UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


  

FORM 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 

 

 

 

For the quarterly period ended March 29, 2020

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

FOR THE TRANSITION PERIOD FROM                 TO

 

COMMISSION FILE NUMBER 000-31051

 


 

SMTC CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 


 

DELAWARE

98-0197680

(STATE OR OTHER JURISDICTION OF 

INCORPORATION OR ORGANIZATION)

(I.R.S. EMPLOYER IDENTIFICATION NO.)

 

7050 WOODBINE AVENUE

MARKHAM, ONTARIO, CANADA L3R 4G8

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

 

(905) 479-1810

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock

SMTX

Nasdaq Global Select Market

 

 


Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an “emerging growth company”. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer    ☐        Accelerated filer    ☒        Non-accelerated filer    ☐        Smaller reporting company    ☒   Emerging growth company    ☐        

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

 

As of May 7, 2020, SMTC Corporation had 28,214,800 shares of common stock, par value $0.01 per share, outstanding.

 



 

 

 

   

 

SMTC CORPORATION

 

Table of Contents

 

PART I FINANCIAL INFORMATION

3

  

  

  

Item 1

Financial Statements

3

  

  

  

 

Interim Consolidated Balance Sheets (unaudited)

3

  

  

  

 

Interim Consolidated Statements of Operations and Comprehensive Income (unaudited)

4

  

  

  

 

Interim Consolidated Statements of Changes in Shareholders’ Equity (unaudited) 

5

  

  

  

 

Interim Consolidated Statements of Cash Flows (unaudited)

6

  

  

  

 

Notes to Interim Consolidated Financial Statements (unaudited)

7

  

  

  

Item 2

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

24

  

  

  

Item 3

Quantitative and Qualitative Disclosures About Market Risk

32

  

  

  

Item 4

Controls and Procedures

34

  

  

PART II OTHER INFORMATION

34

  

  

  

Item 1A

 Risk factors

34

 

 

 

Item 6

Exhibits

35

  

2

 

 

Part I FINANCIAL INFORMATION

 

Item 1 Financial Statements

 

Interim Consolidated Balance Sheets:

(Expressed in thousands of U.S. dollars)

(Unaudited)

 

   

March 29,

2020

   

December 29,

2019

 

Assets

               

Current assets:

               

Cash

  $ 1,354     $ 1,368  

Accounts receivable — net (note 3)

    70,613       69,919  

Unbilled contract assets (note 3)

    28,779       26,271  

Inventories (note 3)

    43,321       47,826  

Prepaid expenses and other assets

    6,393       7,044  

Income taxes receivable

    160        

Total current assets

    150,620       152,428  
                 

Property, plant and equipment — net (note 3)

    24,410       25,310  

Operating lease right of use assets — net (note 3)

    6,588       3,330  

Goodwill (note 3)

    18,165       18,165  

Intangible assets — net (note 3)

    11,229       12,747  

Deferred income taxes — net

    525       540  

Deferred financing costs — net

    804       859  

Total assets

  $ 212,341     $ 213,379  
                 

Liabilities and Shareholders’ Equity

               

Current liabilities:

               

Revolving credit facility (note 4)

  $ 33,340     $ 34,701  

Accounts payable

    67,736       74,126  

Accrued liabilities (note 3)

    14,702       11,164  

Warrant liability (note 4)

    1,213       1,730  

Restructuring liability (note 11)

    887       1,597  

Derivative liabilities (note 9)

    512        

Income taxes payable

    276       157  

Current portion of long-term debt (note 4)

    1,562       1,250  

Current portion of operating lease obligations

    1,566       1,128  

Current portion of finance lease obligations

    1,166       1,226  

Total current liabilities

    122,960       127,079  
                 

Long-term debt (note 4)

    33,365       33,750  

Operating lease obligations

    5,446       2,615  

Finance lease obligations

    8,536       8,838  

Total liabilities

    170,307       172,282  
                 

Shareholders’ equity:

               

Capital stock (note 5)

    508       508  

Additional paid-in capital

    293,551       293,389  

Deficit

    (252,025 )     (252,800

)

      42,034       41,097  

Total liabilities and shareholders’ equity

  $ 212,341     $ 213,379  

 

Commitments (note 11)

 

See accompanying notes to interim consolidated financial statements.

 

3

 

 

Interim Consolidated Statements of Operations and Comprehensive Income

 

(Expressed in thousands of U.S. dollars, except number of shares and per share amounts)

(Unaudited)

 

   

Three months ended

 
   

March 29,

2020

   

March 31,

2019

 

Revenue (note 3)

  $ 95,138     $ 102,649  

Cost of sales (note 9)

    85,499       94,025  

Gross profit

    9,639       8,624  
                 

Selling, general and administrative expenses

    7,219       6,799  

Change in fair value of contingent consideration

          (3,050

)

Restructuring charges (recovery) (notes 3 and 10)

    (221 )     624  

Operating income

    2,641       4,251  

Change in fair value of warrant liability (note 4)

    (517 )     (101 )

Interest expense (note 3)

    2,093       2,870  

Net income before income taxes

    1,065       1,482  

Income tax expense (recovery) (note 6):

               

Current

    275       279  

Deferred

    15       (8

)

      290       271  

Net income and comprehensive income

    775       1,211  

Net income per share:

               

Basic

  $ 0.03     $ 0.05  

Diluted

  $ 0.03     $ 0.05  

Weighted average number of shares outstanding (note 7):

               

Basic

    28,195,300       23,248,918  

Diluted

    29,228,403       24,465,435  

 

See accompanying notes to interim consolidated financial statements.

 

4

 

 

Interim Consolidated Statements of Changes in Shareholders’ Equity

(Expressed in thousands of U.S. dollars)

 

Three months ended March 29, 2020

(Unaudited)

 

   

Common

Shares

   

Capital
stock

   

Additional
paid-in
capital

   

Deficit

   

Total
Shareholders’
equity

 

Balance, December 29, 2019

    28,195,300       508       293,389       (252,800

)

    41,097  
                                         

Stock-based compensation

                162             162  

Net income

                      775       775  

Balance, March 29, 2020

    28,195,300       508       293,551       (252,025 )     42,034  

 

 

Three months ended March 31, 2019

(Unaudited)

 

   

Common

Shares

   

Capital
stock

   

Additional
paid-in
capital

   

Deficit

   

Total
Shareholders’
equity

 

Balance, December 30, 2018

    23,189,381       458       278,648       (246,805

)

    32,301  

RSU vested and issued in common shares

    164,177       2       (2 )            

Stock-based compensation

                88             88  

Net income

                      1,211       1,211  

Balance, March 31, 2019

    23,350,558       460       278,734       (245,594

)

    33,600  

 

See accompanying notes to interim consolidated financial statements.

  

5

 

 

Interim Consolidated Statements of Cash Flows

(Expressed in thousands of U.S. dollars)

(Unaudited)

 

   

Three months ended

 
   

March 29,

2020

   

March 31,

2019

 

Cash provided by (used in):

               

Operations:

               
                 

Net income

  $ 775     $ 1,211  
                 

Items not involving cash:

               
                 

Depreciation of property, plant and equipment

    1,603       1,627  

Amortization of intangible assets

    1,518       1,844  

Unrealized foreign exchange loss on unsettled forward exchange contracts

    512        
                 

Deferred income taxes (recovery)

    15       (8

)

Amortization of deferred financing fees

    294       271  

Stock-based compensation

    162       88  

Change in fair value of warrant liability

    (517 )     (101

)

Change in fair value of contingent consideration

          (3,050

)

                 

Change in non-cash operating working capital:

               

Accounts receivable

    (694 )     (1,194

)

Unbilled contract assets

    (2,508 )     (3,803

)

Inventories

    4,505       4,543  

Prepaid expenses and other assets

    651       (1,067

)

Income taxes receivable/payable

    (41 )     29  

Accounts payable

    (6,196 )     1,970  

Accrued liabilities

    3,475       242  

Restructuring liability

    (644 )     244  

Net change in operating lease right of use asset and liability

    11        
      2,921       2,846  

Financing:

               

Repayments of revolving credit facility

    (1,361 )     (1,384

)

Repayment of long-term debt

    (312 )     (313

)

Principal repayments of finance lease obligations

    (362 )     (417

)

      (2,035 )     (2,114

)

Investing:

               

Purchase of property, plant and equipment

    (900 )     (737

)

      (900 )     (737

)

                 

Decrease in cash

    (14 )     (5 )

Cash, beginning of period

    1,368       1,601  

Cash, end of the period

  $ 1,354     $ 1,596  
                 

Supplemental Information

               

Cash interest paid

  $ 2,576     $ 2,599  

Increase in operating right of use assets

  $ 3,634     $ 5,452  

Property, plant and equipment acquired that was unpaid in cash and included in accounts payable and accrued liabilities

  $ 35     $ 330  

 

See accompanying notes to interim consolidated financial statements.

   

6

 

Unaudited Notes to Interim Consolidated Financial Statements

(in thousands)

 

 

1.

Nature of the business

 

SMTC Corporation (the “Company,” “we,” “our,” or “SMTC”) is 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”). SMTC has more than 50 manufacturing and assembly lines at strategically located facilities in the United States, Canada and Mexico that provide local support and manufacturing capabilities to our global customers. SMTC’s services extend over the entire electronic product life cycle from new product development and new product introduction (“NPI”) through to growth, maturity and end of life phases.

 

Our business operations have generally performed during the first quarter of 2020 as expected. However, the fast-developing coronavirus disease 2019 (“COVID-19”) pandemic presents significant uncertainty for the remainder of the year. During our first quarter, our business has not been significantly impacted by the COVID-19 pandemic and demand from our customers did not change materially. The COVID-19 pandemic could impact our customers and may result in unpredictable reductions or increases in demand across the industry sectors we service. We do anticipate COVID-19-related disruptions, including potential materials constraints for inventory sourced from certain regions, increased shipping costs and lead-times. As at March 29, 2020, the funds available to borrow under our PNC Facility (as described and defined below) after deducting the current borrowing base conditions was $31,185 (December 29, 2019 - $21,644).

         
             We are actively monitoring the global COVID-19 pandemic and continuously communicating with our employees and union representatives, in addition to government and state representatives where our manufacturing facilities reside. We have initiated measures designed to protect our employees and we continue to adapt in order to maintain operations while providing a safe environment. We have experienced increased workplace absenteeism as illness, potential COVID-19 exposure or personal commitments that restrict the ability of some employees to come to work. The Company has modified shift schedules and hired temporary labor to help address this situation and meet our customers’ product shipping schedules. We anticipate incurring higher direct labor charges in the second quarter of 2020 as a result of this. Decisions on further measures or the continuation of these measures will depend on the impact of the COVID-19 pandemic on our operations and the requirements of each jurisdiction in which we operate.

 

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. During the first quarter of 2020 the Company completed final shipments for customers serviced at our Chinese manufacturing facility and completed the relocation of the equipment 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.

 

The accompanying unaudited interim consolidated financial statements of the Company have been prepared in accordance with the accounting principles and methods of application disclosed in the audited consolidated financial statements within the Company’s Form 10-K for the fiscal period ended December 29, 2019, (“Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on March 13, 2020. The accompanying unaudited interim consolidated financial statements include adjustments of a normal, recurring nature that are, in the opinion of management, necessary for a fair statement of the consolidated financial statements under generally accepted accounting principles in the United States (“U.S. GAAP”). These unaudited interim consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s Form 10-K. The consolidated balance sheet at December 29, 2019 was derived from the audited annual consolidated financial statements, but does not contain all of the footnote disclosures from the annual consolidated financial statements.

 

Unless otherwise specified or the context requires otherwise, all statements in these notes to the interim consolidated financial statements regarding financial figures are expressed in thousands of U.S. dollars.

 

7

 

 

2.

Recent Accounting Pronouncements Adopted

 

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. The amendment includes the removal, modification and addition of disclosure requirements under Topic 820. 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 impact of the adoption of the standard expands the disclosure of certain assets and liabilities recorded at fair value.

 

In March 2020, the FASB published ASU 2020-04: Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments in this update are elective and provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments in this Update are effective for all entities as of March 12, 2020, through December 31, 2022. An entity may elect to apply the amendments for contract modifications by Topic or Industry Subtopic as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic, the amendments in this Update must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The impact of the adoption of the standard is not material to the Company, as alternative reference rates are available under the agreements governing the financial instruments.

 

 

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. In November 2019, the FASB published ASU 2019-10 Financial Instruments – Credit losses (Topic 326), which made certain amendments to the effective dates of the new standard. The amendment is effective for the Company for years beginning after December 15, 2022 including interim periods with those years. The Company is currently evaluating the impact of this accounting standard, but it is expected that the new standard may result in additional credit losses being recorded.

 

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, 2022. 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.

 

8

 

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 to simplify 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.

 

 

 

3.

Interim Consolidated financial statement details

 

The following consolidated financial statement details are presented as of the period ended for the consolidated balance sheets and for the periods ended for each of the consolidated statements of operations and comprehensive income.

 

Consolidated Balance Sheets

   

Accounts receivable – net:

 

   

March 29, 2020

   

December 29, 2019

 

Trade accounts receivable

  $ 71,744     $ 71,113  

Other receivables

    1,271       1,098  

Allowance for doubtful accounts

    (2,402 )     (2,292

)

Total

  $ 70,613     $ 69,919  

 

 

The allowance for doubtful accounts pertains primarily to one customer previously serviced out of Dongguan China. This was provisioned and included with the restructuring charges for the closure of the facility in 2019. Refer to note 10 for further details. To date, there has been no impact of the COVID-19 pandemic on the allowance for doubtful accounts.

 

 

Unbilled contract assets

 

   

March 29, 2020

   

December 29, 2019

 

Opening

  $ 26,271     $ 20,405  

Contract assets additions

    87,327       350,709  

Contract assets invoiced

    (84,819 )     (344,843

)

Ending

  $ 28,779     $ 26,271  

 

 

Inventories:

 

   

March 29, 2020

   

 

December 29, 2019

 

Raw materials

  $ 43,504     $ 48,067  

Parts and other

    633       586  

Provision for obsolescence

    (816 )     (827

)

Total

  $ 43,321     $ 47,826  

 

 

The provision for obsolescence primarily pertains to customers previously serviced out of the Dongguan facility. These have been provisioned and included with the restructuring charges for the closure of the facility in 2019. Refer to note 10 for further details.

 

9

 

Property, plant and equipment – net:

 

   

March 29,

2020

   

December 29,

2019

 

Cost:

               

Land

  $ 1,648     $ 1,648  

Buildings (b)

    18,985       18,985  

Machinery and equipment (a) (e)

    42,714       42,732  

Office furniture and equipment (c) (e)

    807       1,005  

Computer hardware and software (d) (e)

    3,630       3,979  

Leasehold improvements (e)

    4,096       4,265  
      71,880       72,614  
                 

Less accumulated depreciation:

               

Land

           

Buildings (b)

    (10,668 )     (10,392

)

Machinery and equipment (a) (e)

    (31,616 )     (31,192

)

Office furniture and equipment (c) (e)

    (364 )     (546

)

Computer hardware and software (d) (e)

    (2,987 )     (3,289

)

Leasehold improvements (e)

    (1,835 )     (1,885

)

      (47,470 )     (47,304

)

Property, plant and equipment—net

  $ 24,410     $ 25,310  

 

 

(a)

Included within machinery and equipment were assets under finance leases with costs of $2,275 and $2,275 and associated accumulated depreciation of $1,084 and $974 as of March 29, 2020 and December 29, 2019, respectively. The related depreciation expense for the three months ended March 29, 2020 and year ended December 29, 2019 was $113 and $565, respectively.

 

 

(b)

Included within buildings are costs associated with Melbourne facility under finance lease of $9,082 and associated accumulated depreciation of $1,102 and $900 as of March 29, 2020 and December 29, 2019, respectively. The related depreciation expense for three months ended March 29, 2020 and year ended December 29, 2019 was $202 and $804, respectively.  

  

  

(c)

Included within office furniture and equipment were assets under finance leases with costs of $307 and associated accumulated depreciation of $69 and $52 as of March 29, 2020 and December 29, 2019, respectively. The related depreciation expense for the three months ended March 29, 2020 and year ended December 29, 2019 was $17 and $46, respectively.

 

 

(d)

Included within computer hardware and software were assets under finance leases with costs of $91 and associated accumulated depreciation of $58 and $51 as of March 29, 2020 and December 29, 2019, respectively. The related depreciation expense for the three months ended March 29, 2020 and year ended December 29, 2019 was $7 and $31, respectively.

   

(e)

Fully depreciated machinery and equipment with cost of $636 and accumulated amortization of $636 was written off. Fully depreciated office furniture and fixtures with cost of $209 and accumulated amortization of $209 was written off. Fully depreciated computer hardware and software with cost of $410 and accumulated amortization of $410 was written off. Write off charges of $3 were incurred on leasehold improvements with cost of $184 and accumulated amortization of $181. These write off charges were incurred related to the closure of the Dongguan facility for those items not otherwise transferred to other manufacturing facilities.

 

10

 

Intangible assets:

 

   

March 29,

2020

   

December 29,

2019

 

Cost:

               

Customer relationships

  $ 12,350     $ 12,350  

Order backlog

    6,990       6,990  

Trade name

    1,300       1,300  

Non-compete agreements

    360       360  
      21,000       21,000  
                 

Less accumulated amortization:

               

Customer relationships

    (1,722 )     (1,414

)

Order backlog

    (6,498 )     (5,333

)

Trade name

    (1,300 )     (1,300

)

Non-compete agreements

    (251 )     (206

)

      (9,771 )     (8,253

)

Intangible assets—net

  $ 11,229     $ 12,747  

 

These intangible assets arose from the acquisition of MC Assembly Holdings Inc. (“MC Assembly”) in November 2018 and were allocated to the following operating segments:

 

   

March 29,

2020

   

December 29,

2019

 

U.S.

  $ 3,369     $ 3,824  

Mexico

    7,860       8,923  

Total

  $ 11,229     $ 12,747  

 

 

Amortization expense of $1,518 is recorded in cost of sales in the consolidated statement of income and comprehensive income for the three months ended March 29, 2020, and $1,844 for the three months ended March 31, 2019. Amortization expense for the next five years and thereafter is as follows:

 

2020

  $ 3,046  

2021

    1,235  

2022

    1,235  

2023

    1,235  

2024

    1,235  

2025 and thereafter

    4,761  

Total amortization

  $ 12,747  

 

11

 

Goodwill:

 

The carrying value of goodwill as at March 29, 2020 was $18,165 (December 29, 2019 – $18,165). This goodwill arose from the acquisition of MC Assembly in November 2018 and was allocated to the following operating segments that are expected to benefit from the synergies of this business combination and has not changed since the acquisition:

 

   

March 29,

2020

   

December 29,

2019

 

U.S.

  $ 5,449     $ 5,449  

Mexico

    12,716       12,716  

Total

  $ 18,165     $ 18,165  

 

The carrying value of goodwill is assessed annually at year-end and at each reporting period for impairment triggers to determine whether there exists any indicators of impairment. The assessment is done at the operating segment level as the group of components (production facilities) within each operating segment all have similar economic characteristics. Our business operations have performed during the first quarter of 2020 as expected. While the COVID-19 pandemic creates significant uncertainty, in the near term, the Company did not identify any triggering events as at March 29, 2020.

 

 

Accrued liabilities: 

 

   

March 29,

2020

   

December 29,

2019

 

Payroll

  $ 6,346     $ 5,504  

Customer related

    3,910       2,185  

Vendor related

    2,495       1,742  

Professional services

    791       612  

Interest

    454       860  

Other

    706       261  

Total

  $ 14,702     $ 11,164  

  

 

Consolidated Statements of Operations and Comprehensive Income

 

Interest expense:

 

   

Three months ended

 
   

March 29,

2020

   

March 31,

2019

 

Long-term debt

  $ 1,048     $ 1,752  

Revolving credit facility

    552       619  

Amortization of deferred financing fees

    55       34  

Amortization of debt issuance costs

    239       237  

Obligations under finance leases

    192       228  

Other interest

    7        

Total

  $ 2,093     $ 2,870  

 

12

 

 

4.

Debt

 

(a) Revolving credit and long-term debt facilities 

 

   

March 29,

2020

   

December 29,

2019

 

Revolving credit facility

  $ 33,340     $ 34,701  
                 

Term loans:

               

Term loan A facility

  $ 38,438     $ 38,750  

Less deferred debt issue costs

    (2,140

)

    (2,286

)

Less unamortized discount on debt

    (1,371

)

    (1,464

)

Total term loans

  $ 34,927     $ 35,000  

Less current portion

    (1,562

)

    (1,250

)

Long term portion

  $ 33,365     $ 33,750  

 

 

The Company borrows money under an Amended and Restated Revolving Credit and Security Agreement with PNC Bank, National Association (“PNC”) which governs the Company’s revolving credit facility (“PNC Facility”). The PNC Facility has a term ending on November 8, 2023. Advances made under the PNC Facility bear interest at the U.S. base rate plus a grid ranging from 0.50% to 1.00% or 1, 2 or 3-month fully-absorbed PNC LIBOR plus a grid ranging from 1.50% to 2.00%. The base commercial lending rate should approximate U.S. prime rate.  

 

The Company also borrows money under a Financing Agreement (the “Financing Agreement”), by and among the Company and certain of its subsidiaries, the lenders party to the Financing Agreement from time to time (collectively, the “Lenders”), and TCW Asset Management Company, LLC, as collateral agent for the Lenders (“TCW”). The Financing Agreement governs 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 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 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.

 

As at March 29, 2020, the funds available to borrow under the PNC Facility after deducting the current borrowing base conditions were $31,185 (December 29, 2019 - $21,644). The maximum amount of funds that could be available under the PNC Facility is $65,000. 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. The Company is 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 March 29, 2020, $33,340 (December 29, 2019 - $34,701) was outstanding under the PNC Facility and is classified as a current liability based on the requirement to hold a “lock-box” under the terms of the PNC Facility.

 

At March 29, 2020, $38,438 (December 29, 2019 - $38,750) was outstanding under the TCW Term Loan A Facility. The TCW Facilities are reported on the consolidated balance sheet net of deferred financing fees of $2,140 (December 29, 2019 - $2,286) and a discount on debt of $1,371 (December 29, 2019 - $1,464) related to the outstanding warrants described below.

 

13

 

The Credit Facilities are joint and several obligations of the Company and its subsidiaries that are borrowers under the Credit 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.

 

(b) Covenants

 

The Credit Facilities contain certain financial and non-financial covenants, including restrictions on dividend payments. The financial covenants require the Company to maintain a fixed charge coverage ratio and a total leverage ratio quarterly during the term of the Credit Facilities.

 

The Company was in compliance with the covenants included in the Credit Facilities as at March 29, 2020.  The Company’s continued financial covenant compliance will depend on key variables, including the Company’s cash flow from earnings before interest, income taxes and depreciation as well as debt levels.  For context, assuming no change to debt balances, a reduction of approximately 19% and 25% of earnings before interest, income taxes, depreciation and amortization over the next six month period, could jeopardize covenant compliance at the end of our second and third quarters 2020, respectively, which test our ratios against twelve-month trailing results.  The Company attempts to address risks of covenant compliance by taking measures to reduce its inventory, revolving credit facility and term debt balances as necessary.

 

Market conditions, including the implications of the COVID-19 pandemic, may negatively impact our ability to secure and source alternative methods of financing. We do not currently foresee a material impact in the short term based on our working capital needs, however if a number of our customers reduce or temporarily cease payments to us, this would present a risk and negatively impact our cash flow and ability to meet our working capital obligations to operate our business, which could require us to secure alternative methods of financing.

 

The Company continues to monitor operations and results closely and manage debt levels relative to our operational results to ensure compliance with its lenders covenants.

 

(c) Warrant liability

 

On November 8, 2018, 504,735 warrants were issued to TCW in connection with the Financing Agreement and are outstanding as at March 29, 2020. As a result of the anti-dilution provisions contained in the warrants that were triggered in connection with the Rights Offering and the Registered Direct Offering in June 2019, the warrants were exercisable to purchase an additional 7,214 shares of common stock (or a total of 511,949) at March 29, 2020. These warrants are exercisable on a cashless basis, or for an exercise price of $0.01. The Company initially recorded the value of the warrants as a warrant liability with a corresponding discount on the long-term debt in the amount of $1,898. The fair value has been assessed at $2.37 per unit or $1,213 as at March 29, 2020 ($3.38 per unit or $1,730 – December 29, 2019). The fair value of the warrant obligation is presented as a warrant liability on the consolidated balance sheet with changes to the fair value recorded each reporting period as either a gain or a loss in the consolidated statement of operations and comprehensive income. 

 

14

 

 

5.

Capital stock 

 

Common shares

 

Issued and outstanding:

 

The issued and outstanding number of common shares included in shareholders’ equity consisted of the following:

 

   

Number
of shares

   

$

 
                 

Balance at December 29, 2019 and March 29, 2020

    28,195,300     $ 508  

 

 

 Stock Options

 

For more detailed information regarding the Company’s stock option arrangements, see Note 7 of the consolidated financial statements within the Company’s Form 10-K for the fiscal period ended December 29, 2019. During the three month period ended March 29, 2020, there were no stock options granted, exercised or forfeited. A summary of stock option activity for the three month period ended March 29, 2020 is as follows:

 

   

Number
of options

   

Weighted
average
exercise
price

   

Aggregate
intrinsic
value

   

Weighted
average
remaining
contractual
term (years)

 

Outstanding at December 29, 2019

    2,344,374     $ 2.14       2,016       7.9  
                                 

Options granted

                       

Options exercised

                       

Options forfeited

                       

Outstanding at March 29, 2020

    2,344,374       2.14       897       7.7  

Exercisable at March 29, 2020

    1,088,140       1.55       897       7.0  

 

 

During the three month periods ended March 29, 2020 and March 31, 2019, the Company recorded stock-based compensation expense related to stock options and a corresponding increase in additional paid-in capital of $57 and $22, respectively.

 

Certain stock options outstanding have market conditions such that the awards are vested and exercisable only if the Company’s stock exceeds specified targets during the vesting period. If the market conditions are not met, the stock options will not vest and will expire.

 

15

 

Restricted Stock Units and Restricted Stock Awards

 

For more detailed information regarding the Company’s Restricted Stock Units (“RSU”) and Restricted Stock Awards (“RSA”) arrangements, see Note 7 of the consolidated financial statements within the Company’s Form 10-K for the fiscal period ended December 29, 2019. During the three months period ended March 29, 2020, 28,000 RSUs were granted. A summary of the RSU activity for the three month period ended March 29, 2020 is as follows:

 

   

Outstanding
RSU

   

Weighted
average
stock
price

   

Weighted
average
remaining
contractual
term (years)

 

Outstanding balance at December 29, 2019

    348,000     $ 3.16       2.23  

RSU granted

    28,000       2.27          

RSU vested and issued in common shares

                   

RSU forfeited

                   

Outstanding balance at March 29, 2020

    376,000       3.09       2.37  

 

 

Certain RSUs outstanding have a market condition such that the awards are vested and issuable only if the market price of the Company’s stock meets or exceeds a specified target during the vesting period. If the market condition is not met, the RSUs will not vest and will be forfeited.

 

Stock based compensation recognized during the three month period ended March 29, 2020, and March 31, 2019, related to the restricted stock units was $105 and $66, respectively.  

 

16

   

 

6.

Income taxes 

 

During the three month period ended March 29, 2020 and March 31, 2019, the Company recorded current income tax expense $275 and $279, respectively, in connection with U.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax expense of $15 and recovery of $8, respectively, in connection with temporary differences related to the Mexican operations.   

 

 In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of its deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. Management considers the scheduled reversal of deferred tax liabilities, change of control limitations, projected future taxable income and tax planning strategies in making this assessment. Guidance under ASC 740, Income Taxes, (“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. The U.S., Canadian and Asian jurisdictions continue to have a full valuation allowance recorded against the deferred tax assets.

 

On March 27, 2020, the U.S. federal government enacted The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which provides for certain tax relief with favorable implications for the Company. Most significantly, these provisions include a temporary relaxation of limitations on annual interest expense under Internal Revenue Code Section 163(j), and accelerated refund of certain federal tax credits. For the three months ended March 29, 2020, the current income tax benefit of these provisions is estimated to be $56, reflected in current tax expense.

 

 

7.

Earnings per common share

 

The following table details the weighted average number of common shares outstanding for the purposes of computing basic and diluted earnings per common share for the following periods:

 

   

Three months ended

 

(Number of common shares)

 

March 29, 2020

   

March 31, 2019

 

Basic weighted average shares outstanding

    28,195,300       23,248,918  

Dilutive stock awards (a)

    1,033,103       1,216,517  

Diluted weighted average shares outstanding

    29,228,403       24,465,435  

 

 

(a)

For the three months ended March 29, 2020 and March 31, 2019, as a result of net income for the period, dilutive earnings per share were calculated using the treasury stock method. The dilutive stock awards have been calculated as 1,053,103 and 1,216,517 for the three months ended March 29, 2020 and March 31, 2019 respectively, related to the outstanding unvested restricted stock units and incremental in-the-money stock options.

 

17

 

 

8.

Segmented information

 

General description

 

During the three months ended March 29, 2020, the Company operated and managed by geographic region in the United States, Mexico and China, which are our operating and reportable segments. During the three months ended March 29, 2020, the Company completed final shipments for customers serviced in our Chinese manufacturing facility and began relocating the equipment to our other North American sites. We utilize each reportable segment’s contribution (revenue minus operating expenses, excluding unrealized foreign exchange gain (loss) on unsettled forward foreign exchange contracts, corporate allocations and restructuring expenses) to monitor reportable segment performance. Contribution by country is utilized by the chief operating decision-maker (defined as the Chief Executive Officer) as the indicator of reportable segment performance, as it reflects costs which our operating segment management are directly responsible for. Intersegment adjustments reflect intersegment sales that are generally recorded at prices that approximate arm’s-length transactions.

 

 In assessing the performance of the reportable segments, management attributes site revenue to the reportable segment that ships the product to the customer, irrespective of the product’s destination. Information about the reportable segments is as follows: 

 

   

Three months ended

 
   

March 29, 2020

   

March 31, 2019

 

Revenue

               

Mexico

  $ 63,364     $ 65,760  

China

    4,206       8,656  

U.S.

    33,382       29,811  

Total

  $ 100,952     $ 104,227  

Intersegment revenue

               

Mexico

  $ (2,422 )   $ (34

)

China

    (3,303 )     (1,427

)

U.S.

    (89 )     (117

)

Total

  $ (5,814 )   $ (1,578

)

Net external revenue

               

Mexico

  $ 60,942     $ 65,726  

China

    903       7,229  

U.S.

    33,293       29,694  

Total segment revenue (which also equals consolidated revenue)

  $ 95,138     $ 102,649  
                 

Segment contribution

               

Mexico

  $ 5,874     $ 5,055  

China

    (2 )     547  

U.S.

    2,962       1,482  

Total

  $ 8,834     $ 7,084  
                 

Corporate expenses

    5,902       5,259  

Restructuring charges (recovery)

    (221 )     624  

Change in fair value of warrant liability

    (517 )     (101 )

Change in fair value of contingent consideration

          (3,050 )

Unrealized foreign exchange loss on unsettled forward exchange contracts

    512        

Interest expense

    2,093       2,870  

Income before income taxes

  $ 1,065     $ 1,482  

 

18

 

Three months ended March 29, 2020

 

Mexico

   

U.S.

   

China

   

Total

 

Market Sector:

                               

Test and Measurement

  $ 21,391     $ 8,048     $     $ 29,439  

Retail and Payment Systems

    12,323                   12,323  

Telecom, Networking and Communications

    3,034       3,791       714       7,539  

Medical

    8,563       2,577       130       11,270  

Industrial, Power and Clean Technology

    10,314       8,492       60       18,866  

Semiconductor

    5,316                   5,316  

Aerospace and Defense

          10,385             10,385  

Segment Revenue

    60,941       33,293       904       95,138  

 

 

Revenue by category

 

Mexico

   

U.S.

   

China

   

Total

 
                                 

Point in time

  $ 499     $ 1,067     $ 452     $ 2,018  

Over time

    60,442       32,226       452       93,120  

Total Revenue

    60,941       33,293       904       95,138  

 

 

Three months ended March 31, 2019

 

Mexico

   

U.S.

   

China

   

Total

 

Market Sector:

                               

Test and Measurement

  $ 19,917     $ 11,005     $ 1,583     $ 32,505  

Retail and Payment Systems

    12,942                   12,942  

Telecom, Networking and Communications

    4,004       2,077       4,726       10,807  

Medical

    8,459       3,652       394       12,505  

Industrial, Power and Clean Technology

    13,099       5,979       526       19,604  

Semiconductor

    7,305                   7,305  

Aerospace and Defense

          6,981             6,981  

Segment Revenue

    65,726       29,694       7,229       102,649  

 

 

Revenue by category

 

Mexico

   

U.S.

   

China

   

Total

 
                                 

Point in time

  $ 435     $ 1,712     $ 2     $ 2,149  

Over time

    65,291       27,982       7,227       100,500  

Total Revenue

    65,726       29,694       7,229       102,649  

 

19

 

Additions to property, plant and equipment

 

The following table contains additions, including those acquired through capital leases, to property, plant and equipment for the three months ended:

 

   

Three months ended

 
   

March 29,

2020

   

December 29,

2019

 

U.S.

  $ 544     $ 1,217  

Mexico

    160       2,461  

China

    2       155  

Segment total

    706       3,833  

Corporate and other

          23  

Total

  $ 706     $ 3,856  

  

 

Property, plant and equipment (a)

 

   

March 29,

2020

   

December 29,

2019

 

U.S.

  $ 20,088     $ 16,904  

Mexico

    10,771       10,970  

China

    58       670  

Segment total

    30,917       28,544  

Corporate and other

    81       96  

Total

  $ 30,998     $ 28,640  

 

 

 Other long term segment assets (b)

 

   

March 29,

2020

   

December 29,

2019

 

U.S.

  $ 9,343     $ 9,273  

Mexico

    20,576       22,179  

China

           

Segment total

    29,919       31,452  

Corporate and other

    804       859  

Total

  $ 30,723     $ 32,311  

 

 

Total segment assets (a)

 

   

March 29,

2020

   

December 29,

2019

 

U.S.

  $ 118,685     $ 112,789  

Mexico

    91,607       93,349  

China

    1,610       6,694  

Segment total

    211,902       212,832  

Corporate and other

    438       547  

Total

  $ 212,341     $ 213,379  

 

 

(a)

Property, plant and equipment information is based on the principal location of the asset. This includes operating lease right of use assets.

(b)

Includes Goodwill, Intangible assets, deferred income taxes and deferred financing costs

 

20

 

Geographic revenue

 

The following table contains geographic revenue based on our customer invoicing location, for the three months ended March 29, 2020 and March 31, 2019.

 

   

Three months ended

 
   

March 29, 2020

   

March 31, 2019

 

U.S.

  $ 89,509     $ 94,186  

Canada

    5,022       5,039  

China

    607       3,424  

Total

  $ 95,138     $ 102,649  

 

  

Significant customers and concentration of credit risk

 

Sales of the Company’s products are concentrated in certain cases among specific customers in the same industry. The Company is subject to concentrations of credit risk in trade receivables. The Company considers concentrations of credit risk in establishing the allowance for doubtful accounts and believes the recorded allowances are adequate.

 

The Company expects to continue to depend upon a relatively small number of customers for a significant percentage of its revenue. In addition to having a limited number of customers, the Company manufactures a limited number of products for each customer. If the Company loses any of its larger customers or any product line manufactured for one of its larger customers, it could experience a significant reduction in revenue. Also, the insolvency of one or more of its larger customers or the inability of one or more of its larger customers to pay for its orders could decrease revenue. As many costs and operating expenses are relatively fixed, a reduction in net revenue can decrease profit margins and adversely affect the business, financial condition and results of operations.

 

During the three months ended March 29, 2020, one customer exceeded 10% of total revenue, comprising of 12.6% of total revenue across all geographic segments. During the three months ended March 31, 2019, one customers exceeded 10% of total revenue, comprising of 13.1% of total revenue across all geographic segments.

 

As of March 29, 2020, no customers represented more than 10% of the trade accounts receivable. At December 29, 2019, one customer comprised 10% of the Company’s trade accounts receivable. No other customers individually represented more than 10% of total revenue or trade accounts receivable.

 

 

 

9.

Derivative financial instruments 

 

During the three months ended March 29, 2020, the Company entered into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Mexican peso expenditures. These contracts were 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 were recognized into net income in the consolidated statement of operations and comprehensive income. The Company had no outstanding forward foreign exchange contracts in the first quarter of 2019.

 

21

 

The following table presents a summary of the outstanding foreign currency forward contracts as at March 29, 2020:

 

Currency

Buy/Sell

Foreign Currency

Amount

 

Notional

Contract

Value

in USD

 

Mexican Peso

Buy

88,000 MXN

  $ 4,206  

 

 

The unrealized loss recognized in earnings as a result of revaluing the instruments to fair value on March 29, 2020 was $512 (March 31, 2019– $Nil) which was included in cost of sales in the interim consolidated statement of operations and comprehensive income. Fair value is determined using the market approach with valuation based on market observables (Level 2 quantitative inputs in the hierarchy set forth under ASC 820 “Fair Value Measurements”).

 

The average contract and mark-to-market rates for outstanding forward foreign exchange contracts were as follows;

 

 

 

March 29,

2020

   

December 29,

2019

Average USD:CAD contract rate

 

 

N/A

     

N/A

Average USD:CAD mark-to-market rate

 

 

N/A

     

N/A

Average USD:PESO contract rate

 

 

20.92

     

N/A

Average USD:PESO mark-to-market rate

 

 

23.82

     

N/A

 

The derivative liability was $512 (March 31, 2019 –Nil) which reflected the fair market value of the unsettled forward foreign exchange contracts. There were no derivative assets as at March 29, 2020 or March 31, 2019.

 

 

 

10.

Restructuring Charges

 

Dongguan facility closure

 

In September 2019, the Company announced it plans to close its Dongguan manufacturing facility in China, concurrent with the expiration of the facility lease in December 2019, which was extended to February 2020. The closure was formally approved by the Board of Directors in September 2019. The closure of the Dongguan facility resulted in a reduced labor force by approximately 137 employees. The employee group was notified of the closure in the last week of September 2019. The closure of the Dongguan facility and majority of the cash outflows associated with the $2,037 included within the restructuring liability was for severance and other exit costs which was substantially completed by the end of the first quarter of 2020. Remaining activities include a small number of support staff performing administrative duties, professional services to be rendered with respect to the closure activities, taxes and duties to be settled in addition to severance payments. Substantially all of the costs are anticipated to be spent by the third quarter of 2020. Manufacturing by the Company of certain products previously manufactured at the Dongguan facility has been transferred to the Company’s other manufacturing facilities. A restructuring charge of $5,000 was recorded in the twelve months ended December 29, 2019 relating to the announced planned closure.

 

During the three months ended March 29, 2020, restructuring recoveries were recorded of $221 primarily related to shipments and cash payments received on previously provisioned Dongguan inventory.

 

22

 

Restructuring Liability

 

   

Termination benefits

and other exit costs

 

Balance as at December 29, 2019

  $ 1,597  

Involuntary employee termination benefits

    100  

Other exit cost provisions reversed unutilized

    (166 )

Payments—Dongguan severance

    (476 )

Payments- (U.S., Canada and Mexico)

    (168 )
         

At March 29, 2020

  $ 887  

 

 

 

11.

Commitments

 

Purchase obligations not recorded on the balance sheet as at March 29, 2020 consist of open non-cancellable purchase orders (PO) for raw materials for $34,696 which are expected to be paid within 12 months of the PO issue date. Purchase obligations not recorded on the balance sheet as at December 29, 2019, consisted of open non-cancellable purchase orders for raw materials for $27,959 to be paid within 12 months of the PO issue date.

 

23

 

 

 Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Where we say “we”, “us”, “our”, the “Company” or “SMTC”, we mean SMTC Corporation or SMTC Corporation and its subsidiaries, as the context may require. Where we refer to the “industry”, we mean the electronics manufacturing services industry.

 

You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in combination with the accompanying unaudited interim consolidated financial statements and related notes as well as the audited consolidated financial statements and the accompanying notes to the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) included within the Company’s Annual Report on Form 10-K filed on March 13, 2020.

 

The forward-looking statements in this discussion and elsewhere in this quarterly report, including those regarding the electronics manufacturing services industry, our expectations regarding our future performance, liquidity and capital resources, the impact of accounting standards not yet adopted, compliance with financial covenants under our Credit Facilities, future response to and effects of COVID-19, including our continued operations, customer demand, supply chain availability and implementation of protective measures, our expectations regarding customer concentration, our expectations regarding timing and mitigation of the identified material weakness in internal control over financial reporting, and other non-historical statements include numerous risks and uncertainties, some of which are as described in the “Risk Factors” section in the Annual Report on Form 10-K filed on March 13, 2020, as updated by Item 1A in Part II of this quarterly report. Certain statements in this MD&A contain words such as “could”, “expects”, “may”, “anticipates”, “believes”, “intends”, “estimates”, “plans”, “envisions”, “seeks” and other similar language and are considered forward looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we operate. These statements are subject to important assumptions, risks and uncertainties, which are difficult to predict and the actual outcome may be materially different. Except as required by applicable law, we do not intend to update these forward-looking statements after the date of this quarterly report, even though our situation may change in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

 

This MD&A contains discussion in U.S. dollars (US$) unless specifically stated otherwise.

 

Background

 

We are a provider of end-to-end electronics manufacturing services (“EMS”), including product design and engineering services, printed circuit board assembly (“PCBA”), production, enclosure, cable assembly, precision metal fabrication, systems integration and comprehensive testing services, configuration to order (“CTO”), build to order (“BTO”) and direct order fulfillment (“DOF”). We operate more than 50 manufacturing and assembly lines in over 555,000 square feet of production space worldwide at strategically located facilities in the United States and Mexico, that provide local support, flexibility, fast turn around and delivery times, and low-cost, volume manufacturing capabilities, as well as new product integration (“NPI”) services, to our global customers. Our services extend over the entire electronic product life cycle from new product development and NPI through to growth, maturity and end of life phases. As of March 29, 2020, we had 2,877 employees of which 2,436 were full time and contract employees.

 

 COVID-19 Update

 

Our business operations have generally performed as expected during the first quarter of 2020. However, the fast developing COVID-19 pandemic represents significant uncertainty for the remainder of the year. So far, our business has not been significantly impacted by the COVID-19 pandemic and demand from our customers has not changed materially. The pandemic could impact our customers and may result in unpredictable reductions or increases in demand across the industry sectors we service. We do anticipate COVID-19-related disruptions, including potential materials constraints for inventory sourced from certain regions, increased shipping costs and lead-times. As at March 29, 2020, the funds available to borrow under our PNC Facility (as described and defined below) after deducting the current borrowing base conditions was $31,185.


          We are taking extensive precautions intended to protect the health and safety of our employees and to ensure business continuity. Despite these efforts it is possible that an extended pandemic could disrupt the operation of one or more of our manufacturing facilities or our supply chain. Additionally, one or more of our manufacturing facilities may need to limit operations or temporarily close. Although many of the products we manufacture for our customers are deemed essential, the COVID-19 pandemic may impact demand for our customers’ products, which could impact our production schedules. These possible impacts could result from both the pandemic itself and the extensive public restrictions imposed to limit the spread of COVID-19. If one or more of our manufacturing facilities were temporarily closed or had its operations limited, or customers pushed out demand due to the pandemic, this would have a material impact on our operations.

 

We are actively monitoring the global COVID-19 pandemic and in continuous communication with our employees and union representatives, in addition to government and state representatives where our manufacturing facilities reside. We have initiated measures designed to protect our employees and we continue to adapt in order to maintain operations while providing a safe environment. We have experience increased workplace absenteeism as illness, potential COVID-19 exposure or personal commitments restrict the ability of some employees to come to work. The Company has modified shift schedules and hired temporary labor to help address this situation and meet our customers’ product shipping schedules. We anticipate incurring higher direct labor charges in the second quarter of 2020 as a result of this. Decisions on further measures or the continuation of these measures will depend on the impact of the COVID-19 pandemic on our operations and the requirements of each jurisdiction in which we operate.

 

24

 

Results of Operations 

 

The unaudited interim consolidated financial statements of SMTC are prepared in accordance with U.S. GAAP.

 

Quarter ended March 29, 2020 compared with the quarter ended March 31, 2019:

 

The following table sets forth summarized operating results in millions of US$ for the periods indicated:

 

   

Three months ended

March 29, 2020

   

Three months ended

March 31, 2019

   

Change

2019 to 2020

 
   

 $

   

%

   

$

   

%

   

$

   

%

 

Revenue

    95.1       100.0       102.6       100.0       (7.5 )     (7.3 )

Cost of sales

    85.5       89.9       94.0       91.6       (8.6 )     (9.1 )

Gross profit

    9.6       10.1       8.6       8.4       1.1       12.8  

Selling, general and administrative expenses

    7.2       7.6       6.8       6.6       0.4       5.9  

Change in fair value of warrant liability

    (0.5 )     (0.5 )     (0.1 )     (0.1 )     (0.4 )     (400.0 )

Change in fair value of contingent consideration

                (3.1

)

    (3.0

)

    3.1       100.0  

Restructuring charges (recovery)

    (0.2 )     (0.2 )     0.6       0.6       (0.8 )     (133.3 )

Operating income

    2.7       2.8       4.3       4.2       (1.6 )     (21.3 )

Change in fair value of warrant liability

    (0.5 )     (0.5 )     (0.1 )     (0.1 )     (0.4 )     (400.0 )

Interest expense

    2.1       2.2       2.9       2.8       (0.8 )     (27.6 )

Income before income taxes

    1.1       1.2       1.5       1.5       (0.4 )     (26.6 )

Income tax expense (recovery)

                                               

Current

    0.3       0.3       0.3       0.3              

Deferred

                (0.0

)

    0.0              
      0.3       0.3       0.3       0.3              

Net income

    0.8       0.8       1.2       1.2       (0.4 )     (33.3 )

 

 

Revenue by Industry Sector

 

Industry Sector

 

Three months ended

March 29,

2020

   

Three months ended

March 31,

2019

   

Change

 
   

 $

   

%

   

$

   

%

   

$

   

%

 

Test and Measurement

    29.4       30.9       32.5       31.7       (3.1

)

    (9.5

)

Retail and Payment Systems

    12.3       13.0       12.9       12.6       (0.6

)

    (4.7

)

Telecom, Networking and Communications

    7.5       7.9       10.8       10.5       (3.3

)

    (30.6

)

Medical

    11.3       11.9       12.5       12.2       (1.2

)

    (9.6

)

Industrial, Power and Clean Technology

    18.9       19.8       19.6       19.1       (0.7

)

    (3.6

)

Semiconductor

    5.3       5.6       7.3       7.1       (2.0

)

    (27.4

)

Aerospace and Defense

    10.4       10.9       7.0       6.8       3.4       48.6  

Total

    95.1       100.0       102.6       100.0       (7.5 )     (7.3 )

 

Revenue decreased $7.5 million to $95.1 million for the first quarter of 2020 from $102.6 million in the same period in the prior year.

 

Revenue decreased $3.1 million in the test and measurement section compared to the first quarter of 2019, primarily due to volume decreases for two customers (one serviced in Mexico; one serviced in the U.S.), and one customer disengaging due to the closure of our Dongguan facility in China, partially offset by volume increases for two customers serviced in Mexico.

 

25

 

Revenue decreased $0.6 million in the retail and payment systems sector compared to the first quarter of 2019, primarily due to decreased volume from one long-standing customer serviced in Mexico, partially offset by increased volume from a different customer serviced in Mexico.

 

Revenue decreased $3.3 million in the telecom, networking and communications sector compared to the first quarter of 2019, primarily due to decreased volume from one customer serviced in Mexico and one customer disengaging in China due to the Dongguan facility closure, partially offset by two customers (one serviced in Mexico; one serviced in the U.S.) with increased volumes.

 

Revenue decreased $1.2 million in the medical sector, compared to the first quarter of 2019, primarily due to one customer serviced in the U.S. experiencing reduced volumes due to the customer’s program transitioning to end-of-life and decreased volume from one other customer serviced in Mexico, partially offset by three customers (two serviced in Mexico; one in the U.S.) with increased volumes.

 

Revenue decreased $0.7 million in the industrial, power and clean technology sector compared to the first quarter of 2019, primarily due to decreased volume from two customers serviced in Mexico, partially offset by three customers (one serviced in Mexico; two serviced in the U.S.) with increased volumes.

 

Revenue decreased $2.0 million in the semiconductor sector compared to the first quarter of 2019, due to decreased volume from one customer serviced in Mexico.

 

Revenue decreased $3.4 million in the aerospace and defense sector compared to the first quarter of 2019, due to the addition of one new customer and increased volume from three other customers.

 

Revenue by Geography

 

During the first quarter of 2020, 64.1% of our revenue was attributable to production from our operations in Mexico, 35.0% of our revenue was attributable to production from our operations in the U.S. and 0.9% of our revenue was attributable to production from our operations in China. During the first quarter of 2019, 64.0% of our revenue was attributable to production from our operations in Mexico, 29.0% of our revenue was attributable to production from our operations in the U.S. and 7.0% of our revenue was attributable to production from our operations in China.  Following the closure of our Dongguan manufacturing facility in China, manufacturing of certain products previously manufactured at that facility has been transferred to the Company’s other manufacturing facilities.

 

Additional Revenue Information

 

We recorded approximately $2.0 million and $2.2 million of revenue from sales of raw materials inventory to customers during the first quarter of 2020 and the first quarter of 2019. The Company purchases raw materials based on customer purchase orders. When a customer requires an order to be altered or changed, the customer is generally obligated to purchase the original on-order raw material at cost, to the extent the materials are not consumed within a specified period.

 

The Company’s ten largest customers represented 52.3% of revenue during the first quarter of 2020, compared with 55.7% in the first quarter of 2019. Revenue from the largest customer during the first quarter of 2020 was $12.0 million representing 12.6% of total revenue. This compares with revenue from the largest customer during the first quarter of 2019 of $13.5 million representing 13.1% of total revenue. No other customers represented more than 10% of revenue in either period.

 

Gross Profit 

 

Gross profit for the first quarter of 2020 increased by $1.0 million to $9.6 million or 10.1% of revenue compared with $8.6 million or 8.4% of revenue for the same period in 2019. When excluding unrealized foreign exchange loss on unsettled forward contracts and amortization of intangible assets, the adjusted gross profit was $11.7 million or 12.3% of revenue for the first quarter of 2020 compared with $10.5 million or 10.2% of revenue for the first quarter of 2019. This was due primarily to higher gross profit due to product mix and lower variable manufacturing expenses.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased to $7.2 million in the first quarter of 2020 from $6.8 million in the same period in 2019, mainly due to increased professional services rendered primarily related to additional compliance obligations under the Sarbanes-Oxley Act of 2002, as well as new headcount hired in the first quarter of 2020.

 

26

 

Change in fair value of contingent consideration

 

During the first quarter of 2019, it was determined that there was no fair value of the contingent consideration liability, and that no obligation existed resulting in a gain of $3.1 million being recognized. The contingent consideration liability was initially recognized at fair value in the fourth quarter of 2018 and relates to a contingent earn-out payment associated with the acquisition of MC Assembly. Fair value estimate under purchase accounting of $3.1 million was derived from a multiple of earnings based on MC Assembly’s forecasted twelve-month earnings for the period ended March 31, 2019. Based on actual earnings, the contingent consideration liability was considered resolved and no longer payable as at March 31, 2019. No contingent consideration existed as at March 29, 2020.

 

Restructuring Charges

 

During the first quarter of 2020, restructuring recoveries were recorded of $0.2 million primarily related to the cash collections of previously provisioned inventory included in the Dongguan facility. During the first quarter of 2019, restructuring charges of $0.6 million were incurred related to the reduction of 10 full-time equivalents (“FTEs”) in the U.S. and 4 FTEs in Canada and 167 FTEs and contract employees in Mexico. As at March 29, 2020, the Company had $887 of accrued restructuring charges remaining to be paid by the end of the third quarter of 2020.

 

Interest Expense

 

Interest expense decreased to $2.1 million in the first quarter of 2020 compared to $2.9 million in the same period in 2019. The decrease was primarily the result of the pay down of the Term Loan B Facility in addition to lower average debt balance in the first quarter of 2020 compared to the same period in 2019. The weighted average interest rates with respect to the debt on our PNC and TCW Facilities was 7.7%. The weighted average interest rates for the same period in the prior year was 9.4%.

 

Income Tax Expense

 

The Company recorded current income tax expense of $0.3 million for each of the first quarters of 2020 and 2019, in connection with U.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax benefit of $0.1 million in the first quarter of 2019, in connection with temporary differences related to the Mexican operations.   

 

Non-GAAP Financial Measures

 

To supplement our consolidated financial statements, which are prepared and presented in accordance 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.

 

27

 

Net Income and Adjusted Net Income Reconciliation

 

Adjusted Net Income, a non-GAAP financial measure, is defined as Net Income before amortization of intangible assets, restructuring charges, stock-based compensation, fair value adjustment of warrant liability, fair value adjustment to contingent consideration, merger and acquisition related expenses and unrealized foreign exchange gains and losses on unsettled forward foreign exchange contracts. 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 Income to Adjusted Net Income (in thousands):

 

   

March 29,

2020

   

March 31,

2019

 

Net Income

  $ 775     $ 1,211  

Add:

               
                 

Amortization of intangible assets

    1,518       1,844  

Restructuring charges (recovery)

    (221 )     624  

Stock based compensation

    162       88  

Fair value adjustment of warrant liability

    (517

)

    (101 )

Fair value adjustment of contingent consideration

          (3,050 )

Merger and acquisitions related expenses

          91  

Unrealized foreign exchange loss on unsettled forward foreign exchange contracts

    512        

Adjusted Net Income

  $ 2,229     $ 707  

 

 

Net income decreased to $0.8 million from $1.2 million in the first quarter of 2020 and 2019. This was due primarily to change in fair value of contingent consideration resulting in a gain of $3.1 million in the first quarter of 2019, partially offset by the change of restructuring charges of $0.8 million incurred in 2020 and 2019. When excluding these items, adjusted Net Income increased $1.5 million in the first quarter of 2020 over the same period in the prior year, which is mainly due to increased gross profit, reduced interest expense due to reduction in debt and partially offset by increased selling, general and administrative expense.

 

28

 

Gross Profit and Adjusted Gross Profit Reconciliation

 

Adjusted Gross Profit, a non-GAAP financial measure, is defined as gross profit exclusive of unrealized foreign exchange gains or losses on unsettled forward foreign exchange contracts and the amortization of intangible assets. The Company calculates an adjusted gross profit amount as we consider gross profit exclusive of such unrealized foreign exchange gains or losses on unsettled forward foreign exchange contracts to be a meaningful measure as it is non-cash and management does not consider the mark-to-market valuation reflective of operating performance in the current period. Management also excludes the impact of intangible assets amortization as these charges are non-cash in nature and are not believed to be reflective of operating performance. We also believe adjusted gross profit provides useful information to investors in understanding and evaluating our operating results in the same manner as management.

 

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

 

   

Three months

ended

March 29, 2020

   

Three months

ended

March 31, 2019

 

Gross profit

  $ 9,639     $ 8,624  

Add:

               

Unrealized foreign exchange loss on unsettled forward exchange contracts

    512        

Amortization of intangible assets

    1,518       1,844  

Adjusted gross profit

  $ 11,669     $ 10,468  

Adjusted gross profit percentage

    12.3 %     10.2 %

 

29

 

EBITDA and Adjusted EBITDA Reconciliation

 

EBITDA and Adjusted EBITDA, non-GAAP financial measures, are defined as earnings before interest, taxes, depreciation and amortization, with Adjusted EBITDA also excluding restructuring charges, stock-based compensation, unrealized foreign exchange gains and losses on unsettled forward foreign exchange contracts, fair value adjustment of warrant liability, fair value adjustment to contingent consideration and merger and acquisition related expenses. 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 income (loss), the closest GAAP measure, to EBITDA and Adjusted EBITDA (in thousands).

 

   

Three months

ended

March 29, 2020

   

Three months

ended

March 31, 2019

 

Net income

  $ 775     $ 1,211  

Add:

               
                 

Depreciation of property, plant and equipment