related to the Mexican operations.
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance withU.S. GAAP, we use the following non-GAAP financial measures: Adjusted Gross Profit, EBITDA, Adjusted EBITDA and Adjusted Net Income (collectively the "Non-GAAP Financial Measures"). We believe that these Non-GAAP Financial Measures, when used in conjunction with GAAP financial measures, provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to the key metrics we use in our financial and operational decision making, as they exclude the effects of items that may not be indicative of, or are unrelated to, our underlying operating results, such as expenses related to the COVID-19 pandemic. The Company's management believes that adjusting for the additional temporary costs attributable to the COVID-19 pandemic allows for a better comparison of the Company's performance to prior periods, which is consistent with our recent amendments to the financial covenants in our financing agreements. These non-GAAP measures are used by the Company's management to manage and monitor the Company's performance, and also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance withU.S. GAAP, and they should not be construed as an inference that our future results will be unaffected by any items adjusted for in these non-GAAP measures. In evaluating these non-GAAP measures, you should be aware that in the future we may incur expenses that are the same as or similar to some of those adjusted in this presentation. The Non-GAAP Financial Measures that we use are not necessarily comparable to similarly titled measures used by other companies due to different methods of calculation. 31
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Net Income and Adjusted Net Income Reconciliation
Adjusted Net Income, a non-GAAP financial measure, is defined as Net Income
before amortization of intangible assets, restructuring charges, stock-based
compensation, fair value adjustment of warrant liability, fair value adjustment
to contingent consideration, merger and acquisition related expenses and
unrealized foreign exchange gains and losses on unsettled forward foreign
exchange contracts and COVID-19 related expenses. Management presents Adjusted
Net Income, as it is believed the information is useful to investors in
understanding and evaluating our operating results as it aligns the net income
(loss) with those adjustments made to EBITDA and gross profit.
Below is the reconciliation of Net Income to Adjusted Net Income (in thousands):
Nine Nine
months months
ended ended
September 27, September 29,
2020 2019
Net income (loss) $ 2,973 $ (6,991 )
Add:
Amortization of intangible assets 2,718 5,532
Restructuring charges 525 $ 8,624
Stock based compensation 475 538
Fair value adjustment of warrant liability 15 (919 )
Fair value adjustment of contingent consideration - (3,050 )
Merger and acquisitions related expenses - 232
COVID-19 related expenses (1) 2,533 -
Unrealized foreign exchange gain on unsettled forward
foreign exchange contracts (720 ) -
Adjusted net income $ 8,519 $ 3,966
(1) Includes costs attributable to the COVID-19 pandemic, including retention of
temporary replacement labor, additional sanitation, cleaning and disinfection
of facilities, personal protective equipment and related supplies, costs
associated with facilitating social distancing and logistics costs associated
with expediting inventory purchases from existing and new sources.
Net income increased to $3.0 million from a $7.0 million loss in the first nine
months of 2020 and 2019. In addition, the increase in net income was due to a
reduction in restructuring charges, increased gross profit, and unrealized
foreign exchange gain on unsettled forward contracts in the third quarter of
2020 over the same period in the prior year. When excluding the items noted in
the above reconciliation, Adjusted Net Income increased $4.6 million in the
first nine months of 2020 over the same period in the prior year, which is
mainly due to increased gross profit, reduced interest expense due to reduction
in debt and partially offset by increased selling, general and administrative
expense.
Gross Profit and Adjusted Gross Profit Reconciliation
Adjusted Gross Profit, a non-GAAP financial measure, is defined as gross profit
exclusive of unrealized foreign exchange gains or losses on unsettled forward
foreign exchange contracts and the amortization of intangible assets. The
Company calculates an adjusted gross profit amount as we consider gross profit
exclusive of such unrealized foreign exchange gains or losses on unsettled
forward foreign exchange contracts to be a meaningful measure as it is non-cash
and management does not consider the mark-to-market valuation reflective of
operating performance in the current period. Management also excludes the impact
of intangible assets amortization as these charges are non-cash in nature and
are not believed to be reflective of operating performance. We also believe
adjusted gross profit provides useful information to investors in understanding
and evaluating our operating results in the same manner as management.
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--------------------------------------------------------------------------------Below is the reconciliation from the financial statement presentation of gross profit to the non-GAAP measure of adjusted gross profit (in thousands):
Nine Nine
months months
ended ended
September 27, September 29,
2020 2019
Gross profit $ 31,427 $ 26,527
Add:
Unrealized foreign exchange gain on unsettled forward
exchange contracts (720 ) -
Amortization of intangible assets 2,718 5,532
COVID-19 related expenses (1) 2,533 -
Adjusted gross profit $ 35,958 $ 32,059
Adjusted gross profit percentage 12.6 % 11.4 %
(1) Includes costs attributable to the COVID-19 pandemic, including retention of
temporary replacement labor, additional sanitation, cleaning and disinfection
of facilities, personal protective equipment and related supplies, costs
associated with facilitating social distancing and logistics costs associated
with expediting inventory purchases from existing and new sources.
EBITDA and Adjusted EBITDA Reconciliation
EBITDA and Adjusted EBITDA, non-GAAP financial measures, are defined as earnings before interest, taxes, depreciation and amortization, with Adjusted EBITDA also excluding restructuring charges, stock-based compensation, unrealized foreign exchange gains and losses on unsettled forward foreign exchange contracts, fair value adjustment of warrant liability, fair value adjustment to contingent consideration and merger and acquisition related expenses and COVID-19 related expenses. Management presents EBITDA and Adjusted EBITDA, as they are utilized by management to monitor performance against budget as well as compliance with bank covenants. We also believe EBITDA and Adjusted EBITDA provide useful information to investors in understanding and evaluating our operating results in the same manner as management.
Below is the reconciliation of net income (loss), the closest GAAP measure, to EBITDA and Adjusted EBITDA (in thousands).
Nine Nine
months months
ended ended
September 27, September 29,
2020 2019
Net income (loss) $ 2,973 $ (6,991 )
Add:
Depreciation of property, plant and equipment 4,767 4,902
Amortization of intangible assets 2,718 5,532 Interest 6,021 8,349 Income taxes 857 606 EBITDA$ 17,336 $ 12,398 Add: Restructuring charges 525 8,624 Stock based compensation 475 538 Fair value adjustment of warrant liability 15 (919 ) Fair value adjustment to contingent consideration - (3,050 ) Merger and acquisition related expenses - 232 COVID-19 related expenses (1) 2,533 - Unrealized foreign exchange gain on unsettled forward exchange contracts (720 ) - Adjusted EBITDA$ 20,164 $ 17,823
(1) Includes costs attributable to the COVID-19 pandemic, including retention of
temporary replacement labor, additional sanitation, cleaning and disinfection
of facilities, personal protective equipment and related supplies, costs
associated with facilitating social distancing and logistics costs associated
with expediting inventory purchases from existing and new sources.
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Liquidity
As atSeptember 27, 2020 , the Company's liquidity was comprised of$0.2 million in cash on hand and$30.5 million of funds available to borrow under the PNC Facility, which matures onNovember 8, 2023 . The Company funds its operations by regularly utilizing its PNC Facility (refer to Note 4). The Company manages it capital requirements through budgeting and forecasting processes while monitoring for compliance with bank covenants. Funds available under the PNC Facility are managed on a weekly basis, based on the cash flow requirements of the various operating segments. Cash flows generated from operations are immediately applied towards paying down the PNC Facility. Market conditions, including the implications of the COVID-19 pandemic, may negatively impact our ability to secure and source alternative methods of financing. We do not currently foresee a material impact in the short term based on our working capital needs, however if a number of our customers reduce or temporarily cease payments to us, this would present a risk and negatively impact our cash flow and ability to meet our working capital obligations to operate our business, which could require us to seek alternative methods of financing. Net cash generated from operating activities was$2.5 million during each of the nine months endedSeptember 27, 2020 andSeptember 29, 2019 . Working capital changes related to$16.5 million unbilled contract asset increase, resulting in a use of cash which was due to the increase in unbilled contract assets for customers when compared to the same period in the prior year. This was partially offset by the$12.0 million increase in the accrued liabilities due to deferred revenue for the first nine months of 2020. Accounts receivable days sales outstanding was 61 days in the first nine months of 2020 and 2019. Accounts Payable represented a source of$3.7 million due to timing of payments. Accounts payable days outstanding increased to 72 days for the first nine months of 2020 compared to 71 days for the first nine months of 2019. Inventory turnover, on an annualized basis, decreased to 4.1 times for the first nine months of 2020 compared to 4.4 times for the first nine months of 2019. Net cash used in financing activities during the first nine months of 2020 was$2.4 million compared to net cash used by$0.3 million for the first nine months of 2019. During the first nine months of 2020, the Company made net borrowing to the revolving debt of$0.3 million , compared to the repayments to the revolving debt of$9.9 million during the first nine months of 2019. The Company also paid down its long-term debt in the amount of$0.9 million and 22.6 million in the first quarters of 2020 and 2019, respectively. Principal repayments on capital lease obligations were$1.0 million in the first nine months of 2020 compared to$1.2 million in the same period in the prior year. Net cash used in investing activities during the first nine months of 2020 was$1.2 million compared to$3.2 million in the first nine months of 2019, related to capital asset purchases. During the first nine months of 2020, the Company used$2.6 million for capital asset purchases, partially offset by leasing proceeds of$1.4 million .
Capital Resources
The Company borrows money under the PNC Facility, which has a term ending onNovember 8, 2023 . Advances made under the PNC Facility bear interest at theU.S. base rate plus an applicable margin ranging from 0.75% to 1.25%, or LIBOR plus an applicable margin ranging from 2.50% to 3.00%. The base commercial lending rate should approximateU.S. prime rate. The Company also borrows money under the Financing Agreement which governs the Term A Loan Facility that matures on the Maturity Date. The Term Loan A Facility bears interest at LIBOR plus an applicable margin of 8.75% throughJune 30, 2020 , and borrowings under the Financing Agreement will thereafter bear interest at LIBOR plus an applicable margin ranging from 7.25% to 8.75%. Payments made under the Term Loan A Facility at any time prior to the Maturity Date (other than scheduled amortization payments and mandatory prepayments) are subject to an applicable premium equal to the amount of such payment multiplied by (i) 3.00% in the event that such payment occurs beforeNovember 8, 2019 , (ii) 2.00% in the event that such payment occurs afterNovember 8, 2019 , and on or beforeNovember 8, 2020 , and (iii) 1.00% in the event that such payment occurs afterNovember 8, 2020 , and on or beforeNovember 8, 2021 . No such applicable premium is payable for any payment of loans made under the Term Loan A Facility occurring afterNovember 8, 2021 . The Credit Facilities are joint and several obligations of the Company and its subsidiaries that are borrowers under the facilities and are jointly and severally guaranteed by other subsidiaries of the Company. Repayment under the PNC Facility and Term A Loan Facility are collateralized by the assets of the Company and each of its subsidiaries. The Credit Facilities contain certain financial and non-financial covenants, including restrictions on dividend payments. The financial covenants under each Credit Facility require the Company to maintain a fixed charge coverage ratio and a total leverage ratio quarterly during the term of the Credit Facilities. The Company was in compliance with the financial covenants included in the Credit Facilities as atSeptember 27, 2020 .
We believe that our sources of liquidity and capital, including cash we expect to generate from operations, available cash and amounts available under our Credit Facilities, will be adequate to meet our debt service requirements, capital expenditures and working capital needs at our current level of operations for the next twelve months. However, we make no assurance that these
34
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sources of liquidity and capital, particularly with respect to amounts available
from lenders, will be sufficient to meet our future needs. We have agreed to a
borrowing base formula under which the amount we are permitted to borrow under
the PNC Facility is based on our accounts receivable and inventory. Further, we
make no assurance that our business will generate sufficient cash flow from
operations or that future borrowings will be available to enable us to service
our indebtedness. Our future operating performance and ability to service
indebtedness will be subject to future economic conditions and to financial,
business and other factors, certain of which are beyond our control.
Market conditions, including the implications of the COVID-19 pandemic, may
negatively impact our ability to secure and source alternative methods of
financing. We do not currently foresee a material impact in the short term based
on our working capital needs, however if a number of our customers reduce or
temporarily cease payments to us, this would present a risk and negatively
impact our cash flow and ability to meet our working capital obligations to
operate our business, which could require us to secure alternative methods of
financing. In order to meet our customers' delivery requirements, we have
incurred and may continue to incur COVID-19 related expenses. These are
primarily due to incremental logistics costs associated with expediting
inventory purchases from existing and new sources, and labor and production
inefficiencies and retention of temporary replacement labor to address workplace
absenteeism due to illness, potential COVID-19 exposure or personal commitments.
We are currently taking steps to limit our expenses, including pausing all
non-essential new hiring and new programs, and reducing our fourth quarter
capital expenditures.
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