PART I

 

Unless the context otherwise requires, in this Annual Report on Form 10-K (the “Form 10-K”) where we say “we”, “us”, “our”, the “Company” or “SMTC,” we mean SMTC Corporation and its subsidiaries, as applicable. Where we refer to the “industry,” we mean the electronics manufacturing services industry. Unless otherwise noted or the context otherwise requires, all references to years in this report are to fiscal years.

 

This Form 10-K and other communications made by us contain forward–looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The forward-looking statements in this Form 10-K regarding, among other things, our cessation of manufacturing operations in China, the electronics manufacturing services industry, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements include numerous risks and uncertainties, some of which are as described in the “Risk Factors” section in this Form 10-K. Statements using words such as “could”, “expects”, “may”, “anticipates”, “believes”, “intends”, “estimates”, “plans”, “envisions”, “seeks” and other similar language are considered forward looking statements 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. Moreover, we operate in a competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for us to predict all risk factors, nor can we address the impact of all factors on our business. You should not place undue reliance on any forward-looking statement, each of which applies only as of the date of this Form 10-K. Except as required by applicable law, we undertake no intention or obligation to update these forward-looking statements after the date of this Form 10-K, even though our situation may change in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

 

Item 1.

Business

 

Overview

 

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”). At the end of 2019, we operated 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. Our focus on delivering best-in-class services has been recognized and we have received Frost & Sullivan Awards for Product Quality, Growth Leadership & Customer Value Leadership Awards in May 2019.

 

During the fourth quarter of 2019 we ceased manufacturing in China and began to relocate the equipment used at our Chinese manufacturing facility to our other North American sites. Customer concerns about uncertainties relating to the prolonged impact of tariffs and macro-economic factors caused a number of our customers to begin to re-evaluate demand for some of their products and reconsider where they outsource their manufacturing. Revenues attributable to production from SMTC’s manufacturing operations in China declined in 2019 as compared to 2018, but more significant declines were anticipated in 2020 which would have resulted in negative operating margins from our China site. This ultimately resulted in the decision to close the manufacturing facility.

 

We offer fully integrated contract manufacturing services to global original equipment manufacturer (“OEMs”), technology companies, Defense Prime Contractors, the U.S. Department of Defense (“DoD”), and various U.S. government agencies. We are focused on seven market sectors:

 

●

Avionics, aerospace and defense;

●

Industrial, power and clean technology;

●

Medical and safety;

●

Retail and payment systems;

●

Semiconductors;

●

Telecom, networking and communications; and

●

Test and measurement.

 

We have customer relationships with industry leading OEMs, Defense Prime Contractors, the DoD, and various other U.S. government agencies. We developed these relationships by capitalizing on the continuing trend of OEMs outsourcing non-core manufacturing services to consolidate their supplier base and forming long-term strategic partnerships with select high-quality EMS providers. We work closely with, and are highly responsive to, our customers throughout the design, manufacturing and distribution process, providing value-added services. We seek to grow our business through the expansion of our share of business with existing customers, participating in the growth of existing customers, the addition of new high-quality customers, and from time-to-time, through strategic acquisitions, such as our acquisition of MC Assembly Holdings, Inc. (“MCA”), a privately held EMS provider based in Melbourne, Florida, in November 2018 (the “MCA Acquisition”). In connection with the MCA Acquisition, we expanded our operations to include locations in Melbourne, Florida, Billerica, Massachusetts, and Zacatecas, Mexico. Our Melbourne, Florida operation provides comprehensive electronic manufacturing services with a focus on delivering product to our customer base in the most cost-efficient manner. Our Billerica, Massachusetts operation has the same competencies as our operation in Florida, but on a smaller scale. An ISO 9001/2008 2015 approved quality system allows for strict controls and process discipline on our manufacturing floor. Our Zacatecas, Mexico operation is a ‘Copy-Exact’ facility of our Melbourne, Florida operation, which functions within the guidelines of ISO-9001:2008 2015 and ISO-13485:2016 Quality System and provides similar manufacturing as our U.S.-based operations with the advantage of the lower cost of labor.

 

We believe that one of the fundamental benefits we offer is our strategic approach in working with customers. This approach involves gaining insight into their business and bringing innovative solutions to enhance their competitiveness, time to market and profitability. We seek to lower total cost of ownership, improve product quality and reliability, accelerate new products to market, improve service and DOF,, reduce working capital requirements and capital expenditures, all of which results in improvement of our customers’ overall margins and end customer satisfaction.

 

 

Industry Background

 

The EMS sector is the outsourced portion of the worldwide electronics assembly industry. EMS has experienced significant change and growth as an increasing number of companies elect to outsource some or all of their design, manufacturing, and after-market services requirements. There is currently considerable outsourcing of manufacturing by traditional OEMs and more recent market entrants in response to rapidly changing markets, technologies and accelerating product life cycles as well as the need to lower total costs and convert typical fixed costs into a variable cost model.

 

Historically, OEMs were vertically integrated manufacturers that invested significantly in manufacturing assets and facilities around the world to manufacture, service and distribute their products. EMS originated as labor intensive functions that OEMs outsourced to obtain additional capacity during periods of high demand. Early EMS providers were essentially subcontractors, providing production capacity on a transactional basis. However, with significant advances in manufacturing process technology, EMS providers developed additional capabilities and were able to improve quality and dramatically reduce OEMs’ costs. Furthermore, as the capabilities of EMS companies expanded, an increasing number of OEMs adopted and relied upon EMS outsourcing strategies. Over time, OEMs engaged EMS providers to perform a broader array of manufacturing services, including design and development activities. In recent years, EMS providers have further expanded their range of services to include advanced manufacturing, configuration, packaging and distribution and overall supply chain management. In addition, many OEMs are reducing the number of vendors from which outsourced services are purchased and are partnering with EMS suppliers that offer broader expertise. The EMS industry has also seen an increased level of diversification by many companies, primarily in the technology sector. Companies that have historically identified themselves as software providers, internet service providers, or e-commerce retailers are entering the highly competitive and rapidly evolving mass hardware markets, with products including mobile devices, home entertainment products, and wearable devices.

 

By outsourcing manufacturing, OEMs can take advantage of the technology and manufacturing expertise of EMS companies and focus on their core business, while leveraging the manufacturing efficiency of and capital investment made by EMS providers. OEMs use EMS providers to enhance their competitive position by:

 

•

Lowering Product Costs.    EMS providers are better able to reduce total product costs due to electronic manufacturing expertise and higher utilization of manufacturing capacity spread over a wider range of product types. Due to their scale of operations as well as their established and ongoing relationships with suppliers, EMS providers are able to achieve better pricing and better working capital management.

•

Reducing Time to Market.    Electronic products are experiencing shorter product life cycles, requiring OEMs to continually reduce the time required to bring new products to market. OEMs can significantly improve product development cycles and reduce time to market by benefiting from the expertise and infrastructure of EMS providers. This expertise includes capabilities relating to design, quick-turn prototype development and rapid ramp-up of new products to high volume production, with the critical support of worldwide supply chain management.

	•	Ability to focus on core branding and R&D initiatives. Through outsourcing, OEMs are able to focus on marketing and product development initiatives which have taken on more prominence as product life cycles have shortened, and as electronic products have become more sophisticated and complex, while at the same time many end markets have become more competitive with companies that have historically identified themselves as software providers, internet service providers, or e-commerce retailers entering the highly competitive and rapidly evolving hardware markets.
	•	Improving Supply Chain and Inventory Management.    OEMs that manufacture internally are faced with greater complexities in planning, sourcing, procurement and inventory management due to frequent design changes, short product life cycles and product demand fluctuations. OEMs can address these complexities by outsourcing to EMS providers that possess sophisticated supply chain management capabilities and can leverage significant component procurement advantages to lower product costs.

•

Accessing Advanced Manufacturing Capabilities and Process Technologies.    Electronic products and electronic manufacturing technology have become increasingly sophisticated and complex, making it difficult for many OEMs to maintain the necessary technological expertise and focus required to efficiently manufacture products internally. By working closely with EMS providers, OEMs gain access to high-quality manufacturing expertise and capabilities in the areas of advanced process, interconnect and test technologies.

•

Improving Access to Global Markets.    OEMs are generally increasing their international activities in an effort to expand sales through access to foreign markets. EMS companies with worldwide capabilities are able to offer those OEMs global manufacturing solutions enabling them to meet local content requirements and to distribute products efficiently around the world at lower costs.

•

Reducing Capital Investments.    OEMs are able to reduce their capital investments in inventory, facilities and equipment by outsourcing their manufacturing to EMS providers and allocating their resources towards their core business activities.

•

Shift from a Fixed to Variable Cost Model.    Through outsourcing, OEMs are able to shed substantial fixed costs of manufacturing and take advantage of EMS providers’ efficient facilities, resulting in a highly variable and more efficient cost structure.

 

 

Our Capabilities and Performance

 

Our EMS activities span the entire electronic product life cycle from the development and introduction of new products through the growth, maturity, and end of life phases. We believe that our focus on quality, superior supply chain management and innovative manufacturing services have the capabilities to reduce our customers’ product costs and time to market, which improves our customers’ competitiveness. We continuously work with our customers to identify, prioritize and implement opportunities for cost reduction.

 

We offer three vertically-integrated manufacturing streams: enclosures and precision metal fabrication products; PCBA products; and larger-scale systems. For each of these streams, we provide a broad range of end-to-end manufacturing services, from assembly, test, integration and box-build through to system level test, CTO, BTO and DOF. These core services are complemented with cable assembly, interconnect and value engineering services. Our three manufacturing streams are vertically integrated to better control quality, lead times and inventory risk and to avoid lost margin that can occur when these services are provided by loosely connected entities. Our customers benefit from lower costs, better quality, and shorter lead times.

 

Our vertically-integrated manufacturing services include:

 

New Product Introduction Services. In 2019, we added a new capability to our Billerica, Massachusetts, United States location that provides our customers with world-class 'Quick-turn' manufacturing. This new capability is designed to enable an accelerated launch timetable for our customers’ products with the flexibility to scale into a low-cost geography that is available from other SMTC sites.

 

PCBA Services.    We provide advanced product assembly and system level integration and test services combined with advanced manufacturing equipment and processes. Our flexible environment allows us to support low-medium and high-mix and volume manufacturing requirements as well as to deliver a final product directly to the end customer.

 

System-Level Integration, Box-Build and Test.    Our system and subsystem assembly services involve combining a wide range of subassemblies, including PCBAs, cables and harnesses, battery boxes and connector blocks, power supplies, backplanes and thermal controls. Our test expertise encompasses the full array of technologies present in today’s system level products, including high-speed digital, radio frequency, precision analog, power, thermal and optical. We provide complete electrical and mechanical testing for cables, harnesses, PCBAs, subassemblies and systems to meet our customers’ requirements and specifications. Our in-house expertise enables us to provide custom test development services to our customers and to implement their product specific tests.

 

Enclosures and Precision Metal Fabrication.    We use premium grade sheet steel, stainless steel, and aluminum to ensure high quality. Technologically advanced equipment and processes enable us to produce medium to complex product enclosures and metal parts while still achieving a low overall product cost. Our soft tooling approach minimizes upfront costs and provides flexibility to respond quickly to engineering changes.

 

Custom Interconnect.    We are experienced in the design, development and manufacturing of interconnect assemblies such as optical and electrical cable and harness assemblies offering customers advanced expertise and low-cost options.

 

Engineering Services.    We provide services across the entire product life cycle including product design, prototyping, qualification testing and sustaining engineering through product end of life.

 

Global Procurement and Supply Chain Network.    As an extension of our offering of vertically-integrated manufacturing services, our Global Procurement Group (“GPG”) plays a fundamental role in our managing a portfolio of assets and relationships in the most efficient manner. Our GPG has expertise that includes outsourcing based on market conditions and demand management criteria established with the customer, building flexibility into the supply chain network, designing a supply chain specific to individual customer needs, and having the ability to proactively plan. A key element of our business is to work closely with our customers to anticipate and/or react to changing market conditions, For example, in 2018 we worked with our customers and key partners and implemented a number of initiatives to manage the risks associated with the industry’s then component shortages as well as new tariffs. These initiatives included a new supply chain center in Phoenix, Arizona opened in 2018, the expanded use of lean manufacturing kan-ban programs, upgraded quoting-tools, tailor-made customer-specific action plans, new agreements with Tier-1 distributors, and extensive investments in safety stock programs. Our GPG is responsible for all aspects of our supply network. Our GPG, led by personnel that have gained experience with large organizations where they have developed key relationships, works together with our customers to establish customized inventory, logistics and distribution services to ensure that any unique delivery requirements are met. Through the use of various management tools, our supply chain team focuses on driving improved inventory turns, lowering excess and obsolete inventory risk and reducing overall costs to our customers.

 

Management Methods and Tools.    We have a web-based system through which it can communicate, collaborate and plan throughout the entire supply chain in real-time with our customers and suppliers. This system accelerates the timeliness and effectiveness of decision making and the efficiency and flexibility with which we can plan for and respond to customers experiencing market fluctuations. We employ technologically advanced quality assurance systems, manufacturing process planning and continuous improvement methodologies.

  

 

Our Footprint

 

At the end of 2019, we operated 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 NPI services, to our global customers. During the fourth quarter of 2019 we ceased manufacturing in China and began to relocate the equipment used at our Chinese manufacturing facility to our other North American sites.

 

All our manufacturing facilities adhere to the “Copy Exact” methodology. Our “Copy Exact” process enables a seamless and timely transition of production between facilities to help customers reach their cost and volume targets faster. We also assign a dedicated manufacturing unit to each customer.

 

Key Benefits to Our Customers

 

Three overarching themes form the core of our differentiation and unique customer value proposition: trusted, proven, and professional. These three themes are exemplified by the following aspects of our business:

 

Operational Counterpart:    Fundamental to our strategic approach in working with customers is to take the time to understand our customers’ business objectives, end markets, performance expectations, competitive advantage, positioning and strategy—to drive better value. We get involved with our customers at both a strategic and operational level. As a trusted partner, we seek to become an extension of their business, helping our customers grow, improve competitiveness, margins, and gain market share.

 

The Customer Experience:    We combine strong performance with a partnership approach that delivers tangible, bottom-line benefits through committing expertise and resources towards customer goals. We believe it is one of many reasons that a number of our customers have been with us for many years.

 

People:    Our customer-based teams are tied to the customer at a strategic, operational and organizational level. Our people create an environment that celebrates collaboration and teamwork. We foster a participatory workplace that enables people, at every level of the organization, to get involved in making decisions that put the customer first.

 

Executive Mindshare:    We fully engage with our customers on many levels—from operational and executive mindshare, to custom-tailored solutions as part of strategic partnership approach to doing business. Our senior management, each of whom has strong relationships with customers from their previous positions at larger companies, are armed with real-time operational metrics and quality data, and are accessible to and actively involved with our customers.

 

Strategic Fit:    Fit matters. Winning OEMs look for winning manufacturing partners. We mitigate the risk of outsourcing and seeks to deliver results and value.

 

Global Footprint:    At the end of 2019, we operated 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 NPI services, to our global customers. During the fourth quarter of 2019 we announced a decision to cease manufacturing in China and relocate the equipment used at our Chinese manufacturing facility to our other North American sites.

 

Supply Chain Expertise: We deliver supply chain capabilities and solutions that support the total product life cycle. Our extended supply chain model recognizes the need for collaboration between our customers, our Company and our supply partners to ensure overall supply chain optimization, from product design processes, manufacturing, sourcing, order management and fulfillment to transportation and logistics. The end result is greater control over a complex, extended supply chain to help our customers realize flexibility, cost savings, process improvements, and competitive advantages.

 

Superior Value:    We continuously work collaboratively with customers to identify, prioritize and implement opportunities for cost reduction. Working collaboratively helps ensure superior service, operational excellence and continuous cost improvement.

 

Customized Solutions:    By gaining insight into our customers businesses, we can proactively tailor customized solutions to their unique challenges to enhance their competitiveness, time to market and profitability.

 

 

 Our Corporate Objective and Strategies

 

Our corporate objective is to create sustainable growth and increase stockholder value through growth in sales, profitability and debt minimization. A cornerstone to our business is our customer-centric focus throughout the organization.

 

Our key strategies include:

  

Provide Outstanding Customer Service and Performance.    Customer acquisition and loyalty comes from our ongoing commitment to understanding our customers’ business performance requirements and our expertise in meeting or exceeding these requirements and enhancing their competitive edge. Our customer focus extends to our unique offering of dedicated resources, a detailed understanding of our customers’ challenges and means to support our customers in meeting their goals. Our dedicated team approach is used throughout our Company and comprises members from all functional areas working together to better understand the unique needs of each customer, their challenges and their future plans. Our commitment to understanding each customer’s goals, challenges, strategies, operations and products to provide a better overall solution is a key focus for our operations personnel and our senior executive team.

 

 Focus on Well Defined Customer Markets.    We focus on specific customer sectors (and within those sectors target a wide range of projects that offer higher value add) that align well with our capabilities:

 

●

Avionics, aerospace and defense;

●

Industrial, power and clean technology;

●

Medical and safety;

●

Retail and payment systems;

●

Semiconductors;

●

Telecom, networking and communications; and

●

Test and measurement.

 

Customers with unique medium to high-mix and volume production requirements with a need for a high level of responsiveness to changing market demands are particularly well suited for our capabilities. We continue to leverage our experience and established relationships in our existing market segments. Through the MCA acquisition, we have increased and expect to continue to expand our business in the avionics, aerospace and defense markets and have been able to further penetrate into the medical and safety market sectors. We target a wide range of projects in the sub-$5 million range that offer higher value add than larger projects typically targeted by Tier-1 EMS competitors.

  

Provide Advanced Technological Capabilities.    We remain committed to enhancing our capabilities and value-added services to become an integral part of our customers’ operations. Through our investment in assembly and fabrication technologies and in design, engineering and test capabilities, we are able to provide our customers with a variety of advanced design and manufacturing solutions.

 

Provide Comprehensive Service Offerings.    Our broad array of EMS activities span the entire electronic product life cycle from introduction and development of new products to the support of products to growth and maturity phases. We perform advanced PCBA and test and complement these capabilities with precision enclosure fabrication, system integration, product configuration, and BTO services. As products mature, we provide comprehensive value engineering services to reduce the cost of the products we produce without compromising quality or function. As products near their end of life, our sustaining engineering and supply chain management systems ensure continued availability and support of hard to source components while mitigating the risks associated with declining inventories. We believe that our breadth of services provides greater control over quality, delivery and costs and enables us to offer our customers a complete, end-to-end solution that is time and cost effective.

 

Maintain a Competitive, Scalable Cost Structure.   We maintain a competitive cost structure that not only delivers highly competitive pricing to customers but is also both variable and scalable as market conditions dictate. We strive to improve profitability through tight cost containment measures, performance excellence, leveraging fixed costs and increased capacity utilization. The MCA Acquisition has enabled us to become a more efficient operator, including sourcing cost reductions, the elimination of certain redundancies in our corporate and shared services, and an increase in manufacturing capacity to better serve existing and new customers. The MCA Acquisition has also accelerated our entry into several new complex and highly regulated, attractive markets that present the opportunity for higher margins, including our entry into the avionics, aerospace and defense markets, and further allowed us to further penetrate into medical industries which we had targeted and previously received key industry certifications.

 

 

Technology, Processes and Development

 

Our engineering services team delivers a wide range of design, engineering and manufacturing solutions. We have electronic engineering expertise in our targeted customer markets. We maintain manufacturing equipment and tools to the highest calibration standards possible. We follow a comprehensive preventative maintenance program. Customers rely on our full range of design services—from software and firmware development, to electronic design, mechanical design and PCB layout. Our design services capability optimizes product design for maximum performance, higher yields, and faster time to market, with the objective of assisting our customers in becoming more profitable and more competitive. We partner with our customers to deliver innovative manufacturing solutions aligned with their business objectives. We offer everything from full-service, turnkey product development and manufacturing to on-site engineering support.

  

Our box build experience spans the past 20 years with all manufacturing sites supporting current customers in this level of outsourcing. Our integration and box build assembly services combine a wide range of subassemblies, including PCBAs, cables and harnesses, external housing (plastic and metal), monitors, battery boxes and connector blocks, power supplies, fan trays, backplanes and thermal controls. Integrated units are packaged, together with manuals, software, and peripherals. DOF and BTO are handled throughout the integration service, specific to the needs of our customers.

 

Our DOF and distribution operations help our customers reduce material storage, lower handling costs and achieve higher inventory turns. We also provide responsive, efficient and cost-effective configure to order and order fulfillment solutions. We align our processes with the customers’ operations, sales and distribution objectives to eliminate redundancies and associated costs.  

 

We continue to invest in new processes and equipment that enable the assembly of industry leading product designs. In 2019, we invested approximately $4 million primarily related to equipment expansion in North America to support our growing global customer base.

 

We believe that we apply best-in-class quality programs, processes and metrics to achieve exceptional quality standards. We endeavor to fully understand the quality requirements for every customer and we continuously review to improve our quality performance to exceed customer expectations. All of our sites currently use Computer Integrated Manufacturing (“CIM”), a common quality management platform. The CIM system tracks quality assurance processes in real-time and reports on all steps in the manufacturing process. We are continuing to make investments in quality, and are in the process of replacing the existing CIM system with Factory Logix, a product from Aegis Industrial Software. This investment will improve transaction control on the production floor and traceability at the component and product level. We use a customer-centric, team-based approach to quality assurance. Dedicated professionals work with our customers to determine key quality requirements, and where applicable, they ensure suppliers adhere to those standards as well. All of our sites are certified with the International Organization for Standardization (“ISO”) ISO-9001 quality management system standard and ISO-13485 medical standards. All ISO 9001 registrations are to the latest level (2015 version of the standard). All of our sites have also achieved the Environmental Management Standards ISO-14001 certification. We build PCBAs according to IPC standards, an association connecting the electronic industries, and has been an IPC member since 1991. We also work closely with standards organizations such as Underwriters Laboratories, a safety consulting and certification company and Canadian Standards Association, in compliance with customer requirements. Our Fremont, California and Chihuahua, Mexico locations are registered FDA facilities and are in compliance with federal Good Manufacturing Practice and the Quality System Regulations. To support our diverse customer base which includes customers in several highly regulated industries, we have achieved a number of required industry certifications, compliance requirements and governmental registrations, including Apple® Authorized Mfi Manufacturing License 6.0, AS9100, Cage Code: 4X3Y1, cGMP Compliant, FAA: PMA Certified, FDA Registration, IATF 16949, IPC-610 Class 3, ISO 9001, ISO 14001, ISO 13485, ITAR Registration, J-STD -001, and TRAC: 4144-7785-7736.  

 

We achieved AS9100 accreditation at our Billerica, Massachusetts, Fremont, California and Melbourne, Florida facilities. We have also achieved ISO-13485 certification at all sites worldwide. ISO-13485 is an internationally recognized quality management system and standard for the manufacture of medical devices. Our Fremont, California and Chihuahua, Mexico locations are registered FDA facilities and are in compliance with federal Good Manufacturing Practice and the Quality System Regulations.  

 

 

Marketing and Sales

 

Our direct sales channel model is organized and managed with territorial assignments based on geographical coverage of our target markets globally. We have developed relationships and established a network of sales representatives that focus on specific territories in the U.S. The MCA acquisition in 2018 further expanded our network of marketing representatives and agencies. Our marketing and sales team work collaboratively to gain insight on potential customers’ business and market positioning and focus on a solutions-based approach to enhance profitability, market positioning and business performance for customers.

 

We develop relationships with our customers and market our vertically-integrated manufacturing services through our direct marketing and sales teams. Our direct sales teams work closely with the customers' engineering and technical personnel to better understand their requirements. Our marketing team supports our business strategy of providing end-to-end services by encouraging cross selling of vertically-integrated manufacturing services across a broad range of major OEM products. To achieve this objective, our marketing and sales teams work closely with our various manufacturing, design and engineering groups to engage in marketing and sales activities targeted towards key customer opportunities.

 

Our customer-centric focus continues through to the execution phase of our relationships with a dedicated customer focused team-based manufacturing approach throughout all of our facilities. A dedicated account team including a global account manager are directly responsible for managing each of our key customer accounts. Global account managers coordinate activities across geographic locations to effectively satisfy customer requirements and have direct access to our senior management to quickly address customer concerns. Local customer account teams further support the global teams and are linked by a comprehensive communications and information management infrastructure.

 

Our largest customer and 10 largest customers represented 12.8% and 52.8%, 10.9% and 68.1%, and 11.9% and 72.5%, respectively, of our total revenue for the fiscal years ended December 29, 2019, December 30, 2018 and December 31, 2017. We expect to continue to depend upon a relatively small number of customers for a significant percentage of our revenue. In addition to having a relatively limited number of customers, we manufacture a relatively limited number of products for each of our customers. See “Item 1A. Risk Factors—Risks Related to our Business and Strategy—A majority of our revenue comes from a relatively small number of customers. If we lose any of these customers, our revenue could decline significantly.”

 

Global Procurement and Supply Chain Management

 

We deliver supply chain capabilities and solutions that support the total product life cycle. Our teams work closely with customers’ supply-base partners to integrate the entire supply chain. Our extended supply chain model recognizes the need for collaboration between OEM customers, our Company and supply partners to ensure overall supply chain optimization, from product design processes, manufacturing, sourcing, order management and fulfillment to transportation and logistics. The end result is greater control over a complex, extended supply chain to help our customers realize flexibility, cost savings, process improvements, and competitive advantages.

 

In lean manufacturing environments, success is defined by how fast and how effectively manufacturers can respond to evolving customer demands and new global supply chain conditions. We leverage supply chain tools and systems to respond rapidly and effectively to changing real-world conditions. Our customers rely on our core processes and capabilities to drive the success of their supply chains. Each supply chain solution we deliver is tailored to address each customer’s unique requirements.

  

We employ Agile Product Lifecycle Management (“Agile”) solutions software to help OEMs accelerate revenue, reduce costs, improve quality, ensure compliance, and drive innovation throughout the product life cycle. Agile provides comprehensive support for product life cycle business processes, platform and integration requirements. Agile enables a single enterprise view of the product and part records across the entire system, helping customers accelerate new product introduction time, reduce direct material costs and ensure regulatory compliance.

 

The demand management process is a core process at our Company, which drives short- and long-term planning and execution activities. Effective demand management optimizes materials availability, supply-base performance and overall liability management. We recognize the need to deploy people, process and technology, as well as extensive customer communication and visibility, to ensure effective demand management execution. This allows for real-time analysis, feedback and implementation of changes in customer and end-market demand, rapid communication to suppliers of changes in requirements, and a truly responsive end-to-end supply chain.

  

 

We also employ Kinaxis RapidResponse, an integrated response management tool that allows supply chain professionals to access real-time information and enable collaboration across extended supply networks. The tool allows us to perform real-time demand scenario simulation, review supply constraints, perform rapid manufacturing resource planning, clear to build analysis and communicate changes in requirements to suppliers—all on the same day. With Kinaxis RapidResponse, our teams are able to achieve high levels of supply chain agility with immediate response to changes in demand, supply, capacity and daily operations. The platform enables real-time supply chain visibility and on-line collaboration anywhere in the world. In this way, we gain the insight needed to quickly and effectively respond to a wide variety of supply chain challenges.

 

Visibility solutions are customized to support a range of requirements, including inventory visibility, master production schedule simulation, clear-to-build, available-to-promise, end-market demand steering, and service parts management. Kinaxis RapidResponse provides a single view of inventory across all of our facilities as well as a view of materials supply. Custom reports can be automatically emailed within our Company and to our customers on regular intervals. This inventory and supply base liabilities dashboard has proven to be a valuable tool for both our Company and our customers. Visibility solutions include intercompany processes and multi-node supply chains.

 

We have a global commodity manager in Kowloon, Hong Kong who serves to improve access to the broad base of component suppliers in the Asia region and provides us with competitive pricing. The Hong Kong office manages component sourcing to support our global operations.  During 2018, a supply chain center was opened in Phoenix, Arizona.  The Phoenix, Arizona location serves as an office for supply chain staff and other members of management. During the fourth quarter of 2019, various news reports have been published on the new Coronavirus, originating within China and considerations of the impact on the economy or more specifically those companies relying on China for supply chain and or having facilities located there. SMTC’s supply chain and its executive team are actively monitoring the Coronavirus and taking actions to mitigate the financial impact on the Company. This included identifying the key components sourced from China required for first quarter and second quarter 2020 demand and confirming commitments from suppliers of those components and changing lead times accordingly. Please see Our supply chain in China may be materially adversely impacted due to the recent coronavirus outbreak outlined in the risk factors under Item1A below.

  

Our Suppliers

 

Kinaxis RapidResponse works hand-in-hand with custom electronical data interchange (“EDI”), business-to-business process that provides real-time and daily information exchange and transactions with suppliers. Through EDI programs, we have an ongoing view into supplier on-hand inventories and are able to more effectively plan factory capacities and provide customer delivery commitments.

 

With our web-based collaborative planning systems, our customers’ needs are integrated with our suppliers in a more efficient and cost-effective manner than is achievable through traditional EDI. We believe our volume of procurement enhances our ability to obtain better pricing, influence component packaging and design and obtain supply of components in constrained markets.

 

We generally order materials and components under our agreements with customers only to the extent necessary to satisfy existing customer orders or forecasts. We have implemented specific inventory management strategies with certain suppliers via vendor managed inventory programs into our supply chain programs. Fluctuations in material costs typically are passed through to customers. We may agree, upon request from our customers, to temporarily delay shipments, which causes a corresponding delay in our shipments and an increase in inventory, which impacts our working capital management. Ultimately, however, our customers generally are responsible for all materials purchased and goods manufactured on their behalf.

 

 

Our Customers

 

We are a distinctive mid-tier EMS provider, supporting customers in the following market sectors:

 

●

Avionics, aerospace and defense;

●

Industrial, power and clean technology;

●

Medical and safety;

●

Retail and payment systems;

●

Semiconductors;

●

Telecom, networking and communications; and

●

Test and measurement.

  

Revenue in 2019 was attributed to the following industry sectors: 31.8% from test and measurement, 20.8% from industrial, power and clean technology, 12.4% from retail and payment systems, 12.2% from medical and safety, 10.0% from telecom, networking and communications, , 6.6% from avionics, aerospace and defense, and 6.2% from semiconductors.

 

Our Competition

 

The EMS industry is composed of numerous companies that provide a range of manufacturing services for OEMs, including PCBA, to design, prototyping, final system assembly, configuration, order fulfillment, repair and aftermarket services. The EMS market consists of contract manufacturers (“CMs”), and original design manufacturers (“ODMs”). CMs manufacture products that have been designed by the OEM; ODMs may also design their own products, primarily commodities, and in many instances are in direct competition with the OEMs. We participate in the mid-sized CM sector.

 

CM providers fall within one of four tiers:

 

Large/Tier 1: Global operations with manufacturing facilities in North America, Europe and Asia, and low-cost manufacturing sites in Asia, Mexico and Eastern Europe. Large CMs annual revenues generally are greater than $2.0 billion. This includes Celestica Inc., Flextronics International Ltd., Jabil Circuit, Inc., Sanmina, Inc., Benchmark Electronics Inc. and Plexus Corp.

 

Mid-size/Tier 2: Usually focused in one region such as North America, Europe or Asia, with facilities in that region supported by additional facilities in low-cost regions. Mid-sized CMs generally have annual revenues of up to $2.0 billion. This includes Key Tronic Corp.

 

Regional /Tier 3: Usually focused in North America and typically with minimum operations in low-cost geographic regions and less than $300 million in annual revenues. This includes IEC and Sigmatron.

 

Small/Tier 4: Usually single facility operations, with annual revenues less than $20 million.

 

We compete with different companies depending on the type of service we are providing and/or the geographic area in which an activity takes place. Some of our competitors may have greater scale and provide a broader range of services than we offer. We believe that the principal competitive factors in the manufacturing services market are quality and range of services, design and technological capabilities, cost, location of facilities, responsiveness and flexibility. To remain competitive, we believe we must continue to provide technologically advanced manufacturing services and solutions, maintain quality levels, offer flexible delivery schedules, deliver finished products and services on time and compete favorably on price.  

  

Environmental and Social Commitment

 

Our commitment is to conduct our business in such a way that protects and preserves the environment, health and safety of our employees, our customers and the communities where we live and operate. Our commitment to this responsibility includes compliance to the European Directives: Waste Electronic and Electrical Equipment, Restriction of Hazardous Substances, as well as assisting customers with conflict minerals and complying with the human trafficking resolutions passed in the California Transparency in Supply Chains Act of 2010. Our commitment goes beyond merely compliance. For example, our MCA Acquisition reduced its annual water consumption by more than 74 percent by investing in the implementation of a Closed Loop Process Water Recycling System at our Melbourne manufacturing facility.

 

 

Our Structure and Our History

 

We were established in Toronto, Canada in 1985. We are a Delaware Corporation incorporated in July 1998. Our present corporate structure resulted from the July 1999 combination of predecessor companies Surface Mount Technology Centre Inc., an Ontario, Canada corporation (“Surface Mount”) and HTM Holdings Inc., a Delaware corporation (“HTM”). Subsequent to the combination, all of Surface Mount’s operating subsidiaries, other than SMTC Canada and Qualtron, Inc., became subsidiaries of HTM. In 2011, we expanded our operations in San Jose, California with the acquisition of ZF Array Technology, Inc. , a privately held electronics manufacturing services provider. In 2012, the Asian entities of SMTC Electronics Dongguan Company Limited and SMTC Electronics (Suzhou) Company Limited were established. Our SMTC Electronics (Suzhou) Company Limited, China facility was closed in accordance with the restructuring plan as announced on May 15, 2017. The closure of the SMTC Electronics (Suzhou) Company Limited, China facility was substantially completed by the end of 2017. In November 2018 we also acquired MCA, a privately held electronics manufacturing services provider. During the fourth quarter of 2019 we announced a decision to cease manufacturing at SMTC Electronics Dongguan Company Limited and relocate the equipment used at our Chinese manufacturing facility to our other North American sites. The closure of the SMTC Electronics Dongguan Company Limited, China facility is expected to be substantially completed by the end of the first quarter of 2020.

 

Our Leadership Team

 

In May 2017 Ed Smith was appointed as our Company’s President and Chief Executive Officer. Mr. Smith’s EMS career spans over three decades and has served as President of AVNET Inc., a multibillion-dollar electronic components distributor, and as President and Chief Executive Officer at SMTEK International Inc., a Tier III EMS manufacture. Following Mr. Smith’s appointment, we added several experienced leaders to our senior management team with strong industry backgrounds, including previous success in building businesses together as a team.

 

Order Backlog

 

Our order backlog is typically a combination of purchase orders and forecasts. Our customers typically provide purchase orders for delivery of products due within 30 to 90 days. We are also provided additional demand beyond 90 days to drive material demand and perform resources and capacity planning. Furthermore, backlog as of a particular date is affected by a number of other factors, including manufacturing schedules and the timing of product shipments. Backlog also is affected by the timing of customers’ orders and product availability. Due to these factors and business model differences around the globe and since additional orders may be added, or orders rescheduled or cancelled, we do not believe that the order backlog of expected product sales covered only by purchase orders is a meaningful measure of future sales and we believe backlog is an imprecise indicator of future revenues that may be achieved in a fiscal period and cannot be relied upon.

 

Employees

 

As of December 29, 2019, we had 2,805 employees of which 2,546 were full time and contract employees. In addition, we employ varying levels of temporary employees as our production demands. Given the variable nature of our project flow and the quick response time required by our customers, it is critical that we are able to quickly adjust our production levels to maximize efficiency. To achieve this, our strategy has been to employ a skilled temporary labor force, as required. We use outside contractors to qualify our temporary employees on a site-by-site basis. Our production level temporary employees are compensated by the hour. We believe we are team-oriented, dynamic and results-oriented with an emphasis on customer service and quality at all levels. We believe this environment is a critical factor for us to be able to fully utilize the intellectual capital of our employees. Because of the surplus of available talent on the market, and the strength of our total compensation packages, to date we have not experienced any issues attracting skilled employees.

 

As of December 29, 2019, our only unionized employees were at our Chihuahua, Mexico facility, representing approximately 37% of our Mexican labor force. We have never experienced a work stoppage or strike and believe we have good employee relations.  

 

Additional Information

 

We are subject to the reporting requirements under the Exchange Act. Consequently, we are required to file reports and information with the Securities and Exchange Commission (the “SEC”), including reports on the following forms: Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports and other information concerning us may be accessed, free of charge, through the SEC’s website at www.sec.gov and on our corporate website address at www.smtc.com. We make such filings available through our corporate website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Reference to our website is for informational purposes only and the information contained in, or that can be accessed through, our website is not incorporated by reference into this Form 10-K. 

 

 

Item 1A.

Risk Factors

 

RISKS RELATED TO OUR BUSINESS AND INDUSTRY

 

A majority of our revenue comes from a relatively small number of customers. If we lose any of these customers, our revenue could decline significantly.

 

We operate in a highly competitive and dynamic marketplace in which current and prospective customers often seek to lower their costs through a competitive bidding process among EMS providers. This creates an opportunity to increase revenue to the extent we are successful in the bidding process, but there is also the potential for revenue to significantly decline to the extent we are unsuccessful in the competitive bidding process. Furthermore, even if we are successful, there is the potential for our margins to decrease if we are required to lower our prices in order to win such bids.

 

Our largest customer and 10 largest customers represented 12.8% and 52.8%, 10.9% and 68.1%, and 11.9% and 72.5%, respectively, of our total revenue for the fiscal years ended December 29, 2019, December 30, 2018 and December 31, 2017. We expect to continue to depend upon a relatively small number of customers for a significant percentage of our revenue. In addition to having a relatively limited number of customers, we manufacture a relatively limited number of products for each of our customers. If we lose any of our largest customers (as we have in the past from time to time), experience a significant reduction in sales to any such customers or no longer manufacture a particular product line for one of our largest customers, we would experience a significant reduction in our revenue. Further, we make no assurance that our largest customers will continue to have us manufacture their products from us at current or historical levels. Moreover, we typically do not enter into long-term volume purchase contracts with our customers, and our customers have certain rights to extend or delay the shipment of their orders. We, however, typically require that our customers contractually agree to buy back inventory purchased within specified lead times to build their products if not used. See also “Our customers may cancel their orders, change production quantities or locations, or delay production, and the inherent difficulties involved in responding to these demands could harm our business.” In addition, because of the concentration in our customer base, we have significant amounts of trade accounts receivable from some of our customers and the insolvency of one or more of our largest customers or the inability of one or more of our largest customers to pay for its orders would decrease our revenue significantly. A reduction in revenue could decrease our profitability, cash flow and adversely affect our business, financial condition and results of operations.

 

Furthermore, the success of our business depends, in part, on the continued growth and financial stability of our customers, including, in particular, our largest customers. Adverse changes in the end markets these customers serve could reduce demand from our customers in those markets and/or cause customers in such end markets to be more price sensitive, which could cause us to lose sales or require us to lower prices and thereby suffer a decrease in our margins. Further, mergers, acquisitions, restructuring or other consolidations among our customers, or their end customers, could intensify our customer concentration or reduce total demand as the combined entities reevaluate their business and consolidate their suppliers, which could materially and adversely affect our business. In the event of consolidation among our customers, depending on which of the entities involved in the consolidation controls the combined company’s supply chain function following the consolidation, we may not be retained as a preferred or approved manufacturer. In addition, product duplication could result in the termination of a product line that we currently manufacture. While there is also the potential to increase our sales to the combined customer, our revenues could decrease if we are not retained as a continuing supplier. Even if we are retained as a supplier, we may face the risk of increased pricing pressure from the combined customer because of its increased market share and purchasing power.

 

As a manufacturer, we are particularly exposed to general economic conditions, which could have an adverse impact on our business, operating results and financial condition.

 

As a result of unfavorable economic conditions, reduced capital spending and changes in our customers’ manufacturing requirements, our revenues could experience significant declines in the future. If general economic conditions deteriorate, including the onset of a global economic recession, other uncertainty in the global economy such as unstable global financial and credit markets or increased inflation and tariffs, we may experience an adverse impact on our business, operating results and financial condition, since end customer demand for our customers’ products could be adversely affected. Due to the current uncertainty surrounding the economy and our ability to predict the effect such conditions will have on its customers, we cannot predict the scope or magnitude of the negative effect that any economic slowdown may have on our business. Further, economic and financial market conditions that adversely affect our customers may cause them to terminate or delay existing purchase orders or to reduce the volume of products they purchase from us in the future. We may have significant accounts receivable outstanding from customers, including our largest customers, that operate in cyclical industries and under leveraged conditions, which could impair their ability to pay amounts owed to us on a timely basis. Our failure to collect a significant portion of those receivables could have a material adverse effect on our results of operations and financial condition. See “—A majority of our revenue comes from a relatively small number of customers. If we lose any of these customers, our revenue could decline significantly.”

 

Similarly, adverse changes in credit terms extended to us by our suppliers, such as shortening the required payment period for outstanding accounts payable or reducing the maximum amount of trade credit extended to us, could negatively and significantly affect our liquidity and thereby have a material adverse effect on our results of operations and financial condition.

 

If we are unable to successfully anticipate changing economic and financial market conditions, we may be unable to effectively plan for, and respond to, those changes, which could have a material adverse effect on our business, operating results and financial condition.

 

 

Our supply chain in China may be materially adversely impacted due to the recent coronavirus outbreak.

 

In December 2019, a novel strain of coronavirus began to impact the population of Wuhan, China. We rely upon the facilities of our suppliers in China to support our business as well as to export components throughout the world. As of December 29, 2019, we sourced components from approximately 137 suppliers located throughout China and approximately 40% of the components in our global supply chain were sourced from our suppliers in China during the year ended December 29, 2019. The outbreak has resulted in significant governmental measures being implemented to control the spread of the virus, including, among others, restrictions on manufacturing and the movement of employees in many regions of the country. As a result of the coronavirus and the measures designed to contain the spread of the virus, our suppliers may not have the materials, capacity, or capability to supply our components according to our schedule and specifications. Any reduction in production capacity or supply capacity at factories in China may reduce or even halt the supply of finished goods and necessary components for many of our customers’ products, which could result in product shortages and an increase in our inventory of unfinished products. Further, there may be logistics issues, including our ability and our supply chain’s ability to quickly ramp up production, and transportation demands that may cause further delays. If our suppliers’ operations are curtailed, we may need to seek alternate sources of supply, which may be more expensive. Alternate sources may not be available or may result in delays in shipments to us from our supply chain and subsequently to our customers, each of which would affect our results of operations. While the disruptions and restrictions on the ability to travel, quarantines, and temporary closures of the facilities of our suppliers, as well as general limitations on movement in the region are expected to be temporary, the duration of the production and supply chain disruption, and related financial impact, cannot be estimated at this time. Should the production and distribution closures continue for an extended period of time, the impact on our supply chain in China and globally could have a material adverse effect on our results of operations and cash flows. See “-We depend on a limited number of suppliers for components that are critical to our manufacturing processes and shortages or price fluctuations of component parts specified by our customers could delay product shipment and affect our profitability.” The coronavirus outbreak could also delay our release or delivery of our or our customers’ new or product offerings or require us or our customers to make unexpected changes to such offerings, which may materially adversely affect our business and operating results.  Our operating results could also continue to be adversely affected to the extent that the coronavirus outbreak harms the Chinese economy in general. In addition, the coronavirus outbreak could evolve into a worldwide health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our products and our customers’ products and materially adversely affect our business, operating results, and financial condition.

 

We are exposed to fluctuations in currencies against the U.S. dollar, which could have a material adverse effect on our business and financial results.

 

As a global company, we have significant costs, primarily payroll denominated in currencies other than the U.S. dollar. Most of our sales and component purchases are denominated in U.S. dollars. Our Canadian, Mexican and Asian payroll, Euro based component purchases and other various expenses are denominated in local currencies. A decrease in the value of foreign currencies relative to the U.S. dollar could result in lower revenues, product price pressures, and increased losses from currency exchange rates. As a result, we may enter into forward foreign exchange contracts to reduce our exposure to foreign exchange currency rate fluctuations related to the forecasted Canadian dollar and Mexican peso. We have decided at this time not to hedge exposure due to foreign exchange currency related to EURO components purchases or Asian payroll. To the extent we are not able to effectively manage this exposure to foreign exchange rate fluctuations, our revenues and profitability could be adversely affected.

 

Our industry is very competitive and we may not be successful if we fail to compete effectively.

 

The EMS industry is highly competitive. We compete against numerous large domestic and foreign EMS providers but consider our peer group and direct competitors to be IEC Electronics Corp., Key Tronic Corp., Nortech Systems Inc., Sigmatron International Inc., and Sypris Solutions Inc. We may in the future encounter competition from additional large electronics manufacturers that are selling, or may begin to sell, electronics manufacturing services. Some of our competitors have substantially greater manufacturing, financial, research and development and marketing resources and lower cost structures than us. We also face competition from the manufacturing operations of current and potential customers, which are continually evaluating the merits of manufacturing products internally compared to the advantages of using external manufacturers such as us.

 

 

Furthermore, larger EMS providers who have greater direct buying power from component suppliers, distributors and raw material suppliers or who have lower cost structures as a result of their geographic location may operate more efficiently than us. As a result, other EMS providers with significant purchasing and marketing power may have a competitive advantage over us. Our manufacturing processes are generally not subject to meaningful proprietary protection, and companies with greater resources, financial or otherwise, or a greater market presence may enter our market or increase their competition with us. As a result, our competitors could copy our non-proprietary designs and processes after we have invested in development of products for customers, which could allow those competitors to offer customers lower prices on such products. We also expect that our competitors will continue to improve the performance of their current products or services, to reduce the prices of their products or services and to introduce new products or services that may offer greater performance and lower prices. Any of the foregoing could cause our sales to decline, a decrease in our profit margin or a loss of market share.

 

In addition, increased pressure to limit U.S. defense spending and changes in the U.S. government procurement environment may limit certain future market opportunities for us. For example, the U.S. Department of Defense (the “DoD”) increasingly is committed to awarding contracts through competitive bidding and relying on competitive contract award types. See “—Our financial results depend, in part, on our ability to perform on our U.S. government contracts, and changes in government defense spending and priorities could have consequences on our financial position, results of operations and business.”

 

If we are unable to continue to compete successfully against our current or future competitors in our core markets, we may experience declines in revenues and market share which could negatively impact our results of operations, financial condition or liquidity.

 

We experience variability in our operating results, which could increase the volatility of the price of our common stock.

 

Our annual and quarterly results have fluctuated in the past. The reasons for these fluctuations may similarly impact our business in the future. You should not rely solely on our results of operations in any past period to indicate what our results will be for any future period. Our operating results may fluctuate in the future as a result of many factors, including, but not limited to:

 

	•	variations in the timing and volume of customer orders relative to our manufacturing capacity;
	•	introduction and market acceptance of our customers’ new products;
	•	changes in demand or market acceptance for our customers’ existing or new products;
	•	the accuracy of our customers’ forecasts of future production requirements;
	•	changes in customers and customer or product attrition;
	•	effectiveness in managing our manufacturing processes, inventory levels and costs;
	•	our level of experience in manufacturing a particular product;
	•	changes in competitive and economic conditions generally or in our customers’ end markets;
	•	price competition;
	•	natural disasters that may impede our operations, the operation of our customers’ business, or availability of manufacturing inputs from our suppliers;
	•	failure or external breach of our information technology systems;
	•	willingness of suppliers to supply the Company on normal credit terms; and
	•	changes in the cost, or availability, of components or skilled labor.

 

In addition, most of our customers typically do not commit to firm production schedules more than 30 to 90 days in advance. Accordingly, it is difficult for us to forecast the level of customer orders with certainty. As a result, we may not be able to schedule production to maximize utilization of our manufacturing capacity. In the past, we have been required to increase staffing, purchase materials and incur other expenses to meet the demand of our customers. Sometimes anticipated orders from customers have failed to materialize and, at times, delivery schedules have been deferred as a result of changes in a customer’s needs. Any material delay, cancellation or reduction of orders from our larger customers could cause our revenue to decline. In addition, a reduction in customer demand may decrease our gross margins and adversely affect our business, financial condition and results of operations. On other occasions, customers have required rapid and unexpected increases in production, which have placed burdens on our manufacturing capacity and supply chain function and adversely affected costs. See “—If we are unable to maintain satisfactory utilization rates at our manufacturing factories, our results of operations and financial condition would be adversely affected.”

 

The EMS industry is affected by the United States and global economies, both of which are influenced by world events. An economic slowdown, particularly in the industries we serve, may result in our customers reducing their forecasts or delaying orders. The demand for our services could weaken, which in turn could substantially influence our sales, capacity utilization, margins and financial results. Results for any one quarter or year are not necessarily indicative of results to be expected for any other quarter or for any year. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price.

 

Any of these factors or a combination of these factors could have an adverse impact on our business, financial condition and results of operations.

 

 

We are dependent upon the industry sectors we service, which produce electronic products that are technologically advanced with short life cycles, and our business could be negatively impacted by economic slowdowns in these sectors.

 

Most of our customers develop technologically advanced electronic products, which are characterized by intense competition, short product life cycles and significant fluctuations in product demand. In addition, these products are generally subject to rapid technological change and product obsolescence. If our customers are unable to create products that keep pace with the changing technological environment, their products could become obsolete and, in turn, the demand for our manufacturing services could significantly decline. Our success is largely dependent on the success achieved by our customers in developing and marketing their products. Furthermore, the electronics industry is subject to economic cycles and has, in the past, experienced downturns. A decline in the industry demand for these products would likely have an adverse impact on our business, financial condition and results of operations.  

 

We make no assurance that our customers will continue to buy products from us at current levels, that we will retain any or all of our existing customers or that we will be able to form new relationships with customers upon the loss of one or more of our existing customers in this market. Any material reduction in sales, consolidation or slowdowns in the industry sectors we service could have a negative impact on our business and financial results.

 

Consolidation in the industry sectors in which we operate in may adversely affect our business by increasing customer buying power or increasing competition.

 

Consolidation in the industry sectors in which we operate among our competitors, our customers, or both, may strengthen existing, large electronics companies or result in the formation of new large electronics companies. The significant buying and market power of these companies may increase competitive pressures on us, which could negatively impact our margins. In addition, if any of our large customers are acquired or merged, we may lose that customer’s business, which would cause our sales to decline and would likely have a material adverse impact on our business, financial condition and results of operations.

 

We depend on a limited number of suppliers for components that are critical to our manufacturing processes and shortages or price fluctuations of component parts specified by our customers could delay product shipment and affect our profitability.

 

A substantial portion of our revenue is derived from turnkey manufacturing. In turnkey manufacturing, we provide both the materials and the manufacturing services. If we fail to manage our inventory effectively, we may bear the risk of fluctuations in materials costs, scrap and excess inventory, all of which can have an adverse impact on our business, financial condition and results of operations. In addition, delays, cancellations or reductions of orders by our customers could result in an excess of materials. Orders received from customers within component lead time, rapid increases in orders or lengthening of lead times by suppliers could cause a shortage of materials. A shortage of materials could lengthen production schedules and increase costs. An excess of materials may increase the costs of maintaining inventory and may increase the risk of inventory obsolescence, both of which may increase expenses and decrease profit margins and operating income.

  

Many of the products we manufacture require one or more components that we order from sole-source suppliers. Supply shortages for a particular component can delay production of all products using that component or cause cost increases in the services we provide. In addition, in the past, some of the materials we use, such as memory and logic devices, have been subject to industry-wide shortages. At such times, suppliers allocate available quantities among their customers, and we have not been able to obtain all of the materials required. Our inability to obtain these materials could slow production or assembly, delay shipments to our customers, increase costs and reduce operating income. Also, we may bear the risk of periodic component price increases, which if we are not able to recover from our customers, could reduce our operating income. In addition, we rely on a variety of common carriers for materials transportation, and we route materials through various world ports. A work stoppage, strike or shutdown of a major port or airport could result in manufacturing and shipping delays or expediting charges, which could have an adverse impact on our business, financial condition and results of operations.

 

 

We may encounter difficulties with acquisitions, including the risks associated with the integration of acquired businesses, such as MC Assembly, and divestitures, which could harm our business.

 

We have completed acquisitions of businesses in the past and we may acquire additional businesses in the future. Any future acquisitions may require additional equity financing, which could be dilutive to our existing shareholders, or additional debt financing, which could increase our leverage and potentially affect our credit ratings. Any downgrades in our credit ratings associated with an acquisition could adversely affect our ability to borrow by resulting in more restrictive borrowing terms. As a result of the foregoing, we also may not be able to complete acquisitions or strategic customer transactions in the future to the same extent as in the past, or at all.

 

To integrate acquired businesses, such as MCA, we must implement our management information systems, operating systems and internal controls, and assimilate and manage the personnel of the acquired operations. The difficulties of this integration may be further complicated by geographic distances. The integration of acquired businesses may not be successful and could result in disruption to other parts of our business. In addition, the integration of acquired businesses may require that we incur significant restructuring charges.

 

Uncertainty about integrations, such as MCA, may affect the relationship between us and our employees, clients and suppliers, which may have an adverse effect on our business, financial condition and results of operations. These uncertainties may cause clients, suppliers and others that deal with us to seek to change existing business relationships and to delay or defer decisions concerning us. Changes to existing business relationships, including termination or modification, could negatively affect our revenues, earnings and cash flow, as well as the market price of our common stock.

 

In addition, we are dependent on the experience and industry knowledge of our officers, key management personnel and other key employees to operate our business and execute our business plans. Our current and prospective employees may experience uncertainty about their roles following integrations, such as MCA, which may have an adverse effect on our ability to attract or retain key management personnel and other key employees. Our business could be negatively impacted if key employees depart because of issues related to the uncertainty and difficulty of integration.

 

Acquisitions involve numerous other risks and challenges, including:

 

	●	diversion of management's attention from the normal operation of our business;
	●	difficulties in achieving target cost synergies of the new combined company;
	●	failure to implement our business plan for the combined business;

●

potential loss of key employees and customers of the acquired companies;

●

difficulties managing and integrating operations in geographically dispersed locations;

●

the potential for deficiencies in internal controls at acquired companies;

●

increases in our expenses and working capital requirements, which reduce our return on invested capital;

●

lack of experience operating in the geographic market or industry sector of the acquired business;

●

cybersecurity and compliance related issues;

●

initial dependence on unfamiliar supply chain or relatively small supply chain partners; and

●

exposure to unanticipated liabilities of acquired companies.

 

Furthermore, we may not be able to maintain the levels of revenue, earnings or operating efficiency that each of us and the acquired business had achieved or might achieve separately. The markets in which the acquired business operates may not experience the growth rates expected and any economic downturn affecting those markets could negatively impact such business. If the acquired business or the markets in which it operates deteriorate, the potential cost savings, growth opportunities and other synergies of the acquisition may not be realized fully, or at all, or may take longer to realize than expected. In such case, our business, financial condition, results of operations and cash flows may be negatively impacted.

 

Divestitures involve significant risks, including without limitation, difficulty finding financially sufficient buyers or selling on acceptable terms in a timely manner, and the agreed-upon terms could be renegotiated due to changes in business or market conditions. Divestitures could adversely affect our profitability and, under certain circumstances, require us to record impairment charges or a loss as a result of the transaction. In addition, completing divestitures requires expenses and management attention and could leave us with certain continuing liabilities.

 

These and other factors have harmed, and in the future could harm, our ability to achieve anticipated levels of profitability at acquired operations or realize other anticipated benefits of an acquisition or divestiture, and could adversely affect our business and operating results. 

   

 

If we are unable to respond to rapidly changing technology and process development, we may not be able to compete effectively.

 

The market for our services is characterized by rapidly changing technology and continuing process development. The future success of our business will depend in large part upon our ability to hire and retain qualified engineering and technical personnel, maintain and enhance our technological capabilities, to develop and market manufacturing services that meet changing customer needs, and to successfully anticipate or respond to technological changes on a cost-effective and timely basis. In addition, the EMS industry could encounter competition from new or revised technologies in the future that render existing technology less competitive or obsolete or that reduce the demand for our services. We may not be able to effectively respond to the technological requirements of the changing market. To the extent we determine that new technologies and equipment are required to remain competitive, the development, acquisition and implementation of such technologies and equipment may require us to make significant capital investments. We may not be able to access capital for these purposes in the future and investments in new technologies may not result in commercially viable technological processes.  

 

Disruptions to our information technology systems, including cyber security incidents, losses of data or outages, could have a material adverse effect on our business, operations and financial results.

 

We rely on information technology networks and systems to process, transmit and store information related to our business. In particular, we depend on our information technology systems for a variety of functions, including, but not limited to, financial reporting, inventory management, procurement, invoicing and email. We also have access to, and we create and store, sensitive data, including intellectual property, our proprietary business information and that of our customers, and personally identifiable information of our employees. Any of the foregoing may be susceptible to outages due to fire, floods, power loss, telecommunications failures, terrorist attacks, attacks by hackers or breaches due to employee error, malfeasance or other disruptions, and similar events. Despite the implementation of network security measures, our systems and those of third parties on which we rely may also be vulnerable to computer viruses, break-ins and similar disruptions. Such events could make it difficult to manufacture or deliver products to our customers due to our reliance on our systems in the day to day operations of our business. While we maintain security and back-up procedures to business recovery plans that are intended to allow us to recover from natural disasters or other events that can be disruptive to our business, some of our systems are not fully redundant and we cannot be sure that our plans will fully protect us from all such disruptions. Any security breaches could compromise our networks and the information stored on them could be improperly accessed, disclosed, lost or stolen. Any such access, disclosure or other loss of information could disrupt our operations and the services we provide to customers, damage our reputation or our relationships with our customers or result in legal claims or proceedings, any of which could adversely affect our business, financial condition, revenues and competitive position.

 

If the products we manufacture are defective, demand for our services may decline and we may be exposed to product liability and product warranty claims.

 

Defects in the products we manufacture, whether caused by, among other things, a design, engineering, manufacturing or component failure or deficiencies in our manufacturing processes, could result in product or component failures, which may damage our business reputation and expose us to product liability or product warranty claims.

 

If a product or component we manufacture is found to cause any personal injury or property damage or is otherwise found to be defective, we could incur significant expenditures to resolve any potential claims resulting from such damages or defects. In addition, any such claim could hurt our reputation or position in the marketplace, which could result in the loss of existing customers or affect our ability to attract new customers. A successful product liability or product warranty claim against us could have a material adverse effect on our business, financial condition and results of operations.

 

Although, generally, liability for these claims in our contracts rest with our customers, our customers may or may not have the resources to satisfy claims for costs or liabilities arising from a defective product or component for which they have assumed responsibility or they may be otherwise unwilling or unable to assume responsibility.

   

We depend on our key personnel and skilled employees and our business could suffer if we are unable to attract and retain key personnel and skilled employees.

 

Our business depends, in part, on our ability to continue to recruit, train and retain skilled employees, particularly executive management, engineering and sales personnel. Recruiting personnel in our industry is highly competitive. Our ability to successfully implement our business plan depends in part on our ability to attract and retain management and existing employees. There can be no assurance that we will be able to attract and retain, now or in the future, executive officers and other key personnel. In addition, if we receive a significant volume of new orders at any one time, we may have difficulty recruiting skilled workers to respond to such orders and accordingly may experience delays that could adversely affect our ability to meet customers’ delivery schedules, which may impact those customers’ decisions to place future orders with us.

 

 

Risks particular to our international manufacturing operations and our operations as a global company could each adversely affect our overall results.

 

Our international manufacturing operations are subject to inherent risks, including:

 

	•	fluctuations in the value of currencies and high levels of inflation;
	•	longer payment cycles relative to the U.S. and greater difficulty in collecting amounts receivable;
	•	reduced credit and payment terms with vendors;
	•	unexpected changes in and the burdens and costs of compliance with a variety of foreign laws;
	•	difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;
	•	political and economic instability;
	•	terrorism or war, which can interrupt commerce;
	•	increases in duties, trade restrictions, tariffs, import and export controls, taxation and other non-tariff barriers such as quotas and local content rules;
	•	delays associated with the manufacture, transportation and delivery of products;
	•	increased transportation costs due to distance, energy prices, or other factors
	•	delays in the transportation and delivery of goods due to increased security concerns;
	•	restrictions and potential penalties due to privacy laws, on the handling and transfer of consumer and other personal information;
	•	potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, business partners or agents, despite our policies and procedures relating to compliance with these laws;
	•	expropriation and nationalization;
	•	difficulties in managing foreign operations effectively and efficiently from the U.S.;
	•	changes in international trade agreements and governmental policies and regulations;
	•	imposition of restrictions on currency conversion or the transfer of funds; and
	•	increased accounting and internal control costs.

 

In fiscal years 2019, 2018 and 2017, 68.4%, 84.4% and 84.9%, respectively, of our revenue was earned from products that we manufactured internationally (outside of the U.S.). As of the end of fiscal years 2019 and 2018, 47.1% and 46.9%, respectively, of our total consolidated assets were located internationally (outside of the U.S.). Changes to laws, regulations or trade agreements in relation to Mexico could have an adverse impact on our business, financial condition and results of operations.

 

In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. We make no assurance that there will not be a control failure around customs enforcement despite the precautions we take. We are currently subject to audits by customs authorities. Any failure to comply with customs laws and regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines and penalties, which could have an adverse effect on our business and financial results. In addition, changes to U.S. trade laws may adversely impact our operations. These changes and any changes to the trade laws of other countries may add additional compliance costs and obligations and subject us to significant fines and penalties for non-compliance. Compliance with these and other foreign legal regimes may have a material adverse impact on our business and results of operations.

 

Finally, as a global company, we are subject to foreign and U.S. laws and regulations designed to combat governmental corruption, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries and a materially negative effect on our brand and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these foreign and U.S. laws and regulations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, there can be no assurance that our employees, business partners or agents will not violate our policies.

 

 

We are subject to a variety of governmental regulations related to the environment, health and safety and defense and our failure to comply with such current and future governmental regulations could have a material adverse affect on our business, financial condition and results of operations.

 

As a result of our use of metals and other hazardous materials in our manufacturing processes, our operations are regulated under a number of federal, state, provincial, local and foreign environmental and safety laws and regulations which govern, among other things, the discharge of hazardous materials into the air and water as well as the handling, storage and disposal of such materials. In addition, we are subject to a variety of U.S. government regulations related to the export and import of defense-related articles and services, as well as federal, state and local regulatory requirements relating to employee occupational health and safety. To date, the cost to us of such compliance has not had a material impact on our business, financial condition or results of operations. However, violations may occur in the future as a result of human error, equipment failure or other causes within and outside of our control. We may be liable under environmental laws for the cost of cleaning up properties we own or operate if they are, or become, contaminated by the release of hazardous materials, regardless of whether we caused such release. In addition, we may be liable for costs associated with an investigation and remediation of sites at which we have arranged for the disposal of hazardous wastes if such sites become contaminated, even if we fully comply with applicable environmental laws. In the event of a contamination or violation of environmental laws, we could be held liable for damages, including fines, penalties and the costs of remedial actions and could also be subject to revocation of our discharge permits. Any such revocations could require us to cease or limit production at one or more of our facilities, thereby having an adverse effect on our operations. In addition, environmental laws could also become more stringent over time, which would impose greater compliance costs and increase the risks and penalties associated with any violation, which could have an adverse effect on our business, financial condition and results of operations. We also cannot predict the nature, scope or effect of environmental legislation or regulatory requirements that could be imposed in the future, or how existing or future laws or regulations will be administered or interpreted. Finally, any such current or future regulations could restrict our ability to expand our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to in order to attempt to comply with such regulations. 

 

Our customers may cancel their orders, change production quantities or locations, or delay production, and the inherent difficulties involved in responding to these demands could harm our business.

 

Our industry must provide increasingly rapid product turnaround for its customers. We generally do not obtain firm, long-term purchase commitments from our customers and we continue to experience reduced lead-times in customer orders. Customers may cancel their orders, change production quantities, delay production or change their sourcing strategy for a number of reasons. Such changes, delays and cancellations may lead to our production and possession of excess or obsolete inventory, which we may not be able to sell to the customer or a third party. The success of our customers’ products in the market affects our business. Cancellations, reductions, delays or changes in sourcing strategy by a significant customer or by a group of customers could negatively impact our operating results by reducing the number of products that we sell, delaying the payment to us for inventory that we purchased and reducing the use of our manufacturing facilities, which have associated fixed costs not dependent on our level of revenue.

 

In addition, we make significant decisions, including determining the levels of business that we will seek and accept, production schedules, component procurement commitments, personnel needs and other resource requirements, based on our estimate of customer requirements. The short-term nature of our customers’ commitments and the possibility of rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers. Our inability to forecast the level of customer orders with certainty can make it difficult to schedule production and maximize utilization of manufacturing capacity and manage inventory levels.

  

On occasion, customers may require rapid increases in production, which can stress our resources and reduce operating margins. In addition, because many of our costs and operating expenses are relatively fixed, a reduction in customer demand can harm our gross profits and operating results. See “Our supply chain in China may be materially adversely impacted due to the recent coronavirus outbreak”, while our customers have not reduced or materially adjusted demand as a result of the Coronavirus outbreak, we have increased risk of servicing customer component demands with our supply chain in China, as a result of the Coronavirus outbreak.

  

We structure our agreements with customers to mitigate our risks related to obsolete or unsold inventory. However, enforcement of these contracts may result in material expense and delay in payment for inventory. If any of our significant customers become unable or unwilling to purchase such inventory, our business may be materially harmed. 

 

 

If we are unable to maintain satisfactory utilization rates at our manufacturing factories, our results of operations and financial condition would be adversely affected. 

 

Given the high fixed costs of our operations, decreases in utilization rates at our manufacturing facilities could have a material adverse effect on our business. Accordingly, our ability to maintain or enhance our margins continues to depend, in part, on maintaining satisfactory utilization rates. In turn, our ability to maintain satisfactory utilization depends on the demand for our products, the volume of orders we receive, and our ability to offer products that meet our customers’ requirements at attractive prices. If current or future production capacity fails to match current or future customer demands, our facilities would be underutilized, our sales may not fully cover our high fixed overhead expenses, and we would be less likely to achieve our anticipated gross margins. Furthermore, if the forecasts and assumptions used to support the implied fair value of goodwill or recoverability of our long-lived assets including intangible assets change, we may incur significant impairment charges, which would adversely affect our results of operations and financial condition, as we have experienced.

 

In addition, we generally schedule our production facilities at less than full capacity to retain our ability to respond to unexpected additional quick-turn orders. However, if these orders are not received, we may forego some production and could experience continued excess capacity. If we conclude that we have significant, long-term excess capacity, we may decide to permanently close one or more of our facilities and terminate some of our employees. See “—We experience variability in our operating results, which could negatively impact the price of our shares.” Facility closures or employee terminations could result in our recording restructuring charges such as severance and other exit costs, and asset impairments. See “—Our restructuring activities will increase our expenses, may not be successful, and may adversely impact employee hiring and retention. Also, we have incurred other substantial restructuring charges in the past and we may continue to in the future.”

 

Any restructuring activities will increase our expenses, may not be successful, and may adversely impact employee hiring and retention. Also, we have incurred other substantial restructuring charges in the past and we may continue to in the future.

 

In September 2019, we announced our plans to close our Chinese manufacturing operation when our current Dongguan, China facility lease expired in December 2019, and extended to February 2020 as approved by our Board of Directors. The closure of the Dongguan manufacturing facility is intended to reduce the labor force, which impacted approximately 137 employees at the Dongguan manufacturing facility. The closure of the Dongguan facility will reduce forecasted losses that would have otherwise been incurred in fiscal year 2020 as the Dongguan facility was not expected to be fully utilized. We expect the wind down and closure of the Dongguan facility will be substantially completed by the end of the first quarter of 2020, however there are still some continued deregistration and filing requirements to be made in 2020. Manufacturing of certain products previously manufactured at the Dongguan manufacturing facility were substantially transferred to our other manufacturing facilities.

 

As a result of the foregoing actions, we incurred corporate restructuring costs totaling approximately $5.0 million in 2019. These restructuring costs adversely impacted our results of operations during 2019. Additionally, the amount of the restructuring expenses we expect to incur in 2020, as well as our ability to achieve the anticipated benefits of our restructuring activities, are subject to assumptions and uncertainties. In addition, restructuring charges of $3.0 million were incurred related to the reduction of 47 full-time equivalents ("FTEs”) in the United States, 8 FTEs in Canada and 630 FTEs and contract employees in Mexico. There is no assurance that we will successfully implement or fully realize the anticipated benefits of our restructuring activities. If we fail to realize the anticipated benefits from these measures, or if we incur charges or costs in amounts that are greater than anticipated, our financial condition and operating results may be adversely affected to a greater degree than we currently expect.

 

Finally, we have incurred other significant expenses related to restructuring of our operations in the past and may continue to in the future. We have incurred in the past, and may incur in the future, costs related to workforce reductions and facility closures. We may be required to record additional charges related to restructuring activities in the future, but cannot predict the timing or amount of such charges. Any such charges would reduce our earnings.

 

Our design and manufacturing processes and services may result in exposure to intellectual property infringement claims against our customers or us, which could harm our business.

 

Our design and manufacturing services offerings involve the creation and use of intellectual property rights, which subject us to the risk of claims of intellectual property infringement from third parties. In addition, our customers may require that we indemnify them against the risk of intellectual property infringement. If any claims are brought against us or our customers for such infringement, whether or not they have merit, we could be required to expend significant resources in defense of such claims. In the event of such an infringement claim, we may be required to spend a significant amount of money to develop non-infringing alternatives or obtain licenses. We may not be successful in developing such alternatives or obtaining such licenses on reasonable terms or at all. 

 

From time to time, we are involved in various legal proceedings, which could result in unexpected expenditures of time and resources.

 

In the past, we have been notified of claims relating to various matters including, among other things, intellectual property rights, contractual matters or other issues arising in the ordinary course of business. In the event of such a claim, we may be required to spend a significant amount of money to defend or otherwise address the claim. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. Any litigation, even where a claim is without merit, could result in substantial costs, such as legal fees, and diversion of resources. Accordingly, the resolution or adjudication of such disputes, even those encountered in the ordinary course of business, could have a material adverse effect on our business, consolidated financial condition and results of operations. Furthermore, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Regardless of the subject matter, any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business.

 

 

We may be required to recognize additional impairment charges.

 

Pursuant to U.S. GAAP, we are required to evaluate for impairment periodically and when events or changes in circumstances indicate that the carrying value of property, plant and equipment, intangible assets and goodwill may not be recoverable. During 2017, we identified a triggering event related to property, plant and equipment in our U.S. segment asset group and recorded an impairment loss related to the U.S. segment of $1.0 million. In addition, during 2017, we recorded an impairment loss of $0.6 million related predominantly to machinery and equipment in our China segment. During 2019, we recorded an impairment loss of $0.2 million related to machinery and equipment in our China segment, which would not otherwise be transferred to our other manufacturing facilities. Disruptions and reductions to our business, unexpected significant declines in the operating results, divestitures and enterprise value declines may result in future impairment charges to property, plant and equipment. Any future impairment charge could substantially affect our reported results during those periods. 

 

Tariffs imposed by the United States and those imposed in response by other countries, as well as rapidly changing trade relations, could have a material adverse effect on our business and results of operations.

 

Modifications of U.S. laws and policies governing foreign trade and investment (including trade agreements and tariffs, such as those tariffs imposed on specified imports from China) could adversely affect our supply chain, business and results of operations. For example, in September 2019, the U.S. imposed tariffs on more than $125 billion worth of imported goods from China. These tariffs have increased the costs of certain components sourced from China which increases the costs to our customers. The implementation of additional tariffs and retaliatory tariffs from trade partners or related uncertainties could further increase the cost of certain of our imported materials, which could thereby adversely affect our profitability if not accepted and paid by our customers.

 

Our financial results depend, in part, on our ability to perform on our U.S. government contracts, and changes in government defense spending and priorities could have consequences on our financial position, results of operations and business.

 

In fiscal years 2019 and 2018, U.S. government sales accounted for approximately 6.6% and 2.4% of our total revenues, respectively. Our revenues from the U.S. government largely result from contracts awarded to us under various U.S. government programs, primarily defense-related programs with the DoD. The funding of our programs is subject to the overall U.S. government policies, budget and appropriation decisions and processes which are driven by numerous factors, including geo-political events, macroeconomic conditions, and the ability of the U.S. government to enact relevant legislation, such as appropriations bills and accords on the debt ceiling.

 

In recent years, U.S. government appropriations have been affected by larger U.S. government budgetary issues and related legislation. In addition, in recent years the U.S. government has been unable to complete its budget process before the end of its fiscal year, resulting in both a governmental shut-down and continuing resolutions to extend sufficient funds only for U.S. government agencies to continue operating.

 

As a result, defense spending levels are difficult to predict beyond the near-term due to numerous factors, including the external threat environment, future governmental priorities and the state of governmental finances. Significant changes in defense spending or changes in U.S. government priorities, policies and requirements could have a material adverse effect on our results of operations, financial condition or liquidity.

 

Government contracts are subject to significant procurement rules and regulations. Changes in such rules, regulations and business practice could negatively affect current programs and potential awards, and our business could be negatively affected if we fail to comply with any procurement rules and regulations.

 

U.S. government contractors must comply with specific procurement regulations and other requirements including export-import control, security, contract pricing and cost, contract termination and adjustment, audit and product integrity requirements. These requirements impact our performance and compliance costs. In addition, the U.S. government has implemented, and may continue to implement, initiatives focused on efficiencies, affordability and cost growth and other changes to its procurement practices which may negatively affect our results of operations, financial condition or liquidity, and could affect whether and, if so, how we pursue certain opportunities and the terms under which we are able to do so.

 

In addition, failure to comply with the procurement regulations and requirements could result in reductions of the value of contracts, contract modifications or termination, cash withholds on contract payments, forfeiture of profits, and the assessment of civil and criminal penalties and fines, which could negatively impact our results of operations, financial condition or liquidity. Our failure to comply with these regulations and requirements could also lead to suspension or debarment, for cause.

 

 

We are subject to extensive regulation and audit by the Defense Contract Audit Agency.

 

The accuracy and appropriateness of certain costs and expenses used to substantiate our direct and indirect costs for U.S. government contracts are subject to extensive regulation and audit by the Defense Contract Audit Agency, an arm of the DoD. Such audits and reviews could result in adjustments to our contract costs and profitability. However, we cannot ensure the outcome of any future audits and adjustments may be required to reduce net sales or profits upon completion and final negotiation of audits. If any audit or review were to uncover inaccurate costs or improper activities, we could be subject to penalties and sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from conducting future business with the U.S. government. Any such outcome could have a material adverse effect on our financial results.

 

We identified a material weakness in our internal control related to ineffective information technology general controls such that there is a reasonably possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis if these deficiencies are not remediated appropriately or timely.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. We are also required to comply with the SEC’s rules implementing Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, as amended (“Sarbanes-Oxley”), which require management to certify financial and other information in our quarterly and annual reports and provide an annual management report on the effectiveness of controls over financial reporting. Our independent registered public accounting firm is also required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of Sarbanes-Oxley. Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. As disclosed in Part II, Item 9A of this Form 10-K, during the fourth quarter of the fiscal year ended December 29, 2019, management identified a material weakness in internal control related to ineffective information technology general controls in the areas of user access and program change-management over certain information technology systems that support the Company’s financial reporting processes. As a result, management concluded that our internal control over financial reporting was not effective as of December 29, 2019.

 

We are implementing remedial measures and, while we make no assurance that our efforts will be successful, we plan to remediate the material weakness by mid-2020. These measures will result in additional technology and other expenses. If we are unable to remediate the material weakness, or are otherwise unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods, could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price.

 

We make no assurance that significant deficiencies or other material weaknesses in our internal control over financial reporting will not be identified in the future. The existence of a significant deficiency or additional material weakness could result in errors in our financial statements that could in turn result in a restatement of the consolidated financial statements, cause us to fail to meet our reporting obligations or cause lenders, suppliers, customers and investors to lose confidence in our reported financial information. Our internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. Any combination of the above could lead to harmful effects on our business and a decline in our stock price. In addition, a material weakness, such as the one disclosed in Part II, Item 9A of this Form 10-K, could cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. We also make no assurances that we will be able to remediate any future internal control deficiencies timely and in a cost effective manner. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we are unable to satisfactorily remediate future deficiencies or if we discover other deficiencies in our internal control over financial reporting, such deficiencies may lead to misstatements in our financial statements or otherwise negatively impact our business, financial results and reputation.

 

 

RISKS RELATED TO OUR CAPITAL STRUCTURE

 

Our indebtedness could adversely affect our financial health and severely limit our ability to plan for or respond to changes in our business.

 

We borrow 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 (the “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 0.75% to 1.25%, or the London Interbank Offered Rate (“LIBOR”) plus an applicable margin ranging from 2.50% to 3.00%. The base commercial lending rate should approximate U.S. prime rate.  

 

We also borrow money under a financing agreement, the lenders from time to time party thereto, TCW Asset Management Company LLC, as administrative agent for the lenders, and TCW Asset Management Company LLC, as collateral agent for the lenders govern a term loan A facility (the “Term A Loan Facility” and, together with the PNC Facility, the “Credit Facilities”) and previously governed a term loan B facility (the “Term Loan B Facility”) until it was paid in full on July 3, 2019. The Term Loan A Facility matures on November 8, 2023 (the “Maturity Date”). The Term Loan A Facility bears interest at LIBOR plus an applicable margin of 8.75% through June 30, 2020, and borrowings 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 occurred before November 8, 2019, (ii) 2.00% in the event that such payment occurs after November 8, 2019 and on or November 8, 2020 and (iii) 1.00% in the event that such payment occurs after November 8, 2020 and on or before November 8, 2021. No such applicable premium is payable for any payment of loans made under the Term Loan A Facility occurring after November 8, 2021.

 

At December 29, 2019 and December 30, 2018, $34.7 million and $25.0 million, respectively, was outstanding under the PNC Facility and was classified as a current liability based on the requirement to hold a “lock-box” under the terms of the PNC Facility. As at December 29, 2019 and December 30, 2018, the funds available to borrow under the PNC Facility after deducting the current borrowing base conditions was $21.6 million and $14.0 million, respectively. The maximum amount of funds that could be available under the PNC Facility is $65.0 million. However, availability under the PNC Facility is subject to certain conditions, including borrowing base conditions based on eligible inventory and accounts receivable, and certain conditions as determined by PNC. We are required to use a “lock-box” arrangement for the PNC Facility, whereby remittances from customers are swept daily to reduce the borrowings under this facility.

 

At December 29, 2019 $38.8 million was outstanding under the Term Loan A Facility, net of deferred financing fees of $2.3 million and a discount on debt of $1.5 million, related to outstanding warrants to purchase shares of our common stock. At December 30, 2018, $62.0 million, was outstanding under the Term Loan A and Term B Facility, net of deferred financing fees of $2.8 million, and a discount on debt of $1.8 million related to outstanding warrants to purchase shares of our common stock.

 

Our debt outstanding under the Credit Facilities could have adverse consequences for our business, including, among others:

 

	•	we are more vulnerable to adverse general economic conditions;
	•	we are required to dedicate a substantial portion of our cash flow from operations to repayment of debt, including interest limiting the availability of cash for other purposes;
	•	we may have difficulty obtaining financing in the future for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes;
	•	we may have limited flexibility in planning for, or reacting to, changes in our business and industry;
	•	we could be limited in our borrowing of additional funds and making strategic investments by restrictive covenants and the borrowing base formula in our credit arrangements; and
	•	we may fail to comply with covenants under our Credit Facilities.

 

Although we were in compliance with the financial covenants included in the Credit Facilities as of December 29, 2019 we make no assurance that we will be in compliance with these covenants going forward. If we breach any of these restrictive covenants, the lenders could either refuse to lend funds to us, accelerate the repayment of any outstanding borrowings or declare an event of default. If an event of default occurs and is not cured or waived, it could result in all amounts outstanding, together with accrued interest, becoming immediately due and payable unless we obtain a waiver from the applicable lender. We may not have sufficient assets to repay such indebtedness upon a default or be unable to receive a waiver of the default from the lender. If we are unable to repay the indebtedness, the lender could initiate a bankruptcy proceeding or collection proceedings with respect to the assets which secure our indebtedness under the Credit Facilities.

 

 

Our leverage and restrictions contained in the Credit Facilities may materially adversely affect our ability to finance our future operations or capital needs or to engage in other business activities. In addition, our ability to pay principal and interest on our indebtedness and to satisfy our other obligations will depend upon our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, certain of which are beyond our control.

 

We face significant restrictions on our ability to operate our business as a result of the covenant restrictions under our Credit Facilities.

 

The terms of our Credit Facilities generally restrict, among other things, our ability to incur additional indebtedness, complete acquisitions, make certain investments, pay dividends or make certain other restricted payments, consummate certain asset sales, make capital expenditures, enter into certain transactions with affiliates, merge, consolidate or sell, assign, transfer, lease, convey or otherwise dispose of our assets (other than in the ordinary course of business). The PNC Facility also has a borrowing base formula that limits our ability to borrow based on the characteristics, including geographic location of our accounts receivable and inventory. Substantially all of our assets and those of our subsidiaries are pledged as security under our Credit Facilities. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors.

 

If we are not able to comply with these covenants and requirements or obtain the prior approval from the applicable lender, the lenders have the right to demand accelerated payment and we would have to seek alternative sources of financing, which may not be available, or be available on acceptable terms. In addition, we could be prohibited from engaging in transactions which could be beneficial to our business and our stockholders. Furthermore, customers may lose confidence in us and reduce or eliminate their orders with us, which may have an adverse impact on our business, financial condition and results of operations. If our borrowing base is diminished we may not have sufficient access to capital to finance operations or capital needs.

 

Our indebtedness could adversely affect our financial condition and prevent us from fulfilling our debt obligations and may otherwise restrict our activities.

 

Our indebtedness could adversely affect our financial condition and thus make it more difficult for us to satisfy our obligations with respect to our Credit Facilities. If our cash flow is not sufficient to service our debt and adequately fund our business, we may be required to seek further additional financing or refinancing or dispose of assets. We might not be able to influence any of these alternatives on satisfactory terms or at all. Our indebtedness could also:

 

●

increase our vulnerability to adverse general economic, industry or competitive developments;

●

require us to dedicate a more substantial portion of our cash flows from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, investments, acquisitions, capital expenditures, and other general corporate purposes;

●

limit our ability to make required payments under our existing contractual commitments, including our existing long-term indebtedness;

●

limit our ability to fund a change of control offer;

●

require us to sell certain assets;

●

restrict us from making strategic investments, including acquisitions or cause us to make non-strategic divestitures;

●

limit our flexibility in planning for, or reacting to, changes in market conditions, our business and the industry in which we operate;

●

place us at a competitive disadvantage compared to our competitors that have less debt;

●

cause us to incur substantial fees from time to time in connection with debt amendments or refinancings;

●

increase our exposure to rising interest rates because our borrowings are at variable interest rates; and

●

limit our ability to borrow additional funds or to borrow on terms that are satisfactory to us.

 

Furthermore, because our debt is variable-rate debt, fluctuations in interest rates could have a material effect on our business. As a result, we may incur higher interest costs if interest rates increase. These higher interest costs could have a material adverse impact on our financial condition and the levels of cash we maintain for working capital.

 

For more information about our indebtedness, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Resources” of Part II of this Annual Report on Form 10-K and Note 6 to our audited consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.

 

 

Despite our current level of indebtedness, we may incur more debt and undertake additional obligations. Incurring such debt or undertaking such additional obligations could increase the risks to our financial condition.

 

Although the agreements governing the Credit Facilities contain restrictions on our incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions and the indebtedness incurred in compliance with these restrictions could increase. To the extent new debt is added to our current debt levels, the risks to our financial condition would increase.

 

While the agreements governing the Credit Facilities also contains restrictions on our ability to make loans and investments, these restrictions are subject to a number of qualifications and exceptions, and the investments incurred in compliance with these restrictions could be substantial.

 

To service our significant indebtedness, we will require cash and we may not be able to generate sufficient cash flow from operations to satisfy these obligations or to refinance these obligations on acceptable terms, or at all.

 

Our ability to generate cash depends on many factors beyond our control. Our ability to make payments on our debt and to fund working capital requirements, capital expenditures and research and development efforts will depend on, among other things, our ability to generate cash in the future, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, many of which are beyond our control, and the future availability of borrowings under the PNC Facility, which depends on, among other things, our complying with the covenants in the agreements governing the Credit Facilities. Our historical financial results have been, and we expect our future financial results will be, subject to fluctuation based upon a wide variety of factors, many of which are not within our control including, among others, those described in this section. We cannot assure you that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our PNC Facility or otherwise, in an amount sufficient to fund our liquidity needs.

 

Unfavorable changes in any of the foregoing factors could harm our operating results and our ability to generate cash to service our debt obligations. If we do not generate sufficient cash flow from operations to satisfy our debt obligations, we may have to undertake alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of existing or future debt agreements, may restrict us from adopting some of these alternatives. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to complete those dispositions for fair market value or at all, and any proceeds that we could realize from any such dispositions may not be adequate to meet our debt service obligations then due. Also, certain of these actions would require the consent of our lenders. The terms of our financing agreements contain limitations on our ability to incur debt. See “—Risks Related to Ownership of our Common Stock—Sales of a significant number of shares of our common stock in the public markets, including sales by our directors and/or executive officers and/or the holders of our warrants upon the exercise of such warrants, or the perception that such sales could occur, could depress the market price of our common stock.”

 

Downgrades of our credit ratings could adversely affect us.

 

We can be adversely affected by downgrades of our credit ratings, which are a factor influencing our ability to access capital and the terms of any new indebtedness, including covenants and interest rates. Our customers and vendors may also consider our credit profile when negotiating contract terms, and if they were to change the terms on which they deal with us, it could have a material adverse effect on our business, results of operations, cash flows, and financial condition.

 

Changes in the method of determining LIBOR, or the replacement of LIBOR with an alternative reference rate, may adversely affect interest expense related to outstanding debt.

 

Amounts drawn under the Credit Facilities may bear interest rates in relation to LIBOR, depending on our selection of repayment options. In July 2017, the United Kingdom Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee (“ARRC”) has proposed that the Secured Overnight Financing Rate (“SOFR”) is the rate that represents best practice as the alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a paced market transition plan to SOFR from USD-LIBOR and organizations are currently working on industry wide and company specific transition plans as it relates to derivatives and cash markets exposed to USD-LIBOR. In November 2019 the FASB approved an Accounting Standards Update (ASU) to provide temporary, optional guidance to ease the reporting burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The Board expects to issue a final ASU in 2020. The guidance will address stakeholder operational challenges, help simplify the migration process away from reference rates such as LIBOR and reduce related costs. However, at this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be enacted in the United Kingdom or elsewhere. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect the trading market for LIBOR-based securities, including certain of our debt that is indexed to USD-LIBOR. Furthermore, we may need to renegotiate any credit agreements extending beyond 2021 that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. As such, potential effect of any such event on our business, financial condition and results of operations cannot yet be determined.

 

 

RISKS RELATED TO TAX LOSS UTILIZATION AND TAX REGULATION

 

Our ability to recognize tax benefits on our existing U.S. net operating loss position may be limited.

 

We have generated substantial loss carryforwards and other tax assets for U.S. tax purposes that can be used to reduce our future federal income tax obligations. Our ability to fully use these tax assets will be adversely affected if we have an “ownership change” within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended (the “IRC”). An ownership change is generally defined as a greater than 50 percentage point increase in equity ownership by “five-percent shareholders” (as that term is defined for purposes of Section 382 of the IRC) in a rolling three-year period.

 

At our 2017 Annual Meeting of Stockholders, we ratified the extension of the SMTC Corporation Tax Benefits Preservation Plan, (the “Plan”) for an additional three year period, expiring on December 29, 2020 in order to protect our ability to utilize our net operating losses (“NOLs”) and other tax assets from an “ownership change” under U.S. federal income tax rules. We continue to have and utilize our net operating losses (“NOLs”) and intend to extend the Plan at our next Annual Meeting of Stockholders. However, there is no guarantee that the Plan will be effective in protecting our NOLs and other tax assets or that Stockholders will vote to extend.

 

In the past, we have had historical net operating losses expire unutilized. If the Company continues to be unable to generate sufficient taxable income, these losses will continue to expire unutilized and we may not be able to recognize the tax benefits that could arise from such tax losses.

 

There may be adverse impact resulting from government tax reform on the Company's tax returns and consolidated financial statements.

 

The Company operates in various foreign jurisdictions and has substantial tax operating loss carryforwards. Accordingly, the Company expects that potential future tax reform could have substantial impact on the Company’s tax filings and consolidated financial statements related to its income tax expense (recovery) and deferred tax assets (liabilities) and corresponding disclosures. 

 

There may be adverse consequences resulting from future governmental tax audits of the Company's tax returns.

 

The Company has taken various tax positions in determining its tax liabilities and the related expense. It is possible that future tax audits or changes in tax regulation may require the Company to change its prior period tax returns and also to incur additional costs. This may negatively affect future period results. 

 

RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK

 

Our common stock price may be volatile or may decline regardless of our operating performance.

 

Volatility in the market price of our common stock may prevent investors from being able to sell their shares at or above the price you paid for such shares. Many factors, which are outside our control, may cause the market price of our common stock to fluctuate significantly, including those described elsewhere in this “Risk Factors” section and this Annual Report Form 10-K, as well as the following:

 

●

our operating and financial performance and prospects;

●

our quarterly or annual earnings or those of other companies in our industry compared to market expectations;

●

conditions that impact demand for our services;

●

future announcements concerning our business or our competitors’ businesses;

●

the public’s reaction to our press releases, other public announcements and filings with the SEC;

●

the size of our public float;

●

coverage by or changes in financial estimates by securities analysts or failure to meet their expectations;

●

market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

●

strategic actions by us or our competitors, such as acquisitions or restructurings;

●

changes in laws or regulations which adversely affect our industry or us;

●

changes in accounting standards, policies, guidance, interpretations or principles;

●

changes in senior management or key personnel;

●

issuances or sales, or expected issuances or sales of our capital stock;

●

changes in our dividend policy;

●

adverse resolution of new or pending litigation against us; and

●

changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural disasters, terrorist attacks, acts of war and responses to such events.

 

These broad market and industry factors may materially reduce the market price of our common stock, regardless of our operating performance. In addition, price volatility may be greater if the public float and trading volume of our common stock is low. As a result, investors may suffer a loss on their investment.

 

 

Our principal stockholders exercise a considerable degree of control over our Company.

 

As of December 29, 2019, our executive officers, directors and entities affiliated with our five percent stockholders beneficially owned, in the aggregate, shares representing approximately 32% of our outstanding common stock. Although we are not aware of any voting arrangements in place among these stockholders, if these stockholders were to choose to act together, as a result of their stock ownership, they would be able to influence our management and affairs and control all matters submitted to our stockholders for approval, including the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of ownership may have the effect of delaying or preventing a change in control of our company or affecting the liquidity and volatility of our common stock, and might affect the market price of our common stock.

 

Sales of a significant number of shares of our common stock in the public markets, including sales by our directors or executive officers and/or the holders of our warrants upon the exercise of such warrants, or the perception that such sales could occur, could depress the market price of our common stock.

 

Sales of a significant number of shares of our common stock in the public market, including sales by our directors or executive officers and/or the holders of our warrants upon the exercise of such warrants, or the perception that such sales could occur, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities. We cannot predict the effect that future sales of our common stock or the market perception that we are permitted to sell a significant number of our securities would have on the market price of our common stock.

 

We may require additional capital in the future to continue our planned operations, and we may seek additional funding through a combination of equity offerings, debt financings, or other third-party business arrangements. These financing activities may have an adverse effect on our stockholders’ rights, the market price of our common stock and on our operations and may require us to issue additional equity or debt securities, or otherwise agree to terms unfavorable to us. Any sale or issuance of securities pursuant to a registration statement or otherwise may result in dilution to our stockholders and may cause the market price of our stock to decline, and new investors could gain rights superior to our existing stockholders. In addition, the agreements governing our indebtedness impose restrictive covenants on our operations. Any future debt financings may impose additional restrictive covenants or otherwise adversely affect the holdings or the rights of our stockholders, and any additional equity financings will be dilutive to our stockholders. Furthermore, additional equity or debt financing might not be available to us on reasonable terms, if at all.

 

Finally, in the future, in addition to financings, we may issue additional shares of our common stock or other equity or debt securities convertible into common stock in connection with an acquisition, employee arrangements, or otherwise. Any such issuance could result in substantial dilution to our then-existing stockholders and could cause the price of our common stock to decline.

 

Our amended and restated certificate of incorporation, amended and restated by-laws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock.

 

Our amended and restated certificate of incorporation, amended and restated by-laws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a change in control of us or changes in our management. The provisions include, among others:

 

●

advance notice requirements for stockholder proposals and nominations;

●

the inability of stockholders to act by written consent or to call special meetings;

●

the ability of our board of directors to make, alter or repeal our amended and restated by-laws;

●

prohibiting the use of cumulative voting for the election of directors; and

●

the authority of our board of directors to issue preferred stock with such terms as our board of directors may determine.

 

These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law, to which we are subject, prohibits us, except under specified circumstances, from engaging in any mergers, significant sales of stock or assets or business combinations with any shareholder or group of shareholders who owns at least 15% of our common stock for three years following their becoming the owner of 15% of our common stock, which may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline.

 

We may issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of our common stock, which could depress the price of our common stock.

 

Our amended and restated certificate of incorporation authorizes us to issue one or more series of preferred stock. Our Board of Directors will have the authority to determine the preferences, limitations and relative rights of the shares of preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by our stockholders. Our preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our common stock. The potential issuance of preferred stock may delay or prevent a change in control of us, discouraging bids for our common stock at a premium to the market price, and materially and adversely affect the market price and the voting and other rights of the holders of our common stock.

 

If securities analysts do not publish research or reports about our Company, or if they issue unfavorable commentary about us or our industry or downgrade our common stock, the price of our common stock could decline.

 

The trading market for our common stock depends in part on the research and reports that third-party securities analysts publish about us and our industry. If one or more analysts cease coverage of us, we could lose visibility in the market. In addition, one or more of these analysts could downgrade our common stock or issue other negative commentary about our company or our industry. As a result of one or more of these factors, the trading price of our common stock could decline.

 

 

Item 1B.

Unresolved Staff Comments

 

None.

 

Item 2.

Properties

 

We conduct our operations within approximately 555,000 square feet of building space after removing the Chang An (Dongguan), China location. During the fourth quarter of 2019 we announced a decision to cease manufacturing in China and relocate the equipment used at our Chinese manufacturing facility to our other North American sites. See “Item 1. Business.” We believe our facilities are currently adequate for our operating needs and provide capacity for future volume growth. Our principal service at all locations is assembly of electronic components, with the exception of the Chihuahua facility where we also manufacture precision enclosures, and our Markham, Canada facility which serves as the principal executive office. Our operating facilities are as follows:

 

Location	Reportable Operating Segment	Approx. Square Footage		Leased/Owned
Fremont, California	U.S.	67,000		Leased
Chihuahua, Mexico	Mexico	216,000		Owned
Chang An (Dongguan), China (1)	China	150,000		Leased
Melbourne, Florida	U.S.	135,000		Leased
Billerica, Massachusetts	U.S.	58,000		Leased
Zacatecas, Mexico	Mexico	79,000		Leased

 

(1)

During the fourth quarter of 2019 we announced a decision to cease manufacturing at SMTC Electronics Dongguan Company Limited and relocate the equipment used at our Chinese manufacturing facility to our other North American sites. The closure of the SMTC Electronics Dongguan Company Limited, China facility is expected to be substantially completed by the end of the first quarter of 2020.

 

The principal executive office of SMTC is located at 7050 Woodbine Ave. Suite 300, Markham, Ontario, Canada L3R 4G8, which is a leased facility. The supply chain center located in Phoenix, Arizona is a leased facility.

 

Item 3.

Legal Proceedings

 

We are a party to various legal actions arising in the ordinary course of our business. At this time, we believe that the resolution of these legal actions will not have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 4.

Mine Safety Disclosures

 

Not Applicable.

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

Our common stock trades on The Nasdaq Global Market under the symbol “SMTX.”

 

Holders 

 

As of March 13, 2020, there were approximately 96 holders of record of the Company’s common stock.

  

Dividends

 

The Company has never declared a cash dividend on its common stock. Our Board of Directors has no present intention to authorize the payment of dividends on our common stock in the foreseeable future. It is the present policy of the Company to retain earnings, if any, to provide for growth and working capital needs.

 

 Stock Performance Graph

 

The following graph sets forth the Company’s total cumulative stockholder return as compared to the Nasdaq Composite Index and to a peer group chosen by the Company for 2019 (the “Peer Group”). The Peer Group is comprised of the following companies: IEC Electronics Corp., Key Tronic Corp., Nortech Systems Inc., Sigmatron International Inc., and Sypris Solutions Inc.

 

The total stockholder return assumes $100 invested on December 28, 2014 in SMTC’s common stock or December 28, 2014 in the Nasdaq Composite Index and the Peer Group of companies that are, (i) publicly traded, and (ii) mid or large tier providers of advanced electronics manufacturing services. Total shareholder return assumes reinvestment of dividends without the payment of any commissions. We make no assurance that the performance of our shares will continue in line with the same or similar trends depicted in the graph below.

 

 

 Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities

 

None.

 

Purchases of Equity Securities by the Issuer

 

None.

 

 

Item 6.

Selected Financial Data

 

The data set forth below should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes thereto appearing elsewhere in this Form 10-K.

 

The Company’s financial reporting year is a 52 or 53 week fiscal period, ending on the Sunday nearest December 31. Accordingly, the consolidated balance sheet, statements of operations and comprehensive loss, the consolidated statements of changes in shareholders’ equity, and consolidated statements of cash flows are reported for the periods from December 31, 2018 to December 29, 2019 (“year ended December 29, 2019”), January 1, 2018 to December 30, 2018 (“year ended December 30, 2018”), January 2, 2017 to December 31, 2017 (“year ended December 31, 2017”), January 4, 2016 to January 1, 2017 (“year ended January 1, 2017”), and December 29, 2014 to January 3, 2016 (“year ended January 3, 2016”).

 

 Selected consolidated financial data has been derived from consolidated financial statements that are prepared in accordance with generally accepted principles in the United States of America (U.S. GAAP).

 

Consolidated Statements of Operations and Comprehensive Loss Data

(in USD millions): 

 

		Years Ended
		December 29, 2019				December 30, 2018				December 31, 2017				January 1, 2017				January 3, 2016
Revenue (a)		$	372.5			$	216.1			$	139.2			$	167.9			$	220.6
Cost of sales			335.5				194.5				128.4				152.8				202.9
Gross profit			37.0				21.7				10.8				15.1				17.7
Selling, general and administrative expenses			27.0				18.1				14.0				14.0				15.9
Change in fair value of warrant liability			(0.3	)			0.1				—				—				—
Change in fair value of contingent consideration			(3.1	)			—				—				—				—
Impairment of property, plant and equipment			—				—				1.6				—				—
Restructuring charges (b)			8.0				0.2				1.7				0.2				—
(Gain) loss on disposal of property, plant and equipment			—				0.0				(0.1	)			0.0				—
Operating earnings (loss)			5.4				3.3				(6.4	)			0.9				1.8
Interest expense - net			10.6				3.1				0.9				0.8				1.2
Earnings (loss) before income taxes			(5.2	)			0.2				(7.3	)			0.1				0.6
Income tax expense - net			0.8				0.7				0.6				0.3				0.7
Net loss and comprehensive loss		$	(6.0	)		$	(0.5	)		$	(7.9	)		$	(0.2	)		$	(0.1	)
Basic loss per common share		$	(0.23	)		$	(0.02	)		$	(0.47	)		$	(0.01	)		$	(0.00	)
Diluted loss per common share		$	(0.23	)		$	(0.02	)		$	(0.47	)		$	(0.01	)			(0.00	)
Weighted average number of shares outstanding
Basic			25.7				19.2				16.8				16.5				16.4
Diluted			25.7				19.2				16.8				16.5				16.4

(a)	The Company adopted Accounting Standards Codification (“ASC”) Topic 606 on a modified retrospective basis effective January 1, 2018. See note 4 to the consolidated financial statements for the impact of adoption in the year of transition. The comparable periods do not reflect the impact of the adoption and therefore may not be comparable.
(b)	During 2019, restructuring charges of $5.0 million were incurred related to the closure of the Dongguan facility related to the reduction of 137 full time equivalents (“FTEs”) in China, including ongoing administrative staff charges to close the facility and certain provisions on property, plant and equipment, accounts receivable and inventory. In addition, restructuring charges of $3.0 million were incurred related to the reduction of 47 FTEs in U.S., 8 FTEs in Canada and 630 FTEs and contract employees in Mexico. During 2017, restructuring charges of $1.7 million were incurred related to severance charges in connection with the Company’s 2017 restructuring plan related to a global reduction in the workforce in addition to the closure of the Suzhou manufacturing facility.

 

 

Consolidated Balance Sheet Data and Cash Flow Data:

(in USD millions)

 

		As at and for the Fiscal Years Ended
		December 29, 2019 (1)				December 30, 2018				December 31, 2017				January 1, 2017				January 3, 2016
Cash		$	1.4			$	1.6			$	5.5			$	8.5			$	6.9
Working capital (2)			25.5				31.0				14.5				20.0				14.0
Total assets			213.5				221.2				69.9				69.0				82.0
Long-term debt and finance lease obligations			48.8				70.0				6.1				8.3				4.2
Shareholders’ equity			41.1				32.3				19.1				26.5				26.3
Capital expenditures			3.9				4.7				1.5				2.2				2.8
Cash flows provided (used in) by operating activities			5.1				(7.8	)			(8.9	)			6.9				10.9
Cash flows (used in) provided by financing activities			(1.4	)			75.8				7.0				(3.2	)			(6.7	)
Cash flows used in investing activities			(3.9	)			(72.0	)			(1.1	)			(1.3	)			(3.5	)

 

(1)

The Company adopted ASC Topic 842 on a modified retrospective basis effective December 31, 2018. See note 4 to the consolidated financial statements for the impact of adoption in the year of transition. The comparable periods do not reflect the impact of the adoption and therefore may not be comparable

 

(2)	Calculated as current assets minus current liabilities.

 

 

Item 7:

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”) in combination with the accompanying audited consolidated financial statements and the accompanying notes to the consolidated financial statements prepared in accordance with U.S. GAAP included within this annual report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-K, including information with respect to our plans and strategies for our business, statements regarding the industry outlook, our expectations regarding the future performance of our business and the other non-historical statements contained herein, are forward-looking statements. You should also review the “Risk Factors” in Item 1A. of this Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described herein or implied by such forward-looking statements.

 

This MD&A contains discussion in thousands of U.S. dollars unless specifically stated otherwise.

 

Overview

 

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”). At the end of 2019, we operated 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. Our focus on delivering best-in-class services has been recognized and we have received Frost & Sullivan Awards for Product Quality, Growth Leadership & Customer Value Leadership Awards in May 2019.

 

During the fourth quarter of 2019 we announced a decision to cease manufacturing in China and relocate the equipment used at our Chinese manufacturing facility to our other North American sites. See “Item 1. Business.”

 

We are offer fully integrated contract manufacturing services to global OEMs, technology companies and governmental entities. We have redefined our market sectors from those previously reported. We are focused on seven market sectors:

 

●

Avionics, aerospace and defense

●

Industrial, power and clean technology

●

Medical and safety

●

Retail and payment systems

●

Semiconductors

●

Telecom, networking and communications

●

Test and measurement

 

Developments in the year ended December 29, 2019

 

Total revenue increased by $156.4 million or 72.4% in 2019 compared to 2018. With the acquisition of MC Assembly Holdings, Inc. (“MCA”) in November of 2018, we recognized incremental revenue of $143.4 million in 2019 over 2018.

 

Net loss increased to $6.0 million in 2019 from $0.4 million in 2018. This was due primarily to restructuring charges of $8.0 million incurred in 2019 in addition to amortization of intangible assets of $7.2 million, partially offset by change in fair value of contingent consideration resulting in a gain of $3.1 million. In the prior year, restructuring charges were limited to $0.2 million and amortization of intangible assets was $1.0 million.    

 

Adjusted EBITDA increased to $24.8 million in 2019 from $10.2 million in 2018. Adjusted EBITDA as a percentage of revenue increased to 6.7% in 2019 compared to 4.7% in 2018. The improvement in Adjusted EBITDA, was primarily driven by the full year of results due to MCA, which represented a $12.5 million increase in EBITDA.  In addition, the increase in EBITDA was due to increased revenue and increased utilization at the manufacturing facilities.  For additional information and a reconciliation of Adjusted EBITDA, see “EBITDA and Adjusted EBITDA Reconciliation” below.

 

 

In September 2019, the Company announced it plans to close its Chinese manufacturing operation when its current Dongguan, China facility lease expires in December 2019 as approved by the Board of Directors. The closure of the Dongguan manufacturing facility is intended to reduce the labor force which is anticipated to impact approximately 137 employees at the Dongguan manufacturing facility. Impacted employees were notified in the last week of September 2019. The closure of the Dongguan manufacturing facility will reduce forecasted losses that would have otherwise been incurred in fiscal 2020 as the Dongguan manufacturing facility was not expected to be fully utilized. The wind down and closure of the Dongguan manufacturing facility is anticipated to be substantially completed by the end of the first quarter of 2020, however it is expected there will be some continued deregistration and filing requirements in 2020. Manufacturing by the Company of certain products previously manufactured at the Dongguan manufacturing facility will be transferred to the Company’s other manufacturing facilities.

 

During 2019, restructuring charges of $5.0 million were incurred related to the closure of the Dongguan facility related to the reduction of 137 full time equivalents (“FTEs”) in China, including ongoing administrative staff charges to close the facility and certain provisions on property, plant and equipment, accounts receivable and inventory. In addition, restructuring charges of $3.0 million were incurred related to the reduction of 47 FTEs in U.S., 8 FTEs in Canada and 630 FTEs and contract employees in Mexico.

 

Results of Operations  

 

The following table sets forth certain operating data expressed as a percentage of revenue for the years presented:   

 

		Fiscal Year ended December 29, 2019				Fiscal Year ended December 30, 2018				Fiscal Year ended December 31, 2017
Revenue			100.0	%			100.0	%			100.0	%
Cost of sales			90.1				90.0				92.2
Gross profit			9.9				10.0				7.8
Selling, general and administrative expenses			7.3				8.4				10.1
Change in fair value of warrant liability			—				—				—
Change in fair value of contingent consideration			(0.8	)			—				—
Impairment of property, plant and equipment			—				—				1.2
Restructuring charges			2.1				0.1				1.2
Gain on disposal of property, plant and equipment			—				—				(0.1	)
Operating earnings (loss)			1.4				1.5				(4.6	)
Interest expense			2.9				1.4				0.7
(Loss) earnings before income taxes			(1.5	)			0.1				(5.3	)
Income tax expense
Current			0.2				0.4				0.5
Deferred			(0.1	)			—				(0.1	)
			0.1				0.4				0.4
Net loss			(1.6	)			(0.3	)			(5.7	)

 

 

Year ended December 29, 2019 compared to the year ended December 30, 2018

  

Revenue (in millions)

 

Industry Sector		Fiscal Year ended December 29, 2019								Fiscal Year ended December 30, 2018								Change
		$				%				$				%				$				%
Test and Measurement			118.6				31.8				45.8				21.2				72.8				159.0
Industrial, Power and Clean Technology			77.4				20.8				28.3				13.1				49.1				173.5
Retail and Payment Systems			46.1				12.4				41.6				19.3				4.5				10.8
Medical and safety			45.5				12.2				31.4				14.5				14.1				44.9
Telecom, Networking and Communications			37.2				10.0				37.4				17.3				(0.2	)			(0.5	)
Avionics, Aerospace and Defense			24.7				6.6				5.1				2.3				19.6				384.3
Semiconductors			23.0				6.2				26.5				12.3				(3.5	)			(13.2	)
Total			372.5				100				216.1				100				156.4				72.4

 

Total revenue increased by $156.4 million or 72.4% in 2019 compared to 2018. With the acquisition of MC Assembly Holdings, Inc. (“MCA”), we recognized incremental new customer revenue of $143.4 million in 2019 over 2018 in addition to volume increases with existing customers in the test and measurement, industrial, power and clean technology sectors.

 

Revenue in the test and measurement sector increased by $72.8 million year over year, due primarily to $66.2 million of incremental revenue represented from new customers with the MCA acquisition. In addition, revenue in the test and measurement sector increased $4.1 million mainly due to volume increases with two customers serviced in the U.S., offset by volume decreases with one customer serviced in Mexico. One new customer serviced in China accounted for $2.5 million of additional revenue.

 

Revenue in the retail and payment sector increased by $4.5 million year over year, due primarily to volume increases with one customer serviced in Mexico partially offset by volume decreases with another customer also serviced in Mexico.

 

Revenue in the telecom, networking and communications sector reduced by $0.2 million year over year, due primarily to reductions in revenue of $7.1 million mainly due to decreased volumes with four customers (three serviced in China, one serviced in Mexico). The reductions in China were primarily related to two customers, one of which experienced much higher demand in prior year when the product launched, while the second customer resulted in reduced volume due to declining end customer demand. This decrease was offset by $6.9 million of incremental new customer revenue represented from the MCA acquisition.

 

Revenue in the medical and safety sector increased by $14.1 million year over year, due primarily to incremental revenue represented from the MCA acquisition.

 

Revenue in the industrial, power and clean technology sector increased by $49.1 million year over year, due primarily to $35.3 million of incremental revenue represented from the MCA acquisition. In addition, revenue in the industrial, power and clean technology sector increased $13.8 million mainly due to increased volumes from one customer serviced in the U.S. which was a new customer in 2018 and had expanded business with SMTC in 2019.

 

Revenue in the semiconductors sector reduced by $3.5 million year over year, due primarily to reduced volumes due to reduced end customer demand from one customer serviced in Mexico.

 

Revenue in the avionics, aerospace and defense sector increased by $19.6 million year over year, due to incremental new customer revenue represented from the MCA acquisition.

 

During 2019, the Company recorded approximately $11.3 million of sales of raw materials inventory to customers, which carried limited margin, compared to $4.1 million in 2018. The Company’s contract terms are structured such that it purchases raw materials based on a customer’s purchase orders. To the extent a customer subsequently requests that an order be changed, whether cancelled or pushing out the demand, the customer is generally contractually obligated to purchase the original on-order raw material at cost.

  

Due to changes in market conditions, the life cycle of products, the nature of specific programs and other factors, revenues from any particular customer typically vary from year to year. The Company’s ten largest customers represented 52.8% of revenue in 2019, compared to 68.1% in 2018. Revenue from our largest customer during 2019 was $47.7 million, representing 12.8% of revenue. This compared to revenue from our largest customer during 2018 of $23.5 million, representing 10.9% of revenue. No other customer represented more than 10% of revenue in either year.

 

In addition to tracking our revenues based on industry sector, the Company also monitors revenue (as well as associated segment contribution margin) based on the geographic location of our operations, which in 2019 included Mexico, China and the U.S. This is consistent with how we report our segmented information, as set out in Note 11 to our consolidated financial statements. 

  

During 2019, 63.3% of our revenue was attributable to our operations in Mexico, 31.6% in the U.S and 5.1% in China. During 2018, 70.7% of our revenue was attributable to our operations in Mexico, 19.3% in the U.S. and 10.0% in China.

 

 

Non-GAAP Financial Measures

 

To supplement our consolidated financial statements, which are prepared and presented in accordance with U.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, provide additional understanding of past financial performance and future prospects, and allow us to provide transparency with respect to the key metrics we use in our financial and operational decision making. These non-GAAP measures are 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 with U.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 Loss and Adjusted Net Income Reconciliation: 

 

Adjusted Net Income, a non-GAAP financial measure, is defined as Net 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, as it is believed the information is useful to investors in understanding and evaluating our operating results as it aligns the net loss with those adjustments made to EBITDA and gross profit.

 

Below is the reconciliation of Net loss to Adjusted Net Income:

 

		Year ended December 29, 2019				Year ended December 30, 2018
Net loss		$	(5,995	)		$	(448	)
Add:
Amortization of intangible assets			7,188				1,065
Restructuring charges			7,955				172
Stock based compensation			776				407
Fair value adjustment of warrant liability			(279	)			111
Fair value adjustment of contingent consideration			(3,050	)			—
Merger and acquisitions related expenses			286				1,676
Unrealized foreign exchange gain on unsettled forward foreign exchange contracts			—				(353	)
Adjusted Net Income		$	6,881			$	2,630

 

Net loss increased to $6.0 million in 2019 from $0.4 million in 2018. This was due primarily to restructuring charges of $8.0 million incurred in 2019 in addition to amortization of intangible assets of $7.2 million, partially offset by change in fair value of contingent consideration resulting in a gain of $3.1 million. In the prior year, restructuring charges were limited to $0.2 million and amortization of intangible assets was $1.0 million. When excluding these items, adjusted Net Income increased $4.3million in 2019 over the same period in the prior year, which is due to increased gross profit, partially offset by increased selling, general and administrative expenses.

 

Gross Profit

 

Gross profit increased to $37.0 million in 2019 from $21.7 million in 2018. Gross profit percentage was 9.9% in 2019 and 2018. When excluding the impact of the unrealized foreign exchange gains on unsettled forward contracts and amortization of intangible assets, the adjusted gross profit percentage increased to 11.9% in 2019 from 10.3% in the prior year. This was due primarily to incremental gross profit of $17.3 million due to the acquisition of MCA in addition to improved product mix and cost reductions, primarily related to headcount.

 

 

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. Management presents adjusted gross profit as management considers 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.

 

Below is the reconciliation from the financial statement presentation of gross profit to the non-GAAP measure of adjusted gross profit (in thousands):

 

		Fiscal Year ended December 29, 2019				Fiscal Year ended December 30, 2018
Gross profit		$	37,021			$	21,661
Add (deduct):
Amortization of intangible assets			7,188				1,065
Unrealized foreign exchange gain on unsettled forward foreign exchange contracts			—				(353	)
Adjusted gross profit		$	44,209			$	22,373
Adjusted gross profit percentage			11.9	%			10.3	%

 

The Company did not enter into forward foreign exchange contracts during the year. Historically the Company has used forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican peso expenditures. These contracts are effective as hedges from an economic perspective, but do not meet the requirements for hedge accounting under ASC Topic 815 “Derivatives and Hedging”. Accordingly, changes in the fair value of these contracts are recognized in earnings in the consolidated statement of operations and comprehensive loss. Included in cost of sales in 2019 and 2018 was a realized loss of $0.1 million. In 2019, as a result of revaluing the outstanding forward contracts to fair value, an unrealized gain of $NIL million was recorded compared to an unrealized gain of $0.4 million in 2018, which was included in cost of sales.

 

EBITDA and Adjusted EBITDA Reconciliation

 

EBITDA and Adjusted EBITDA, non-GAAP financial measures, are defined as earnings before interest, income 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 loss, the closest GAAP measure, to EBITDA and Adjusted EBITDA (in thousands):

 

		Year ended December 29, 2019				Year ended December 30, 2018
Net loss		$	(5,995	)		$	(448	)
Reconciling items:
Depreciation of property, plant and equipment			6,548				3,791
Amortization of intangible assets			7,188				1,065
Interest			10,562				3,117
Income taxes			788				677
EBITDA		$	19,091			$	8,202
Additional reconciling items:
Restructuring charges			7,955				172
Stock based compensation			776				407
Fair value adjustment of warrant liability			(279	)			111
Merger and acquisitions related expenses			286				1,676
Fair value adjustment of contingent consideration			(3,050	)			—
Unrealized foreign exchange gain on unsettled forward foreign exchange contracts			—				(353	)
Adjusted EBITDA		$	24,779			$	10,215
Adjusted EBITDA percentage			6.7	%			4.7	%

   

The improvement in Adjusted EBITDA was due primarily to the MCA Acquisition, which contributed $12.5 million of the increase in Adjusted EBITDA, which were not included in the results in the same period in the prior year. The additional increase was due to incremental margin, due to improved product mix and cost reductions, primarily related to head-count reductions.

 

 

  Selling, General & Administrative Expenses

 

Selling, general and administrative expenses increased to $27.0 million in 2019 from $18.2 million in 2018 was primarily due to the MCA Acquisition which represented an increase of $9.4 million over the same period in the prior year. However, selling, general and administrative expenses decreased to 7.3% of revenue in 2019 down from 8.4% of revenue in 2018. The selling, general and administrative expensed in 2019 included incremental professional service charges of $0.5 million related to internal control compliance. The 2018 selling, general and administrative expenses included additional charges of $1.3 million, pertaining to non-recurring expenses related to the MCA Acquisition.

 

Change in fair value of warrant liability

 

For the twelve months ended December 29, 2019 the Company recorded a $0.3 million gain as a result of the valuation of the 511,949 outstanding warrants issued to TCW. The fair value has been assessed at $3.38 per unit or $1.7 million as at December 29, 2019 which represented a reduction in the stock price from the prior valuation assessment at December 30, 2018. For the twelve months ended December 30, 2018 the Company recorded a $0.1 million loss as a result of the valuation of the 511,949 outstanding warrants issued to TCW.

 

Change in fair value of contingent consideration

 

During the first quarter of 2019, the fair value of the contingent consideration liability that was payable to the former owners of MC was determined to be $Nil resulting in the recognition of a gain of $3.1 million. The contingent consideration liability was initially recognized at fair value in the fourth quarter of 2018 and related to a contingent earn-out payment associated with the MCA Acquisition. The fair value estimate under purchase accounting of the $3.1 million was derived from a multiple of earnings based on MCA’s forecasted twelve-month earnings for the period ended March 31, 2019. Based on results, the contingent consideration liability was considered resolved and no longer payable as at March 31, 2019.

 

Restructuring Charges

 

During 2019, restructuring charges of $5.0 million were incurred related to the closure of the Dongguan facility related to the reduction of 137 full time equivalents (“FTEs”) in China, including ongoing administrative staff charges to close the facility and certain provisions on property, plant and equipment, accounts receivable and inventory. In addition, restructuring charges of $3.0 million were incurred related to the reduction of 47 FTEs in U.S., 8 FTEs in Canada and 630 FTEs and contract employees in Mexico.

 

Interest Expense

 

Interest expense increased to $10.6 million in 2019 compared to $3.1 million in 2018. The increase was the result of a full twelve month period of interest incurred on the debt to finance the MCA Acquisition, in addition to higher average interest rates compared to the same period in 2018, driven by the higher interest on the term debt utilized to finance the MCA Acquisition. The weighted average interest rates with respect to the debt on our Credit Facilities was 11.2%. The weighted average interest rates with respect to the debt under our Credit Facilities was 6.5% for 2018.

 

Income Tax Expense

 

The net tax expense for 2019 of $0.8 million related to taxes incurred in Mexico due to profits in that jurisdiction in addition to minimum taxes and state taxes in the U.S. The current income tax expense of $0.9 million was partially offset by $0.1 million in deferred tax recovery recorded related to temporary differences on assets and liabilities in Mexico, which have resulted in an increase to the corresponding deferred tax asset.

 

 

Year ended December 30, 2018 compared to the year ended December 31, 2017

  

The industry sectors have been reclassified to align with the presentation in “—fiscal year ended December 29, 2019 compared to the fiscal year ended December 30, 2018.” 

 

Revenue  (in millions)

 

Industry Sector		Fiscal Year ended December 30, 2018								Fiscal Year ended December 31, 2017								Change
		$				%				$				%				$				%
Test and Measurement			45.8				21.2				26.3				18.9				19.5				74.1
Retail and Payment Systems			41.6				19.3				33.7				24.2				7.9				23.4
Telecom, Networking and Communications			37.4				17.3				25.2				18.1				12.2				48.4
Medical and safety			31.4				14.5				18.8				13.5				12.6				67.0
Industrial, Power and Clean Technology			28.3				13.1				13.7				9.9				14.6				106.6
Semiconductors			26.5				12.3				21.5				15.4				5.0				23.3
Avionics, Aerospace and Defense			5.1				2.3				—				—				5.1			100
Total			216.1				100				139.2				100				76.9				55.2

 

Total revenue increased by $76.9 million or 55.2% in 2018 compared to 2017. Volume increases with two long standing customers, serviced in the U.S. in the test and measurement sector, representing an increase in revenue of $8.7 million. An additional three retail and payment systems customers serviced in Mexico represented an increase in revenue of $9.0 million. Three telecom, networking and communications customers (one serviced in Mexico; two serviced in Asia) had increased volumes, combined with revenues from two new customers (one serviced in Asia; one serviced in the U.S.), represented increased revenues of $13.9 million.  One long standing customer serviced in Mexico in the semiconductor sector represented increased volumes resulting in $6.9 million of additional revenue. In the medical sector, one new customer (one serviced in the U.S.) represented increased revenues of $9.8 million. In the industrial, power and clean technology sector one customer serviced in Mexico had increased volumes offset with one customer serviced out of Asia that transferred its business to other contract manufacturers, represented an increase of $8.8 million in revenue.

 

With the acquisition of MCA, we reported additional revenue of $23.5 million from Acquisition Date through to December 30, 2018.  Revenue from the test and measurement sector represented $10.2 million, or 43.2% of this additional revenue, $4.7 million or 19.8% in the industrial, power and clean technology sector, $3.0 million or 12.9% in the medical sector, and $0.5 million or 2.3% in the telecom, networking and communications sector. The acquisition of MCA has also introduced us to the new sector in aerospace and defense that resulted in revenues of $5.1 million, or 21.8% of the additional revenue.

 

During 2018, the Company recorded approximately $4.1 million of sales of raw materials inventory to customers, which carried limited margin, compared to $2.8 million in 2017.

  

Due to changes in market conditions, the life cycle of products, the nature of specific programs and other factors, revenues from any particular customer typically vary from year to year. The Company’s ten largest customers represented 68.1% of revenue in 2018, compared to 72.5% in 2017. Revenue from our largest customer during 2018 was $23.5 million, representing 10.9% of revenue. This compared to revenue from our two largest customers during 2017 of $16.6 million and $16.5 million, both representing 11.9% of revenue. No other customer represented more than 10% of revenue in either year.

 

In addition to tracking our revenues based on industry sector, the Company also monitors revenue (as well as associated segment contribution margin) based on the geographic location of our operations, which in 2019 included Mexico, China and the U.S. This is consistent with how we report our segmented information, as set out in Note 11 to our consolidated financial statements. 

  

During 2018, 70.7% of our revenue was attributable to our operations in Mexico, 19.3% in the U.S. and 10.0% in China. During 2017, 71.5% of our revenue was attributable to our operations in Mexico, 15.1% in the U.S. and 13.4% in China.

 

 

Non-GAAP Financial Measures

 

To supplement our consolidated financial statements, which are prepared and presented in accordance with U.S. GAAP, we use the following non-GAAP financial measures: Adjusted Gross Margin, EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin 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. These non-GAAP measures are 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 with U.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.

 

Gross Profit

 

Gross profit increased to $21.7 million in 2018 from $10.8 million in 2017. Gross profit percentage increased to 10.0% in 2018 compared to 7.8% in the prior year. When excluding the impact of the unrealized foreign exchange gains on unsettled forward contracts and amortization of intangible assets the adjusted gross profit percentage increased to 10.3% in 2018 from 7.1% in the prior year. This increase in gross profit was primarily the result of increased revenues, impacting our Company’s ability to cover variable and fixed overhead costs in addition to improved product mix resulting in increased margins.

 

Adjusted Gross Profit

 

The Company calculates an adjusted gross profit amount as we consider 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. Below is the reconciliation from the financial statement presentation of gross profit to the non-GAAP measure of adjusted gross profit (in thousands):

 

		Year ended December 30, 2018				Year ended December 31, 2017
Gross profit		$	21,661			$	10,851
Add (deduct):
Amortization of intangible assets			1,065				—
Unrealized foreign exchange gain on unsettled forward foreign exchange contracts			(353	)			(918	)
Adjusted gross profit		$	22,373			$	9,933
Adjusted gross profit percentage			10.3	%			7.1	%

 

The Company entered into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican peso expenditures. These contracts are effective as hedges from an economic perspective, but do not meet the requirements for hedge accounting under ASC Topic 815 “Derivatives and Hedging”. Accordingly, changes in the fair value of these contracts are recognized in earnings in the consolidated statement of operations and comprehensive loss. Included in cost of sales in 2018 was a realized loss of $0.1 million compared to a realized loss of $0.1 million in 2017. In 2018, as a result of revaluing the outstanding forward contracts to fair value, an unrealized gain of $0.4 million was recorded compared to an unrealized gain of $0.9 million in 2017, which was included in cost of sales.

 

		December 30, 2018			December 31, 2017
Average USD:CAD contract rate			—			1.29
Average USD:CAD mark-to-market rate			—			1.26
Average USD:PESO contract rate			20.43			18.69
Average USD:PESO mark-to-market rate			19.66			20.11

 

 

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 on warrant liability, 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 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 loss, the closest GAAP measure, to EBITDA and Adjusted EBITDA (in thousands):

 

		Year ended December 30, 2018				Year ended December 31, 2017
Net loss		$	(448	)		$	(7,845	)
Reconciling items:
Depreciation of property, plant and equipment			3,791				3,588
Amortization of intangible assets			1,065				—
Interest			3,117				903
Income taxes			677				560
EBITDA		$	8,202			$	(2,794	)
Additional reconciling items:
Restructuring charges			172				1,732
Stock based compensation			407				432
Fair value adjustment of warrant liability			111				—
Merger and acquisitions related expenses			1,676				—
Unrealized foreign exchange gain on unsettled forward foreign exchange contracts			(353	)			(918	)
Adjusted EBITDA		$	10,215			$	(1,548	)
Adjusted EBITDA percentage		$	4.7	%		$	(1.1	)%

   

The improvement in Adjusted EBITDA was due primarily to the increase in revenue in 2018 by $76.9 million, or 55.2%, from 2017. The increase in revenue was primarily driven by the ability to cover our fixed costs and the additional incremental provisions and impairment charges incurred in the prior year.

  

Selling, General & Administrative Expenses

 

Selling, general and administrative expenses increased to $18.2 million in 2018 from $14.0 million in 2017. However, selling, general and administrative expenses decreased to 8.4% of revenue in 2018 down from 10.1% of revenue in 2017. The selling general and administrative expenses included $1.7 million of additional professional services related to the acquisition of MC Assembly. Additional stock based compensation was incurred for $0.1 million related to the valuation of the outstanding warrants issued to TCW.

 

Restructuring Charges

 

During 2018, restructuring charges of $0.2 million were incurred related to the closure of the Suzhou facility, including ongoing administrative staff charges to close the facility. In accordance with the restructuring plan effected in 2017, restructuring charges of $1.7 million were incurred related to the reduction of 49 full-time equivalents (“FTEs”) in Mexico, 102 FTEs in China, 22 FTEs in the U.S., and 10 FTEs in Canada. Additional charges were incurred related to the closure of the Suzhou facility, including ongoing administrative staff charges to close the facility.

 

Interest Expense

 

Interest expense increased to $3.1 million in 2018 compared to $0.9 million in 2017. The increase was primarily the result of a higher average debt balance in 2018 compared to 2017, specifically with $62.0 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 PNC Facility was 5.76% and TCW Facilities was 10.98%. The weighted average interest rates with respect to the debt on our predecessor PNC Facility was 4.90% for 2017.

  

Income Tax Expense

 

The net tax expense for 2018 of $0.8 million related to taxes incurred in Mexico due to profits in that jurisdiction in addition to minimum taxes and state taxes in the U.S. The current income tax expense of $0.9 million was partially offset by a $0.1 million deferred tax recovery recorded related to temporary differences on assets and liabilities in Mexico, which have resulted in an increase to the corresponding deferred tax asset.

 

On December 22, 2017, the Tax Cuts and Jobs Act ("TCJA") was enacted, which includes a broad range of tax reform proposals, with many provisions significantly differing from current U.S. tax law. Management has considered the impact of these provisions, including a decrease in the federal corporate income tax rate, from 35% to 21% for years beginning after December 31, 2017, substantially reducing the value of the Company's deferred tax assets. The Company has recorded a corresponding reduction to its deferred tax asset of $8.0 million as at December 31, 2017. The reduction in the Company's deferred tax assets was fully offset by a corresponding reduction to the valuation allowance. 

 

 

Off-Balance Sheet Arrangements

 

As of December 29, 2019 and December 30, 2018, we did not have any material off-balance sheet arrangements (as defined in Item 303(a)(4)(ii) of Regulation S-K). With the adoption of ASC 842, effective December 31, 2018 operating leases which were otherwise recorded as rental expenses as incurred for the year ended December 30, 2018 and previously are now also capitalized on the balance sheet as operating right of use assets and operating lease obligations.

  

Liquidity and Capital Resources

 

As at December 29, 2019, the Company’s liquidity is comprised of $1.4 million in cash on hand and $21.6 million of funds available to borrow under the PNC Facility which matures on November 8, 2023. The Company funds its operations by regularly utilizing its PNC Facility (refer to Note 5 of the consolidated financial statements included in Part IV of this Annual Report on Form 10-K). 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.

 

The following table summarizes cash flow changes for the following periods (in millions):

 

		Year ended December 29, 2019				Year ended December 30, 2018				Year ended December 31, 2017
Cash provided by (used in):
Operating activities		$	5.1			$	(7.7	)		$	(8.9	)
Financing activities			(1.4	)			75.8				7.0
Investing activities			(3.9	)			(72.0	)			(1.1	)
Decrease in cash			(0.2	)			(3.9	)			(3.0	)
Cash, beginning of year			1.6				5.5				8.5
Cash, end of the year		$	1.4			$	1.6			$	5.5

  

2019

 

Net cash provided by operating activities for 2019 was $5.1 million. This was mainly driven by net collections of accounts receivable of $3.1 million, reduced inventory balances compared to the prior year end of $5.4 million, partially offset by increased payments in accounts payable and accrued liabilities of $2.6 million and $2.5 million respectively.  Significant non-cash charges included in the net loss from operations when added back contributed to the cash flow from operations, which pertained to $7.2 million of intangible asset amortization, $6.5 million of depreciation of property, plant and equipment and $1.6 million in amortization of deferred financing fees partially offset by the add back of the gain on the contingent consideration of $3.1 million. Accounts receivable days reduced to 61 days in 2019 from 64 days in 2018 due to improved collections. Accounts payable days outstanding for 2019 decreased to 72 days versus 91 days for 2018, due to timing of payments. Inventory turnover was 4.3 times or 85 days in 2019 compared to 4.0 times or 91 days in 2018.

 

Net cash used from financing activities during 2019 was $1.4 million. During 2019, the Company generated net cash of $14.0 million from issuance of common stock through the Rights Offering. The Company received net advances from the PNC Facility of $9.7 million compared to $12.8 million for 2018. The Company paid down its long-term debt in the amount of $23.3 million and $8.0 million, respectively in 2019 and 2018. Principal repayments on finance lease obligations were $1.6 million in 2019 compared to $0.5 million in prior year. 

 

Cash used in investing activities for 2019 of $3.9 million in 2019 compared to $72.0 million in 2018 due to the acquisition of MCA in 2018 of $67.6 million and capital expenditures of $4.4 million.

  

2018

 

Net cash used by operating activities for 2018 was $7.7 million. The use of cash was mainly driven by increase of accounts receivable of $24.0 million, unbilled contract assets of $8.0 million and inventory of $8.0 million, partially offset from an increase in accounts payable of $23.7 million.  Accounts receivable days remained at 64 days in 2018 and 2017. Inventory turnover decreased to four times or 91 days in 2018 from seven times or 65 days in 2017. Accounts payable increased due to extended payment terms with some vendors, and timing of payments. Accounts payable days outstanding for 2018 increased to 91 days versus 65 days for 2017 due to timing of payments in addition to negotiated extended terms with a number of suppliers.

 

As at December 30, 2018, the Company’s liquidity is comprised of $1.6 million in cash on hand and $14.0 million of funds available to borrow under the PNC Facility.  The Company also has additional capacity of $5.0 million dollars available to draw from the Term Loan B Facility. 

 

Net cash provided by financing activities during 2018 was $75.8 million, consisting of TCW Facilities borrowing of $62.0 million partially offset by the repayment of the PNC Long-Term Debt Facility of $8.0 million. In addition, net cash advanced on the PNC Revolving Credit Facility of $12.8 million and proceeds from issuance of common stock of $12.6 million which was raised from the rights offering, partially offset by deferred financing cost and debt issuance cost of $3.5 million. Principal payments on finance lease obligations was $0.5 million in 2018.

 

Cash used in investing activities for 2018 of $72.0 million was due to MCA Acquisition in 2018 of $67.6 million and capital expenditures of $4.4 million.

 

 

2017

 

Net cash used by operating activities for 2017 was $8.9 million. The use of cash was mainly driven by a net loss from operations, in part due to cash severance and other charges of $1.7 million as a result of the 2017 restructuring plan. In addition it is the result of a reduction in gross profit due to reduced revenues, lower margin product mix and the resulting impact to cover fixed costs compared to the prior year. In addition, accounts receivables in 2017 included a small number of customers with aged receivables which increased the day sales outstanding, which reduced cash provided from accounts receivable. Accounts receivable days increased to 64 days in 2017 up from 49 days in 2016. Inventory turnover increased to six times or 65 days in 2017 from seven times or 49 days in 2016. Cash used from accounts receivable and inventory was partially offset from decreased payments of accounts payable of $2.2 million due in large part to the reduction in revenue resulting in a decrease in inventory purchases when compared to 2016. In addition, accounts payable increased due to extended payment terms with some vendors, and timing of payments effectively increasing cash year over year. Accounts payable days outstanding for 2017 increased to 65 days versus 55 days for 2016 due to timing of payments.

 

As at December 31, 2017, the Company’s liquidity is comprised of $5.5 million in cash on hand and $5.3 million of funds available to borrow under the PNC Revolving Credit Facility. As at January 1, 2017, the Company’s liquidity is comprised of $8.5 million in cash on hand and $7.4 million of funds available to borrow under the PNC Revolving Credit Facility.

 

Net cash provided by financing activities during 2017 was $7.0 million, consisting of cash advanced on the PNC revolver of $9.5 million partially offset by payments on the PNC Long-Term Debt Facility of $2.0 million. Principal payments on finance lease obligations was $0.4 million in 2017.

 

Cash used in investing activities for 2017 of $1.1 million was due to capital expenditures of $1.5 million partially offset by the proceeds of $0.3 million on the sale of property, plant and equipment.

  

Capital Resources

 

The Company borrows money under the 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 0.75% to 1.25%, or LIBOR plus an applicable margin ranging from 2.50% to 3.00%. The base commercial lending rate should approximate U.S. prime rate.

 

The Company also borrows money under the Financing Agreement, which governs a term loan A facility (“Term A Loan Facility” and, together with the PNC Facility, the “Credit Facilities”), and previously governed a term loan B facility (the “Term Loan B Facility”) until it was repaid in full on July 3, 2019 with a portion of the proceeds from the Offerings. The Term A Loan Facility matures on November 8, 2023 (the “Maturity Date”). The Term Loan A Facility bears interest LIBOR plus an applicable margin of 8.75% through June 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 before November 8, 2019, (ii) 2.00% in the event that such payment occurs after the November 8, 2019 and on or before November 8, 2020 and (iii) 1.00% in the event that such payment occurs after November 8, 2020 and on or before November 8, 2021. No such applicable premium is payable for any payment of loans made under the Term Loan A Facility occurring after November 8, 2021.

 

On August 8, 2019, the Company and certain of its subsidiaries entered into that certain Amendments No. 2 to the Amended and Restated Revolving Credit and Security Agreement (the “PNC Amendment No. 2”) and that certain Amendment No. 3. to the Financing Agreement (the “TCW Amendment No. 3”). The PNC Amendment No. 2, among other things, (i) increased the total amount available for borrowings under the PNC Facility to $65 million, (ii) provided for borrowings of up to $15 million on assets located in Mexico, (iii) provided that borrowings under the PNC Facility bear interest at the U.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%, (iv) reset the financial covenants, and (v) permitted the pay down of the Term A Loan Facility by up to $10 million. The TCW Amendment No. 3, among other things, (i) provided for a $20 million increase in the total amount available for borrowings under the PNC Facility, (ii) provided for the pay down of the Term A Loan Facility by up to $10 million, (iii) provided that the interest rate for borrowings under the Financing Agreement was reset to LIBOR plus an applicable margin of 8.75% through June 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%, (iv) deleted the senior leverage ratio covenant, (v) amended the total leverage ratio covenant, including the definition of total leverage ratio, to increase the maximum total leverage on a quarterly basis beginning with the fiscal quarter ended September 30, 2019, (vi) amended the fixed charge coverage ratio covenant to decrease the minimum fixed charge coverage ratio on a quarterly basis beginning with the fiscal quarter ending September 30, 2020 through the fiscal quarter ending December 31, 2021 and (vii) reset the call protection on the Term Loan A Facility.

 

 

On September 27, 2019, the Company and certain of its subsidiaries entered into that certain Amendments No. 3 to the Amended and Restated Revolving Credit and Security Agreement (the “PNC Amendment No. 3”) and that certain Amendment No. 4. to the Financing Agreement (the “TCW Amendment No. 4”). The PNC Amendment No. 3, among other things, amended the (i) definition of “Consolidated EBITDA” by permitting an addback for restructuring and transition costs and charges incurred on or before December 31, 2020 in connection with the Company’s previously announced closure of business operations in Dongguan, China, subject to certain exceptions, not to exceed (a) with respect to cash restructuring costs, $2.3 million, (b) with respect to write-offs of accounts receivable, $1.6 million, and (c) with respect to write-offs of Inventory (as defined in the Amended and Restated Revolving Credit and Security Agreement), $1.6 million, (ii) definition of “Permitted Intercompany Investments” by permitting certain investments by a Domestic Loan Party (as defined in the Amended and Restated Revolving Credit and Security Agreement) to or in SMTC Electronics Dongguan Company Limited, a limited liability company organized under the laws of China (“SMTC Dongguan”), solely to facilitate the closure of business operations in Dongguan, China, so long as, among other things, (a) such Investments (as defined in the PNC Agreement) are made prior to March 31, 2020, (b) the aggregate amount of all such Investments does not exceed $2.3 million during the term of the Amended and Restated Revolving Credit and Security Agreement, (c) the Borrowers (as defined in the Amended and Restated Revolving Credit and Security Agreement) maintain certain minimum liquidity requirements and (iii) negative covenant regarding excess cash. The TCW Amendment No. 4, among other things, amended the (i) definition of “Consolidated EBITDA” by permitting an addback for restructuring and transition costs and charges incurred on or before December 31, 2020 in connection with the closure of business operations in Dongguan, China, subject to certain exceptions, not to exceed (a) with respect to cash restructuring costs, $2.3 million, (b) with respect to write-offs of accounts receivable, $1.6 million, and (c) with respect to write-offs of Inventory (as defined in the Financing Agreement), $1.6 million, (ii) definition of “Permitted Intercompany Investments” by permitting certain investments by a Domestic Loan Party (as defined in the Financing Agreement) to or in SMTC Dongguan solely to facilitate the closure of business operations in Dongguan, China, so long as, among other things, (a) such Investments (as defined in the Financing Agreement) are made prior to March 31, 2020, (b) the aggregate amount of all such Investments does not exceed $2.3 million during the term of the Financing Agreement and (c) the Borrowers (as defined in the Financing Agreement) maintain certain minimum liquidity requirements and (iii) negative covenant regarding excess cash.

 

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 is in compliance with the financial covenants included in the Credit Facilities as at December 29, 2019. Management projects compliance with the financial covenants included in the Credit Facilities.

 

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 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, there 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.

 

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 $14.0 million, after deducting the offering expenses and fees payable the Company. The proceeds of the Offerings were used, in part, to repay the Term Loan B Facility in full as at July 3, 2019.

  

 

Accounting changes and recent accounting pronouncements

  

Recently adopted Accounting Pronouncements

  

In February 2016, the FASB published ASU 2016-02: Leases (Topic 842). The amendment requires that all lessees should recognize the assets and liabilities that arise from leases. Elections may be available for those leases with terms of 12 months or less. The amendment still retains the distinction between finance leases and operating leases. In July 2018, the FASB published ASU 2018-10 (Topic 842). The update provides codification improvements to the application of the standard. In July 2018, the FASB published ASU 2018-11 (Topic 842). The update provides clarification on comparative reporting at time of adoption, specifically this amendment allows an entity initially applying the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings. Accordingly, comparative periods will continue to be presented in accordance with current GAAP. The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842), as of December 31, 2018, using the modified retrospective approach, which allows comparative periods not to be restated. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which, among other things, allowed the Company to carry forward the historical lease classification, not reassess whether any expired or existing contracts are or contain leases and not to reassess initial direct costs for any existing leases. The Company also elected the hindsight expedient to determine the lease terms for existing leases. The election of the hindsight expedient did not have a significant impact on the calculation of the expected lease term.

 

In June 2018, the Financial Accounting Standards Board (the “FASB”) published ASU 2018-07: Compensation – Stock Compensation (Topic 718): Improvements to Non-employee Share-Based Payment Accounting. The amendment simplifies the application of share-based payment accounting for non-employees. The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The impact of the adoption of the standard did not have a material impact on the consolidated financial statements.

 

Recent Accounting Pronouncements Not Yet Adopted

 

In May 2016, the FASB published ASU 2016-13 Financial Instruments – Credit losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The main objective of Topic 326 is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. In April 2019, the FASB published ASU 2019-04 Codification Improvements to Topic 326, Financial Instruments – Credit Losses, which made certain amendments and corrections to the original codification. In May 2019, the FASB published ASU 2019-05 Financial Instruments – Credit losses (Topic 326) which made transitional relief available, specifically allowing the option to elect a fair value option for financial instruments measured at amortized cost. In November 2019, the FASB published ASU 2019-11 Codification Improvements to Topic 326, Financial Instruments – Credit losses, which made certain amendments and corrections to the original codification. The amendment is effective for years beginning after December 15, 2019 including interim periods with those years. The Company is currently evaluating the impact of this accounting standard.

 

In December 2019, the FASB published ASU 2019-12: Income Taxes (Topic 740): Simplifying the Accounting for income taxes. The purpose of this codification is the simply the accounting for income taxes, which addresses a number of topics including but not limited to the removal of certain exceptions currently included in the standard related to intraperiod allocation when there are losses, in addition to calculation of income taxes when current year to date losses exceed anticipated loss for the year. The amendment also simplifies accounting for certain franchise taxes and disclosure of the effect of enacted change in tax laws or rates. Topic 740 is effective for public entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The impact of the adoption of the standard has not yet been determined and is being evaluated.

 

In January 2017, the FASB published ASU 2017-04: Intangibles – Goodwill and Other (Topic 350): Topic 350 seeks to simplify goodwill impairment testing requirements for public entities. Under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The FASB also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently evaluating the impact of this accounting standard. however it is expected that this may reduce the complexity of evaluating goodwill for impairment.

 

In August 2018, the FASB published ASU 2018-13: Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. Topic 820 includes the removal, modification and additional of disclosure requirements. Topic 820 is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The impact of the adoption of the standard is not expected to have a material impact on the consolidated financial statements.

  

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Note 3 to the consolidated financial statements describe the significant accounting policies and methods used in the preparation of our consolidated financial statements. The following critical accounting policies are affected significantly by judgments, assumptions and estimates used in the preparation of the consolidated financial statements. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.  

 

Impairment of Property, plant and equipment

 

We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with subtopic 10 of ASC 360, “Property, Plant and Equipment”. Under ASC 360-10 assets must be classified as either held-for-use or held-for-sale. An impairment loss is recognized when the carrying amount of an asset that is held and used exceeds the projected undiscounted future net cash flows expected from its use and disposal, and is measured as the amount by which the carrying amount of the asset exceeds its fair value, which is measured by discounting cash flows when quoted market prices are not available. For assets held-for-sale, an impairment loss is recognized when the carrying amount exceeds fair value less costs to dispose.

 

Deferred Tax Asset Valuation Allowance

 

In assessing the realization of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Guidance under ASC 740 states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence, such as cumulative losses in recent years in the jurisdictions to which the deferred tax assets relate. Based upon consideration of these factors, management believes the recorded valuation allowance related to all of its deferred tax assets arising in Canada, United States and Asia is appropriate. There is no valuation allowance related to deferred tax assets in Mexico.

 

Estimate of percentage completion on satisfying performance obligations

 

The Company records an unbilled contract asset for revenue related to its WIP when the manufacturing process has commenced and there is a non-cancellable customer purchase order. The Company uses direct manufacturing inputs, to estimate the percentage of completion in satisfying its performance obligation associated with WIP inventory. If assumptions change related to the inputs or outputs utilized to estimate the performance obligation associated with WIP inventory, this could have a material impact on the revenue and corresponding margin recognized.

 

Inventory valuation

 

Raw material inventories are valued, on a first-in, first-out basis, at the lower of cost and replacement cost. The Company writes down estimated obsolete or excess inventory for the difference between the cost of inventory and estimated net realizable value based upon customer forecasts, shrinkage, the aging and future demand for the inventory, past experience with specific customers, and the ability to sell inventory back to customers or return to suppliers. If these assumptions change, additional write-downs may be required. Parts and other inventory items relate to equipment servicing parts that are capitalized to inventory and expensed as utilized to service the equipment.

 

 

Business Combinations

 

The acquisition method of accounting is used to account for business combination. The consideration transferred in a business combination is measured at fair value at the date of acquisition. Acquisition-related transaction costs are recognized in the consolidated statements of loss and comprehensive loss as incurred. At the acquisition date, the identifiable assets acquired and the liabilities assumed are initially recognized at their fair value. Goodwill is measured as the excess of the sum of the consideration transferred and the fair value of the acquirer’s previously held equity interest in the acquire (if any) over the new of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed. When the consideration transferred by the Company in a business combination includes assets or liabilities resulting from a contingent consideration arrangement, the contingent consideration is measured at its acquisition date fair values of the identifiable assets, liabilities and contingent consideration that qualify as measurement period adjustments are adjusted retrospectively, with corresponding adjustments against goodwill. Measurement period adjustments are adjustments that arise from additional information obtained during the measurement period (which cannot exceed one year from the acquisition date) about facts and circumstances that existed at the acquisition date.

 

Other measurement period adjustments, contingent considerations that is classified as a financial liability is re-measured at subsequent reporting period, with the corresponding gain or loss recognized in the consolidated statement of loss and comprehensive loss.

 

Goodwill

 

Goodwill represents the excess of purchase price over the fair value of net identifiable assets acquired in a purchase business combination. Goodwill is not subject to amortization and is tested for impairment annually or more frequently if events or circumstances indicate that the asset might be impaired. The Company assigns its goodwill to the reporting units (or groups of reporting units that have similar economic characteristics) that are expected to benefit from the synergies of the business combination and at least on an annual basis at the end of the fourth quarter, performs a qualitative assessment of its reporting units goodwill and certain select quantitative calculations against its current long-range plan to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. The Company first assesses certain qualitative factors to determine whether the existence of events or circumstances leads to determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carry amount, then performing the two-step impairment test is unnecessary. When necessary, impairment of goodwill is tested at the reporting unit level (or group of reporting units) by comparing the reporting unit’s (or group of reporting units) carrying amount, including goodwill, to the fair value of the reporting unit (or group of reporting units). The fair value of the reporting unit (or group of reporting units) is estimated using a discounted cash flow approach. If the carrying amount of the reporting unit (or group of reporting units) exceeds its fair value, then a second step is performed to measure the amount of impairment loss, if any, by comparing the fair value of each identifiable asset and liability in the reporting unit (or group of reporting units) to the total fair value of the reporting unit (or group of reporting units). Any impairment loss is expensed in the consolidated statement of operations and is not reversed if the fair value subsequently increases.

 

Intangible assets

 

Intangible assets acquired in a business combination are recognized at fair value using generally accepted valuation methods appropriate for the type of intangible asset and reported separately from goodwill. Purchased intangible assets other than goodwill are amortized over their useful lives unless these lives are determined to be indefinite. Purchased intangible assets are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally one to ten years. The Company periodically re-assesses the useful lives of its intangible assets when events or circumstances indicate that useful lives have significantly changed from the previous estimate. Definite-lived intangible assets consist primarily of customer relationships, order backlog, trade name and non-compete agreements. They are generally valued as the present value of estimated cash flows expected to be generated from the asset using a risk-adjusted discount rate. When determining the fair value of our intangible assets, estimates and assumptions about future expected revenue and remaining useful lives are used. Intangible assets are tested for impairment on an annual basis and during interim periods if indicators of impairment exist, and written down when impaired.

 

Amortization is generally calculated on a straight-line basis over the expected useful lives as follows:

 

Customer relationships (years)	10
Order backlog (years)	1.5
Trade name (years)	1
Non-compete agreements (years)	2

 

 

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

  

Interest Rate Risk

 

The Company borrows money under the 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 0.75% to 1.25%, or LIBOR plus an applicable margin ranging from 2.50% to 3.00%. The base commercial lending rate approximates U.S. prime rate.

 

The Company also borrows money under the Financing Agreement. The Term Loan A Facility matures on November 8, 2023. The Term Loan A Facility bears interest LIBOR plus an applicable margin of 8.75% through June 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%. In July 2019, the Company paid the Term Loan B Facility in full. In August 2019, the Company paid $10.0 million off the Term Loan A Facility.. 

 

The impact of a 10% change in interest rates would have a material impact on our reported earnings.

 

10% increase in interest rate (millions)		$	0.6
10% decrease in interest rate (millions)		$	(0.6)

 

Foreign Currency Exchange Risk

 

Given our global business operations, we are exposed to exchange rate fluctuations on expenditures denominated in foreign currencies. However, most of our sales and component purchases are denominated in U.S. dollars, which limits our foreign currency risk. Our foreign exchange risk relates primarily to our Canadian and Mexican payroll, Euro based component purchases and other operating expenses denominated in local currencies in our geographic locations. To mitigate this risk, the Company enters into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican peso. The strengthening of the Canadian dollar and Mexican peso would result in an increase in costs to the organization and may lead to a reduction in reported earnings.

 

The impact of a 10% change in exchange rates would be estimated to have the following impact on cost of sales for the Company:

 

10% increase in both the CAD and PESO foreign exchange rates (millions)		$	2.3
10% decrease in both the CAD and PESO foreign exchange rates (millions)		$	(2.9)

 

Credit Risk

 

In the normal course of operations, there is a risk that a counterparty may default on its contractual obligations to us which would result in a financial loss that could impact our reported earnings. In order to mitigate this risk, we complete credit approval procedures for new and existing customers and obtain credit insurance where it is financially viable to do so given anticipated revenue volumes, in addition to monitoring our customers’ financial performance. We believe our procedures in place to mitigate customer credit risk and the respective allowance for doubtful accounts are adequate. During the year ended December 29, 2019, the Company recorded an additional provision for bad debt expense of $2.2 million predominantly related to one customer because of the closure of the Dongguan manufacturing facility, which has been included within the restructuring charges in 2019. The Company takes measures to reduce credit risk, these charges can have a material impact on our financial performance.

 

There is limited risk of financial loss of defaults on our outstanding forward currency contracts as the counterparty to the transactions had a Standard and Poor’s rating of A- or above as at December 29, 2019.

 

 

Liquidity Risk

 

There is a risk that we may not have sufficient cash available to satisfy our financial obligations as they come due. The financial liabilities we have recorded in the form of accounts payable, accrued liabilities and other current liabilities are primarily due within 90 days with the exception of the current portion of finance lease obligations which could exceed 90 days and our PNC Facility which utilizes a lock-box to pay down the obligation effectively daily. As at December 29, 2019, the Company’s liquidity was comprised of $1.4 million in cash on hand and $21.6 million of funds available to borrow under the PNC Facility. We believe that cash flow from operations, together with cash on hand and our PNC Facility, which has a maximum credit limit of $65.0 million is sufficient to fund our financial obligations. However, availability under the PNC Facility is subject to certain conditions, including borrowing base conditions based on eligible inventory and accounts receivable, as determined by the lender, and is currently limited to $21.6 million.

 

On July 3, 2019, the Company used the net proceeds from the Rights Offering to repay the $12.0 million of borrowings outstanding under its Term Loan B Facility. On August 8, 2019, the Company paid down $10.0 million of borrowings outstanding under its Term Loan A Facility, funded through the use of its PNC Facility.

 

Fair Value Measurement

 

The carrying values of the Company’s cash, accounts receivable, accounts payable and accrued liabilities due within one-year approximate fair values due to the short-term maturity of these instruments. The Company’s financial instruments are comprised of the following:

 

		As at December 29, 2019								As at December 30, 2018
		Carrying Amount				Estimated Fair Value				Carrying Amount				Estimated Fair Value
Level 1
Cash		$	1,368			$	1,368			$	1,601			$	1,601
Level 2
Revolving credit facility			34,701				34,701				25,020				25,020
Current and long term debt			35,000				38,750				57,407				62,000
Warrant liability			1,730				1,730				2,009				2,009
Level 3
Contingent consideration			—				—				3,050				3,050

 

Item 8.

Financial Statements and Supplementary Data

 

The information called for by this item is indexed on page F-1 of this Report and is contained on pages F-2 through F-34.

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.

Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K.    Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of December 29, 2019 due to a material weakness in internal control over financial reporting, described below.

 

Management’s Annual Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in rules 13a-15(f) of the Exchange Act.  Under Section 302 of the Sarbanes-Oxley Act of 2002 management is required to certify that we have designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. In addition, for fiscal 2019, as our market capitalization exceeded $75 million as of the last business day of our most recently completed second fiscal quarter, we were, for the first time, required to have our external auditor attest to and report on management's assessment of our internal accounting controls as of December 29, 2019 pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002.  

 

The Company’s internal control over financial reporting is a process designed by, or under the supervision of, the Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, and effected by the Company’s Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with United States generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the U.S., and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

 

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Furthermore, projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management conducted an assessment of the Company’s internal control over financial reporting based on the framework established by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in Internal Control—Integrated Framework (2013). Based on this assessment, management has concluded that, as at December 29, 2019, the Company’s internal control over financial reporting were not effective.

 

Specifically, we identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over the information technology (IT) systems that support the Company’s financial reporting processes. Our business process controls (automated and manual) that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted.  A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.  The material weakness did not result in any identified misstatements to the financial statements, and there were no changes to previously released financial results. Based on this material weakness, the Company’s management concluded that at December 29, 2019, the Company’s internal control over financial reporting was not effective.

 

We believe that these control deficiencies were the result of: lack of proper training and understanding with respect to the control owners; insufficient documentation clearly outlining and defining the established user roles within the key systems; insufficient documentation and tracking or logging of changes completed throughout the assessment period; insufficient training of IT personnel on the importance of ITGCs with respect to the control environment; and risk-assessment processes inadequate to identify and assess changes in IT environments that could impact internal control over financial reporting.

 

Following identification of the material weakness and prior to filing this Annual Report on Form 10-K, we completed substantive procedures for the fiscal year ended December 29, 2019. Based on these procedures, management believes that our consolidated financial statements included in this Form 10-K have been prepared in accordance with U.S. GAAP. Our CEO and CFO have certified that, based on their knowledge, the financial statements, and other financial information included in this Form 10-K, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this Form 10-K.

 

PricewaterhouseCoopers LLP, an independent registered public accounting firm, is responsible for auditing (i) the financial statements to obtain reasonable assurance about whether they are free of material misstatement, and (ii) the effectiveness of the Company’s internal control over financial reporting as of December 29, 2019.  PricewaterhouseCoopers LLP did not identify any material misstatements with its audit of the Company’s financial statements and issued an unqualified opinion on the financial statements in their report dated March 13, 2020.  Due to the material weakness in internal controls, PricewaterhouseCoopers LLP issued an adverse opinion on the internal controls thereon, as stated in their report dated March 13, 2020, which appears in Item 8 of Part II of this Form 10-K.

 

Remediation

 

Management has been implementing and continues to implement measures designed to ensure that control deficiencies contributing to the material weakness are remediated, such that these controls are designed, implemented, and operating effectively. The remediation actions include: (i) developing a training program addressing ITGCs and policies, including educating control owners concerning the principles and requirements of each control, with a focus on those related to user access and change-management over IT systems impacting financial reporting; (ii) developing and enhancing documentation on user roles and access rights within the key systems; (iii) developing enhanced risk assessment procedures and controls related to changes in IT systems; (iv) implementing a management review and testing plan to monitor ITGCs with a specific focus on systems supporting our financial reporting processes; and (v) expanding the change management policy, clearly defining what constitutes a system change that requires proper testing, approval and documentation; and (vi) enhanced quarterly reporting on the remediation measures to the Audit Committee of the Board of Directors.

 

We believe that these actions will remediate the material weakness. The material weakness will not be considered remediated, however, until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed by mid-2020.

 

Changes in Internal Control over Financial Reporting

 

Except for the material weakness identified during the fiscal quarter ended December 29, 2019, as of December 29, 2019, there were no changes in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended December 29, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B.

Other Information

 

None. 

 

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

 

EXECUTIVE OFFICERS AND DIRECTORS

 

Our executive officers and directors and their ages as of March 13, 2020, are as follows:

 

Name		Age		Office/Title
Clarke H. Bailey		65		Chair of the Board of Directors
David Sandberg		47		Director
Frederick Wasserman		65		Director
J. Randall Waterfield		46		Director
Edward Smith		57		President, Chief Executive Officer, and Director
Richard Fitzgerald		52		Chief Operating Officer
Steve Waszak		62		Chief Financial Officer

 

 

Clarke H. Bailey joined our Board in June 2011. Mr. Bailey served as executive chairman (“Executive Chairman”) and interim Chief Financial Officer (“CFO”) of our Company from May 2013 to April 2014. Mr. Bailey is presently the Chairman and Chief Executive Officer (“CEO”) of EDCI Holdings, Inc., a holding company, a position held since 2009. In addition to his position at EDCI, he serves as a director of Iron Mountain Incorporated where he has served since 1998 and is currently Chairman of its risk and safety committee. Previously, Mr. Bailey served as the Chairman and CEO of Arcus, Inc. until 1998 and as managing director and head of the Principal Investment Group at Oppenheimer & Co. until 1990. Mr. Bailey has also previously served as a director on four (4) other public company boards, five (5) private company boards, and three (3) non-profit boards of trustees. Our Board believes that his significant experience in manufacturing, finance, and M&A, and serving as a CEO and on both public and private boards, make him well-qualified to serve as a director.

 

David Sandberg joined our Board in April 2009. Mr. Sandberg is the managing member of Red Oak Partners, LLC, which he founded in March 2003.  Previously, Mr. Sandberg co-managed JH Whitney & Co’s Green River Fund, where he was employed from 1998 to 2002. Mr. Sandberg serves as the chairman of the board of directors of Asure Software, Inc. and Cord Blood America, Inc., both of which are public companies. He also serves as a director of WTI Holdings, LLC, and WO Partners, LLC, both are private companies. Mr. Sandberg has previously served as a director of the public companies EDCI, Inc., RF Industries, Ltd., Issuer Direct Corp., and Planar Systems, Inc. Mr. Sandberg has experience serving as a member of and as chairman of each of the audit, compensation, nominating and governance, and strategic committees for public companies. He received a B.A. in Economics and a B.S. in Industrial Management from Carnegie Mellon University in 1994. Red Oak Partners, LLC is the largest Stockholder of our Company. Our Board believes that Mr. Sandberg’s experience serving as director on other public companies, as well has his experience in finance and public company capital market transactions, make him well-qualified to serve as a director.

 

Frederick Wasserman joined our Board in August 2013. Mr. Wasserman is a seasoned executive who has over forty (40) years of business experience helping to create stockholder value with a number of companies. Mr. Wasserman has been the President, Chief Operating Officer (“COO”), and CFO for a number of companies, including Mitchell & Ness Nostalgia Company where he was CFO and COO. He also served as President and CFO of Goebel of North America. Mr. Wasserman is currently, and has been since 2008, the President of FGW Partners LLC. Mr. Wasserman served as the Chief Compliance Officer of Wynnefield Capital, Inc., a Stockholder of our Company from 2008 to January 1, 2020. He continues to provide consulting services to Wynnefield Capital, Inc. He served on the board of directors for National Holdings Corporation from October 2013 to September 2016. Mr. Wasserman currently serves as a member of the board of directors of Marker Therapeutic, Inc. (formerly known as Tapimmune Inc.), a position held since January 2016. Mr. Wasserman served as a director of MAM Software Group, Inc. and MAM Software Group, Inc. until October 2019. Mr. Wasserman continues to serve as a director of DLH Holdings Corp., which is a publicly-traded company. Our Board believes that Mr. Wasserman’s experience serving as a director on publicly-traded companies and his significant management experience make him well-qualified to serve as a director.

 

J. Randall Waterfield joined our Board in April 2012. Mr. Waterfield is the chairman of Waterfield Group, a diversified financial services holding company that traces its origins back to 1928. After selling the largest private mortgage company in the U.S. and largest Indiana-based bank in 2006 and 2007, respectively, Waterfield Group has diversified into technology, real estate, asset management, and merchant banking. Mr. Waterfield holds the Chartered Financial Analyst designation, and is the 2017-18 chairman of the board of directors of YPO, a member of Mensa, and a graduate of Harvard University. Also, Mr. Waterfield currently serves on the board of directors of Waterfield Group and its affiliates, Environmental Risk Transfer and Asure Software Inc. Previously, Mr. Waterfield was an equity research analyst at Goldman Sachs & Co. from 1996 through 1999, where he was primarily responsible for small capitalization growth portfolios. Our Board believes that Mr. Waterfield’s experience in finance and M&A make him well-qualified to serve as a director.

 

 

Edward Smith joined our Company and Board in February 2017. He currently serves as our Company’s President and CEO, a position he has held since May 2017. From February 2017 to May 2017, Mr. Smith served as interim President and CEO of our Company. Mr. Smith has extensive experience in the EMS industry and the electronic components distribution industry. He served as a member of the board of advisors of Zivelo, Inc., a position he held from 2015 to 2019. Most recently, Mr. Smith served as Senior Vice President of Global Embedded Solutions at Avnet, Inc. during 2016 and as President of Avnet Electronics Marketing Americas from February 2009 to March 2016. Mr. Smith worked in many positions during his tenure at Avnet, Inc., which began in 1994. From 2002 to 2004, Mr. Smith served as President and CEO of SMTEK International, Inc., a tier II manufacturer in the EMS industry. From 2009 to 2017, Mr. Smith served as a Board member of the Electronic Components Industry Association. Mr. Smith is also the founder and CEO of We Will Never Forget Foundation, Inc., a nonprofit organization that supports first responders through gifts to other charitable organizations. Our Board believes that Mr. Smith’s extensive experience in the EMS industry and as an executive officer of various other companies, make him well-qualified to serve as a director.

 

Rich Fitzgerald joined our Company in June 2017. He currently serves as our Company’s COO. Mr. Fitzgerald honorably served twelve (12) years in the U.S. Marine Corps where he reached the rank of captain. Prior to joining our Company, Mr. Fitzgerald served as Global Vice President of Avnet Integrated Solutions from January 2017 to May 2017 and as Vice President of Business Operations of Avnet Electronics Embedded from July 2014 to January 2017. Prior