Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
Where we say “we”, “us”, “our”, the “Company” or “SMTC”, we mean SMTC Corporation or SMTC Corporation and its subsidiaries, as the context may require. Where we refer to the “industry”, we mean the electronics manufacturing services industry.
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
with the Securities and Exchange Commission
on March
15, 2019
. The forward-looking statements in this discussion regarding the electronics manufacturing services industry, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion 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
15, 2019
, 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 may not update these forward-looking statements after the date of this Form 10-Q, 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 U.S. dollars (US$) unless specifically stated otherwise.
Background
We are a provider of end-to-end electronics manufacturing services, including product design and engineering services, printed circuit board assembly, production, enclosure, cable assembly, precision metal fabrication, systems integration and comprehensive testing services, configuration to order, build to order and direct order fulfillment. We have more than 50 manufacturing and assembly lines at strategically located facilities in the United States, Canada, Mexico, and China that provide local support and manufacturing capabilities to our global customers. Our services extend over the entire electronic product life cycle from new product development and new product introduction through to growth, maturity and end of life phases. As of June 30, 2019, we had 3,086 employees of which 2,559 were full time and contract employees.
Results of Operations
The unaudited interim consolidated financial statements of SMTC are prepared in accordance with U.S. GAAP.
Quarter ended
June 30
, 201
9
compared with the quarter ended
July
1
, 201
8
:
The following table sets forth summarized operating results in millions of US$ for the periods indicated:
|
|
Three months ended
June 30
, 201
9
|
|
|
Three months ended
July
1
, 201
8
|
|
|
Change
201
8
to 201
9
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Revenue
|
|
|
90.9
|
|
|
|
100.0
|
|
|
|
44.5
|
|
|
|
100.0
|
|
|
|
46.4
|
|
|
|
104.3
|
|
Cost of sales
|
|
|
81.9
|
|
|
|
90.1
|
|
|
|
40.2
|
|
|
|
90.3
|
|
|
|
41.7
|
|
|
|
103.7
|
|
Gross profit
|
|
|
9.0
|
|
|
|
9.9
|
|
|
|
4.3
|
|
|
|
9.7
|
|
|
|
4.7
|
|
|
|
109.3
|
|
Selling, general and administrative expenses
|
|
|
6.7
|
|
|
|
7.4
|
|
|
|
3.7
|
|
|
|
8.1
|
|
|
|
3.0
|
|
|
|
81.1
|
|
Restructuring
|
|
|
1.5
|
|
|
|
1.7
|
|
|
|
0.1
|
|
|
|
0.2
|
|
|
|
1.4
|
|
|
|
1,400.0
|
|
Operating income
|
|
|
0.8
|
|
|
|
0.9
|
|
|
|
0.5
|
|
|
|
1.4
|
|
|
|
0.3
|
|
|
|
60.0
|
|
Interest expense
|
|
|
2.8
|
|
|
|
3.1
|
|
|
|
0.4
|
|
|
|
1.0
|
|
|
|
2.4
|
|
|
|
600.0
|
|
Income (loss) before income taxes
|
|
|
(2.0
|
)
|
|
|
(2.2
|
)
|
|
|
0.1
|
|
|
|
0.4
|
|
|
|
(2.1
|
)
|
|
|
(2,100.0
|
)
|
Income tax expense (recovery)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
0.4
|
|
|
|
0.4
|
|
|
|
0.2
|
|
|
|
0.4
|
|
|
|
0.2
|
|
|
|
100.0
|
|
Deferred
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
—
|
|
|
|
—
|
|
|
|
0.1
|
|
|
|
100.0
|
|
|
|
|
0.5
|
|
|
|
0.6
|
|
|
|
0.2
|
|
|
|
0.4
|
|
|
|
0.3
|
|
|
|
150.0
|
|
Net loss
|
|
|
(2.5
|
)
|
|
|
(2.8
|
)
|
|
|
(0.1
|
)
|
|
|
0.0
|
|
|
|
(2.4
|
)
|
|
|
(2,400.0
|
)
|
Revenue
Industry Sector
|
|
Three months ended
June 30
,
2019
|
|
|
Three months ended
July
1,
2018
|
|
|
Change
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Test and Measurement
|
|
|
30.6
|
|
|
|
33.7
|
|
|
|
8.3
|
|
|
|
18.6
|
|
|
|
22.3
|
|
|
|
268.67
|
|
Retail and Payment Systems
|
|
|
12.1
|
|
|
|
13.3
|
|
|
|
9.5
|
|
|
|
21.3
|
|
|
|
2.6
|
|
|
|
27.37
|
|
Telecom, Networking and Communications
|
|
|
8.0
|
|
|
|
8.8
|
|
|
|
7.6
|
|
|
|
17.1
|
|
|
|
0.4
|
|
|
|
5.26
|
|
Medical
|
|
|
11.2
|
|
|
|
12.3
|
|
|
|
6.8
|
|
|
|
15.3
|
|
|
|
4.4
|
|
|
|
64.71
|
|
Industrial, Power and Clean Technology
|
|
|
18.4
|
|
|
|
20.2
|
|
|
|
4.8
|
|
|
|
10.8
|
|
|
|
13.6
|
|
|
|
283.33
|
|
Semiconductor
|
|
|
5.8
|
|
|
|
6.4
|
|
|
|
7.5
|
|
|
|
16.9
|
|
|
|
(1.7
|
)
|
|
|
(22.67
|
)
|
Aerospace and Defense
|
|
|
4.8
|
|
|
|
5.3
|
|
|
|
—
|
|
|
|
—
|
|
|
|
4.8
|
|
|
|
—
|
|
Total
|
|
|
90.9
|
|
|
|
100.0
|
|
|
|
44.5
|
|
|
|
100.0
|
|
|
|
46.4
|
|
|
|
104.27
|
|
Revenue increased $46.4 million to $90.9 million for the second quarter of 2019 from $44.5 million in the same period of 2018. With the acquisition of MC Assembly Holdings, Inc. (“MCA”), we recognized additional revenue of $40.2 million during the second quarter of 2019 compared to the same period during 2018. Net volume increases with customers serviced in the U.S. and Mexico in the test and measurement sector, represented an increase in revenue of $0.7 million with an additional $19.4 million represented from the MCA acquisition. One long-standing retail and payment systems customer serviced in Mexico represented an increase in revenue of $2.4 million. An increase of $2.0 million in the telecom, networking and communications sector was represented from the MCA acquisition, offset by a decrease in revenue of $1.2 million from 2 long standing customers serviced in Asia. Two customers serviced in Mexico in the semiconductor sector had decreased volumes resulting in $1.8 million of reduced revenue. In the industrial, power and clean technology sector, one customer serviced in the U.S. had increased volumes representing an increase of $3.6 million in revenue with an additional $9.7 million represented from the MCA acquisition. Also, revenue in the medical and aerospace and defense sectors increased as a result of the MCA acquisition, totaling $4.7 million and $4.8 million, respectively.
We recorded approximately $2.2 million and $0.5 million of revenue from sales of raw materials inventory to customers during the second quarter of 2019 and the second quarter of 2018, which generally carries limited margin. 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.
Due to changes in market conditions, the life cycle of products, the nature of specific programs and other factors, revenue from a particular customer typically varies from quarter-to-quarter and year-to-year. The Company’s ten largest customers represented 55.9% of revenue during the second quarter of 2019, compared with 78.4% in the second quarter of 2018. Revenue from the largest customer during the second quarter of 2019 was $12.3 million representing 13.5% of total revenue. This compares with revenue from the three largest customers during the second quarter of 2018 of $6.4 million, $4.6 million, and $4.5 million representing 14.4%, 10.4%and 10.0% respectively of total revenue. No other customers represented more than 10% of revenue in either period.
During the second quarter of 2019, 64.6% of our revenue was attributable to production from our operations in Mexico, 32.0% of our revenue was attributable to production from our operations in the U.S. and 3.4% of our revenue was attributable to production from our operations in China. During the second quarter of 2018, 78.6% of our revenue was attributable to production from our operations in Mexico, 11.9% of our revenue was attributable to production from our operations in the U.S. and 9.5% of our revenue was attributable to production from our operations in China.
Gross Profit
Gross profit for the second quarter of 2019 increased by $4.7 million to $9.0 million or 9.9% of revenue compared with $4.3 million or 9.7% of revenue for the same period in 2018. When excluding unrealized foreign exchange gains on unsettled forward contracts and amortization of intangible assets, the adjusted gross profit was $10.8 million or 11.9% of revenue for the second quarter of 2019 compared with $4.3 million or 9.8% of revenue for the second quarter of 2018. This was due primarily to the $46.4 million increase in revenue quarter over quarter due to acquisition of MC Assembly and additional gross margin associated with contract assets of $0.6 due to higher finished goods and work in process inventory when compared to the same period in the prior year.
Adjusted Gross Margin Reconciliation:
Adjusted gross margin, 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. Management presents adjusted gross margin as management considers gross margins 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 margin 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:
|
|
Three months
ended
June 30
, 201
9
|
|
|
Three months
ended
July
1
, 201
8
|
|
Gross profit
|
|
$
|
8,997
|
|
|
$
|
4,283
|
|
Add:
|
|
|
|
|
|
|
|
|
Unrealized foreign exchange gains on unsettled forward exchange contracts
|
|
|
—
|
|
|
|
89
|
|
Amortization of intangible assets
|
|
|
1,844
|
|
|
|
—
|
|
Adjusted gross profit
|
|
$
|
10,841
|
|
|
$
|
4,372
|
|
Adjusted gross profit percentage
|
|
|
11.9
|
%
|
|
|
9.8
|
%
|
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, 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. Management presents EBITDA and Adjusted EBITDA, as it is utilized by management to monitor performance against budget as well as compliance with covenants governing our Credit Facilities (as defined below). 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 loss, the closest GAAP measure, to EBITDA and Adjusted EBITDA.
|
|
Three months
ended
June 30
, 201
9
|
|
|
Three months
ended
July
1
, 201
8
|
|
Net loss
|
|
$
|
(2,468
|
)
|
|
$
|
(97
|
)
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation of property, plant and equipment
|
|
|
1,626
|
|
|
|
769
|
|
Amortization of intangible assets
|
|
|
1,844
|
|
|
|
—
|
|
Interest
|
|
|
2,800
|
|
|
|
403
|
|
Income taxes
|
|
|
519
|
|
|
|
234
|
|
EBITDA
|
|
$
|
4,321
|
|
|
$
|
1,309
|
|
|
|
|
|
|
|
|
|
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charges
|
|
|
1,546
|
|
|
|
96
|
|
Stock based compensation
|
|
|
97
|
|
|
|
77
|
|
Fair value adjustment of warrant liability
|
|
|
40
|
|
|
|
—
|
|
Merger and acquisition related expenses
|
|
|
73
|
|
|
|
—
|
|
Unrealized foreign exchange gain on unsettled forward exchange contracts
|
|
|
—
|
|
|
|
89
|
|
Adjusted EBITDA
|
|
$
|
6,077
|
|
|
$
|
1,571
|
|
Adjusted EBITDA for three months ended June 30, 2019 increased by $4.5 million to $6.1 million compared with $1.6 million for the same period in 2018 due in large part to the acquisition of MC Assembly, which represented an increase in adjusted EBITDA of $3.9 million compared to the same period in the prior year, in addition to incremental gross profit associated with contract assets of $0.6 due to higher finished goods and work in process inventory when compared to the same period in the prior year.
Net loss and Adjusted Net Income (Loss) Reconciliation:
Adjusted Net Income (Loss), a non-GAAP financial measure, is defined as Net Income (Loss) 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. Management presents Adjusted Net Income (Loss), as it is believed the information is useful to investors in understanding and evaluating our operating results.
Below is the reconciliation of net loss to Adjusted Net Income (Loss):
|
|
Three months
ended
June 30, 2019
|
|
|
Three months
ended
July 1, 2018
|
|
Net loss
|
|
$
|
(2,468
|
)
|
|
$
|
(97
|
)
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangible assets
|
|
|
1,844
|
|
|
|
—
|
|
Restructuring charges
|
|
|
1,546
|
|
|
|
96
|
|
Stock based compensation
|
|
|
97
|
|
|
|
77
|
|
Fair value adjustment of warrant liability
|
|
|
40
|
|
|
|
—
|
|
Merger and acquisition related expenses
|
|
|
73
|
|
|
|
—
|
|
Unrealized foreign exchange gain on unsettled forward exchange contracts
|
|
|
—
|
|
|
|
89
|
|
Adjusted Net Income
|
|
$
|
1,132
|
|
|
$
|
165
|
|
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $6.7 million in the second quarter of 2019 from $3.7 million in the same period in 2018, $2.2 million of selling general and administrative expenses relates to the MC assembly acquisition which were not reflected in the same period in the prior year. However, selling, general and administrative expenses decreased to 7.4% of revenue in the second quarter of 2019 down from 8.1% of revenue in the same period in 2018 due to the increase in revenue.
Restructuring Charges
During the second quarter of 2019, restructuring charges of $1.5 million were incurred related to the reduction of 18 full-time equivalents (“FTEs”) in U.S. and 292 FTEs and contract employees in Mexico.
Interest Expense
Interest expense increased to $2.8 million in the second quarter of 2019 compared to $0.4 million in the same period in 2018. The increase was primarily the result of a higher average debt balance in the second quarter of 2019 and higher interest rates compared to the same period in 2018, specifically with $61.3 million of debt outstanding on the TCW Facilities related to financing the MCA acquisition. The weighted average interest rates with respect to the debt on our
Credit Facilities was 9.8%. The weighted average interest rates with respect to the debt on our predecessor PNC Facility (as defined below) was 5.7% for 2018.
Income Tax Expense
The Company recorded current income tax expense of $0.4 million and $0.2 million, respectively, for each of the second quarters of 2019 and 2018, in connection with U.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax expense of $0.1 million and benefit of $0 for each of the second quarters of 2019 and 2018, in connection with temporary differences related to the Mexican operations.
Six months
ended
June 30
, 201
9
compared with the
six months
ended
July
1
, 201
8
:
The following table sets forth summarized operating results in millions of US$ for the periods indicated:
|
|
Six
months ended
June 30
, 201
9
|
|
|
Six
months ended
July 1
, 201
8
|
|
|
Change
2018
to 201
9
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Revenue
|
|
|
193.6
|
|
|
|
100.0
|
|
|
|
81.6
|
|
|
|
100.0
|
|
|
|
112.0
|
|
|
|
137.3
|
|
Cost of sales
|
|
|
176.0
|
|
|
|
90.9
|
|
|
|
73.5
|
|
|
|
90.0
|
|
|
|
102.5
|
|
|
|
139.5
|
|
Gross profit
|
|
|
17.6
|
|
|
|
9.1
|
|
|
|
8.1
|
|
|
|
10.0
|
|
|
|
9.5
|
|
|
|
117.3
|
|
Selling, general and administrative expenses
|
|
|
13.3
|
|
|
|
6.9
|
|
|
|
7.1
|
|
|
|
8.8
|
|
|
|
6.2
|
|
|
|
87.3
|
|
Change in fair value of contingent consideration
|
|
|
(3.1
|
)
|
|
|
(1.6
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(3.1
|
)
|
|
|
100.0
|
|
Restructuring
|
|
|
2.2
|
|
|
|
1.1
|
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
2.1
|
|
|
|
2,100.0
|
|
Operating income
|
|
|
5.2
|
|
|
|
2.7
|
|
|
|
0.9
|
|
|
|
1.1
|
|
|
|
4.3
|
|
|
|
477.8
|
|
Interest expense
|
|
|
5.7
|
|
|
|
2.9
|
|
|
|
0.7
|
|
|
|
0.9
|
|
|
|
5.0
|
|
|
|
714.3
|
|
Income (loss) before income taxes
|
|
|
(0.5
|
)
|
|
|
(0.3
|
)
|
|
|
0.2
|
|
|
|
0.2
|
|
|
|
(0.7
|
)
|
|
|
(350.0
|
)
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
0.7
|
|
|
|
0.4
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
0.4
|
|
|
|
133.3
|
|
Deferred
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
—
|
|
|
|
—
|
|
|
|
0.1
|
|
|
|
100.0
|
|
|
|
|
0.8
|
|
|
|
0.4
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
0.5
|
|
|
|
166.7
|
|
Net loss
|
|
|
(1.3
|
)
|
|
|
(0.7
|
)
|
|
|
(0.1
|
)
|
|
|
(0.1
|
)
|
|
|
(1.2
|
)
|
|
|
(1,200.0
|
)
|
Revenue
Industry Sector
|
|
Six
months ended
June 30,
2019
|
|
|
Six
months ended
July 1,
2018
|
|
|
Change
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Test and Measurement
|
|
|
63.1
|
|
|
|
32.6
|
|
|
|
13.8
|
|
|
|
16.9
|
|
|
|
49.3
|
|
|
|
357.25
|
|
Retail and Payment Systems
|
|
|
25.0
|
|
|
|
12.9
|
|
|
|
16.8
|
|
|
|
20.5
|
|
|
|
8.2
|
|
|
|
48.81
|
|
Telecom, Networking and Communications
|
|
|
18.8
|
|
|
|
9.7
|
|
|
|
14.8
|
|
|
|
18.3
|
|
|
|
4.0
|
|
|
|
27.03
|
|
Medical
|
|
|
23.7
|
|
|
|
12.2
|
|
|
|
14.6
|
|
|
|
17.9
|
|
|
|
9.1
|
|
|
|
62.33
|
|
Industrial, Power and Clean Technology
|
|
|
38.1
|
|
|
|
19.7
|
|
|
|
8.5
|
|
|
|
10.3
|
|
|
|
29.6
|
|
|
|
348.24
|
|
Semiconductor
|
|
|
13.1
|
|
|
|
6.8
|
|
|
|
13.1
|
|
|
|
16.1
|
|
|
|
—
|
|
|
|
—
|
|
Aerospace and Defense
|
|
|
11.8
|
|
|
|
6.1
|
|
|
|
—
|
|
|
|
—
|
|
|
|
11.8
|
|
|
|
—
|
|
Total
|
|
|
193.6
|
|
|
|
100.0
|
|
|
|
81.6
|
|
|
|
100.0
|
|
|
|
112.0
|
|
|
|
137.25
|
|
Revenue increased $112.0 million to $193.6 million for the first half of 2019 from $81.6 million in the first half of 2018. With the acquisition of MCA, we reported additional revenue of $83.7 million during the first half of 2019 compared to July 1, 2018. Volume increases with two customers serviced in the U.S., along with one new customer serviced in China, partially offset by volume decreases with one customer serviced in Mexico in the test and measurement sector, represented an increase in revenue of $7.0 million with an additional $39.3 million represented from the MCA acquisition. Three long-standing retail and payment systems customers serviced in Mexico represented an increase in revenue of $8.1 million. An increase of $4.3 million in the telecom, networking and communications sector was due from the MCA acquisition. In the industrial, power and clean technology sector one customer serviced in Mexico and one customer serviced in the U.S. had increased volumes representing an increase of $9.6 million in revenue with additional $19.7 million represented from the MCA acquisition. Also, revenue increased as a result of the MCA acquisition in the medical, and aerospace and defense sectors totaling $9.0 million and $11.8 million respectively.
We recorded approximately $4.4 million and $1.3 million of revenue from sales of raw materials inventory to customers during the first quarter of 2019 and the first quarter of 2018, which generally carries limited margin. 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.
Due to changes in market conditions, the life cycle of products, the nature of specific programs and other factors, revenue from a particular customer typically varies from quarter-to-quarter and year-to-year. The Company’s ten largest customers represented 54.9% of revenue during the first half of 2019, compared with 78.7% in the first quarter of 2018. Revenue from the largest customer during the first half of 2019 was $25.8 million representing 13.3% of total revenue. This compares with revenue from the three largest customers during the first half of 2018 of $11.4 million, $8.5 million, and $8.3 million representing 13.9%, 10.4%, and 10.1% respectively of total revenue. No other customers represented more than 10% of revenue in either period.
During the first half of 2019, 64.3% of our revenue was attributable to production from our operations in Mexico, 30.4% of our revenue was attributable to production from our operations in the U.S. and 5.3% of our revenue was attributable to production from our operations in China. During the first half of 2018, 78.3% of our revenue was attributable to production from our operations in Mexico, 12.8% of our revenue was attributable to production from our operations in the U.S. and 8.9% of our revenue was attributable to production from our operations in China.
Gross Profit
Gross profit for the first half of 2019 increased by $9.5 million to $17.6 million or 9.1% of revenue compared with $8.1 million or 10.0% of revenue for the same period in 2018. When excluding unrealized foreign exchange gains on unsettled forward contracts and amortization of intangible assets, the adjusted gross profit was $21.3 million or 11.0% of revenue for the first half of 2019 compared with $7.9 million or 9.7% of revenue for the first half of 2018. This was due primarily to the $111.9 million increase in revenue, of which $83.7 was due to acquisition of MC Assembly. The decrease in gross profit percentage was due in part to the amortization of intangible assets of $3.7 million included in cost of sales that was not included in the same period in the prior year.
Adjusted Gross Margin Reconciliation:
Adjusted gross margin, 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. Management presents adjusted gross margin as management considers gross margins 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 margin 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:
|
|
Six
months
ended
June 30
, 201
9
|
|
|
Six
months
ended
July 1
, 201
8
|
|
Gross profit
|
|
$
|
17,621
|
|
|
$
|
8,133
|
|
Add:
|
|
|
|
|
|
|
|
|
Unrealized foreign exchange gains on unsettled forward exchange contracts
|
|
|
—
|
|
|
|
(230
|
)
|
Amortization of intangible assets
|
|
|
3,688
|
|
|
|
—
|
|
Adjusted gross profit
|
|
$
|
21,309
|
|
|
$
|
7,903
|
|
Adjusted gross profit percentage
|
|
|
11.0
|
%
|
|
|
9.7
|
%
|
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, 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. Management presents EBITDA and Adjusted EBITDA, as it is utilized by management to monitor performance against budget as well as compliance with covenants governing our Credit Facilities. 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.
|
|
Six
months
ended
June 30
, 201
9
|
|
|
Six
months
ended
July 1
, 201
8
|
|
Net loss
|
|
$
|
(1,257
|
)
|
|
$
|
(89
|
)
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation of property, plant and equipment
|
|
|
3,253
|
|
|
|
1,543
|
|
Amortization of intangible assets
|
|
|
3,688
|
|
|
|
—
|
|
Interest
|
|
|
5,670
|
|
|
|
710
|
|
Income taxes
|
|
|
790
|
|
|
|
260
|
|
EBITDA
|
|
$
|
12,144
|
|
|
$
|
2,424
|
|
|
|
|
|
|
|
|
|
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charges
|
|
|
2,170
|
|
|
|
96
|
|
Stock based compensation
|
|
|
185
|
|
|
|
203
|
|
Fair value adjustment of warrant liability
|
|
|
(61
|
)
|
|
|
—
|
|
Fair value adjustment to contingent consideration
|
|
|
(3,050
|
)
|
|
|
—
|
|
Merger and acquisition related expenses
|
|
|
164
|
|
|
|
—
|
|
Unrealized foreign exchange gain on unsettled forward exchange contracts
|
|
|
—
|
|
|
|
(230
|
)
|
Adjusted EBITDA
|
|
$
|
11,552
|
|
|
$
|
2,493
|
|
Adjusted EBITDA for six months ended June 30, 2019 increased by $9.1 million to $11.6 million compared with $2.5 million for the same period in 2018 due primarily to the acquisition of MC Assembly, which represented an increase in adjusted EBITDA of $7.1 million which was not included in the results in the same period in the prior year.
Net loss and Adjusted Net Income (Loss) Reconciliation:
Adjusted Net Income (Loss), a non-GAAP financial measure, is defined as Net Income (Loss) 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. Management presents Adjusted Net Income (Loss), as it is believed the information is useful to investors in understanding and evaluating our operating results.
Below is the reconciliation of net loss to Adjusted Net Income (Loss):
|
|
Six months
ended
June 30, 2019
|
|
|
Six months
ended
July 1, 2018
|
|
Net loss
|
|
$
|
(1,257
|
)
|
|
$
|
(89
|
)
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangible assets
|
|
|
3,688
|
|
|
|
—
|
|
Restructuring charges
|
|
|
2,170
|
|
|
|
96
|
|
Stock based compensation
|
|
|
185
|
|
|
|
203
|
|
Fair value adjustment of warrant liability
|
|
|
(61
|
)
|
|
|
—
|
|
Fair value adjustment to contingent consideration
|
|
|
(3,050
|
)
|
|
|
—
|
|
Merger and acquisition related expenses
|
|
|
164
|
|
|
|
—
|
|
Unrealized foreign exchange gain on unsettled forward exchange contracts
|
|
|
—
|
|
|
|
(230
|
)
|
Adjusted Net Income (Loss)
|
|
$
|
1,839
|
|
|
$
|
(20
|
)
|
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $13.3 million in the first half of 2019 from $7.1 million in the same period in 2018, $4.9 million of selling general and administrative expenses relates to the MC assembly acquisition which were not reflected in the same period in the prior year. However, selling, general and administrative expenses decreased to 6.9% of revenue in the first half of 2019 down from 8.8% of revenue in the same period in 2018 due to increase in revenue and certain cost reductions due to restructuring that occurred in the first half of 2019.
Change in fair value of contingent consideration
During the first quarter of 2019, the fair value of the contingent consideration liability was determined to be $Nil resulting in a gain of $3.1 million being recognized. 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 of MC Assembly. Fair value estimate under purchase accounting of $3.1 million was derived from a multiple of earnings based on MC Assembly’s forecasted twelve-month earnings for the period ended March 31, 2019. Based on actual earnings, the contingent consideration liability was considered resolved and no longer payable as at March 31, 2019.
Restructuring Charges
During the first half of 2019, restructuring charges of $2.2 million were incurred related to the reduction of 28 FTEs in U.S. and 4FTEs in Canada and 459 FTEs and contract employees in Mexico.
Interest Expense
Interest expense increased to $5.7 million in the first half of 2019 compared to $0.7 million in the same period in 2018. The increase was primarily the result of a higher average debt balance in the first half of 2019 and higher interest rates compared to the same period in 2018, specifically with $61.3 million issuance of debt on the TCW Facilities on November 8, 2018 in order to finance the MCA acquisition. The weighted average interest rates with respect to the debt on our Credit Facilities was 9.6%. The weighted average interest rates with respect to the debt on our predecessor PNC Facility was 5.6% for 2018.
Income Tax Expense
The Company recorded current income tax expense of $0.7 million and $0.3 million, respectively, for each of first six months of 2019 and 2018, in connection with U.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax expense of $0.1 million and benefit of $NIL million for each of first six months of 2019 and 2018, in connection with temporary differences related to the Mexican operations.
Liquidity
As at June 30, 2019, the Company’s liquidity is comprised of $0.6 million in cash on hand and $27.1 million of funds available to borrow under the PNC Facility and TCW Facility (each as defined below), which mature on November 8, 2023. The Company funds its operations by regularly utilizing its PNC Facility (refer to Note 5). 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.
Net cash used in operating activities during the first six months ended June 30, 2019 was $0.2 million. Cash of $10.1 million was used from accounts payable due to timing of payments and an increased inventory purchase compared to the same period in the prior year. Accounts payable days outstanding increased to 72 days for the first six months of 2019 compared to 71 days for the first six months of 2018. Working capital changes related to $7.1 million decrease in inventory offset by the $7.2 million of increase in unbilled contract assets. Inventory turnover, on an annualized basis was 4.5 times for the first six months of 2019 compared to 4.9 times for the first six months of 2018. Accounts receivable days outstanding decreased to 61 days from 62 days for the first six months of 2019 compared to the first six months of 2018 primarily the result of improved cash cycle days compared to the same period in the prior year in addition to higher collections in the final month of the quarter.
Net cash generated from financing activities during the first six months of 2019 and 2018 was $1.3 million and $0.9 million, respectively. During the six months ended June 30, 2019, the Company generated net cash by $14.0 million from issuance of common stock through the rights offering. The Company made net repayments to the revolving debt of $11.3 million compared to net repayments of $0.2 million for the same period in 2018. The Company also paid down its long-term debt in the amount of $0.6 million and $1.0 million, respectively in the six months ended June 30, 2019 and July 1, 2018. Principal repayments on capital lease obligations were $0.8 million in the six months ended June 30, 2019 compared to $0.1 million in the same period in prior year.
Net cash used in investing activities during the six months ended June 30, 2019 was $2.1 million compared to $2.4 million in the same period of 2018, related to capital asset purchases.
Capital Resources
The Company borrows money under an Amended and Restated Revolving Credit and Security Agreement with PNC Bank, National Association (“PNC”), which governs the Company’s Revolving Credit Facility (“PNC Facility”). The PNC Facility has a term ending on November 8, 2023. Advances made under the PNC Facility bear interest at the U.S. base rate plus an applicable margin ranging from 0.50% to 1.00%, or LIBOR plus an applicable margin ranging from 1.50% to 2.00%. The base commercial lending rate should approximate U.S. prime rate.
The Company also borrows money under a Financing Agreement (the “Financing Agreement”), by and among us and certain of our subsidiaries, the lenders party to the Financing Agreement from time to time (collectively, the “Lenders”), and TCW Asset Management Company LLC, as collateral agent for the Lenders ( “TCW”), which governs a term loan A facility (“Term A Loan Facility”) and a term loan B facility (“Term Loan B Facility” and, together with the Term Loan A Facility, the “TCW Facilities” and, together with the PNC Facility, the “Credit Facilities”). The TCW Facilities mature on November 8, 2023 (the “Maturity Date”). The Term Loan A Facility bears interest, as selected by the Company at the time of borrowing, at the base rate plus an applicable margin of 5.00%. The Term Loan B Facility bears interest, as selected by the Company at the time of borrowing, at the base rate plus an applicable margin of 8.50% or LIBOR plus an applicable margin of 10.50%. The base rate should approximate U.S. prime rate. 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 before the first anniversary of the closing date, (ii) 2.00% in the event that such payment occurs after the first anniversary of the closing date and on or before the second anniversary of the closing date and (iii) 1.00% in the event that such payment occurs after the second anniversary of the closing date and on or before the third anniversary of the closing date. No such applicable premium is payable for any payment of loans made under the Term Loan A Facility occurring after the third anniversary of the Closing Date. On July 3, 2019, the Company repaid the TCW Term Loan B Facility in full.
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 TCW Facilities are collateralized by the assets of the Company and each of its subsidiaries. The Credit Facilities contain certain financial and non-financial covenants. The financial covenants under each Credit Facility require the Company to maintain a fixed charge coverage ratio, a total leverage ratio, and a senior leverage ratio quarterly during the term of the Credit Facilities. The Company is in compliance with the financial covenants included in the Credit Facilities as at June 30, 2019. Management projects compliance with the financial covenants included in the Credit Facilities.
We believe that 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, although no assurance can be given in this regard, particularly with respect to amounts available from lenders. 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, there can be 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.
Rights Offering and Registered Direct Offering
In June 2019, the Company completed its (i) offering of subscription rights (the “Rights Offering”) to the Company’s stockholders and holders of the Company’s outstanding warrants as of the close of business on May 24, 2019, which was fully subscribed for the maximum offering amount of $9.1 million and (ii) registered direct offering (the “Registered Direct Offering” and, together with the Rights Offering, the “Offerings”) of 1,732,483 shares of the Company’s common stock directly to certain investors, resulting in net proceeds to the Company of approximately $14.2 million, after deducting the offering expenses and fees payable the Company. The proceeds of the Offerings were used, in part, to repay the TCW Term Loan B Facility in full as at July 3, 2019.