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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 29, 2002
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 0-31051
SMTC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 98-0197680
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
635 HOOD ROAD
MARKHAM, ONTARIO, CANADA L3R 4N6
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(905) 479-1810
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether SMTC Corporation: (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 [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of September 29, 2002, SMTC Corporation had 23,196,443 shares of common
stock, par value $0.01 per share, and one share of special voting stock, par
value $0.01 per share, outstanding. As of September 29, 2002, SMTC Corporation's
subsidiary, SMTC Manufacturing Corporation of Canada, had 5,493,336 exchangeable
shares outstanding, each of which is exchangeable into one share of common stock
of SMTC Corporation.
SMTC CORPORATION
FORM 10-Q
TABLE OF CONTENTS
PAGE NO.
--------
PART I Financial Information
Item 1. Financial Statements 3
Consolidated Balance Sheets as of December 31, 2001
and September 29, 2002 (unaudited) 3
Consolidated Statements of Operations for the three
and nine months ended September 29, 2002 and September 30, 2001 (unaudited) 4
Consolidated Statement of Changes in Shareholders' Equity for the
nine months ended September 29, 2002 (unaudited) 6
Consolidated Statements of Cash Flows for the three and nine
months ended September 29, 2002 and September 30, 2001 (unaudited) 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk 47
Item 4. Controls and Procedures 48
PART II Other Information
Item 5. Other Information 49
Item 6. Exhibits and Reports on Form 8-K 49
Signatures 50
Certifications 51
2
SMTC CORPORATION
Consolidated Balance Sheets
(Expressed in thousands of U.S. dollars)
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
September 29, December 31,
2002 2001
- -------------------------------------------------------------------------------------------
(unaudited)
ASSETS
Current assets:
Cash $ 658 $ 12,103
Accounts receivable 70,279 81,374
Inventories (note 2) 49,403 80,900
Prepaid expenses 3,315 4,782
Income taxes recoverable 696 997
Deferred income taxes 632 632
--------------------------------------------------------------------------------------
124,983 180,788
Capital assets 52,580 60,416
Goodwill (note 1) - 55,560
Other assets 11,624 11,538
Deferred income taxes 34,342 33,118
- -------------------------------------------------------------------------------------------
$ 223,529 $ 341,420
===========================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 57,750 $ 56,487
Accrued liabilities 33,342 36,276
Current portion of long-term debt (note 3) 16,250 12,500
Current portion of capital lease obligations 237 198
--------------------------------------------------------------------------------------
107,579 105,461
Long-term debt (note 3) 73,913 110,297
Capital lease obligations 231 406
Deferred income taxes 595 595
Shareholders' equity:
Capital stock 68,496 68,496
Loans receivable (5) (13)
Additional paid-in-capital 161,007 161,666
Warrants 659 -
Deficit (188,946) (105,488)
--------------------------------------------------------------------------------------
41,211 124,661
- -------------------------------------------------------------------------------------------
$ 223,529 $ 341,420
===========================================================================================
See accompanying notes to consolidated financial statements.
3
SMTC CORPORATION
Consolidated Statements of Operations
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
(Unaudited)
Three months ended Nine months ended
-------------------------------- --------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------
(restated, note 8) (restated, note 8)
Revenue $ 152,943 $ 125,663 $ 453,441 $ 473,403
Cost of sales (including restructuring
and other charges) (note 7) 151,289 145,165 438,034 494,368
- ---------------------------------------------------------------------------------------------------------------
Gross profit (loss) 1,654 (19,502) 15,407 (20,965)
Selling, general and
administrative expenses 5,812 16,666 19,120 33,997
Amortization 639 2,359 1,695 7,064
Restructuring charges (note 7) 6,533 7,839 6,533 23,398
- ---------------------------------------------------------------------------------------------------------------
Operating loss (11,330) (46,366) (11,941) (85,424)
Interest 1,929 1,900 6,633 7,353
- ---------------------------------------------------------------------------------------------------------------
Loss before income taxes,
discontinued operations and
the cumulative effect of a change in
accounting policy (13,259) (48,266) (18,574) (92,777)
Income tax expense (recovery) 157 (15,548) (873) (28,250)
- ---------------------------------------------------------------------------------------------------------------
Loss before discontinued operations
and the cumulative effect of a change
in accounting policy (13,416) (32,718) (17,701) (64,527)
Loss from discontinued operations
(note 8) - (1,499) (10,197) (3,576)
Cumulative effect of a change
in accounting policy (note 1) - - (55,560) -
- ---------------------------------------------------------------------------------------------------------------
Net loss $ (13,416) $ (34,217) $ (83,458) $ (68,103)
===============================================================================================================
See accompanying notes to consolidated financial statements.
4
SMTC CORPORATION
Consolidated Statements of Operations (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
(Unaudited)
Three months ended Nine months ended
-------------------------------- --------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------
(restated, note 8) (restated, note 8)
Loss per share:
Basic loss per share before
discontinued operations
and the cumulative effect of a
change in accounting policy $ (0.47) $ (1.14) $ (0.62) $ (2.26)
Loss from discontinued
operations per share - (0.05) (0.36) (0.12)
Loss from the cumulative effect of
a change in accounting policy
per share - - (1.93) -
------------------------------------------------------------------------------------------------------------
Basic loss per share $ (0.47) $ (1.19) $ (2.91) $ (2.38)
============================================================================================================
Diluted loss per share $ (0.47) $ (1.19) $ (2.91) $ (2.38)
============================================================================================================
Weighted average number of common
shares used in the calculations
of loss per share:
Basic 28,689,779 28,689,779 28,689,779 28,580,537
Diluted 28,689,779 28,689,779 28,689,779 28,580,537
===============================================================================================================
See accompanying notes to consolidated financial statements.
5
SMTC CORPORATION
Consolidated Statement of Changes in Shareholders' Equity
(Expressed in thousands of U.S. dollars)
Nine months ended September 29, 2002
(Unaudited)
Additional
Capital paid-in Loans Shareholders'
stock Warrants capital receivable Deficit equity
- ---------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 $ 68,496 $ - $ 161,666 $ (13) $ (105,488) $ 124,661
Warrants issued - 659 (659) - - -
Repayment of loans receivable - - - 8 - 8
Net loss for the period - - - - (83,458) (83,458)
- ---------------------------------------------------------------------------------------------------------------------
Balance, September 29, 2002 $ 68,496 $ 659 $ 161,007 $ (5) $ (188,946) $ 41,211
=====================================================================================================================
See accompanying notes to consolidated financial statements.
6
SMTC CORPORATION
Consolidated Statement of Cash Flows
(Expressed in thousands of U.S. dollars)
(Unaudited)
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Cash provided by (used in):
Operations:
Net loss $ (13,416) $ (34,217) $ (83,458) $ (68,103)
Items not involving cash:
Amortization 639 2,359 1,695 7,064
Depreciation 3,047 3,150 9,082 8,946
Deferred income tax benefit (12) (9,872) (1,224) (24,777)
(Gain) loss on disposition of assets 1 - (24) -
Impairment of assets - - 56,689 5,023
Change in non-cash operating working capital:
Accounts receivable 10,705 21,346 11,095 104,489
Inventories 31,842 33,490 31,497 98,914
Prepaid expenses 2,056 1,094 1,467 (842)
Accounts payable, accrued liabilities and
income taxes recoverable (11,165) (19,613) (1,370) (100,777)
---------------------------------------------------------------------------------------------------------------
23,697 (2,263) 25,449 29,937
Financing:
Increase (decrease) in long-term debt (23,873) 35,643 (32,634) 21,663
Principal payments on capital leases (31) (50) (136) (303)
Loans to shareholders - - - (5,236)
Proceeds from issuance of common stock - - - 313
Repayment of loans receivable 8 - 8 14
Debt issuance costs - - (2,031) -
---------------------------------------------------------------------------------------------------------------
(23,896) 35,593 (34,793) 16,451
Investments:
Purchase of capital assets (200) (3,398) (2,510) (17,598)
Proceeds from sale of capital assets 58 - 159 -
Purchase of other assets, net - (18) - (18)
Other 250 (124) 250 (124)
---------------------------------------------------------------------------------------------------------------
108 (3,540) (2,101) (17,740)
- --------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash (91) 29,790 (11,445) 28,648
Cash, beginning of period 749 1,556 12,103 2,698
- --------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 658 $ 31,346 $ 658 $ 31,346
====================================================================================================================
See accompanying notes to consolidated financial statements.
7
SMTC CORPORATION
Consolidated Statement of Cash Flows (continued)
(Expressed in thousands of U.S. dollars)
(Unaudited)
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Supplemental disclosures:
Cash paid during the period:
Income taxes $ 344 $ - $ 1,644 $ 3,502
Interest - 1,973 4,365 7,217
Non-cash investing activities:
Cash released from escrow - - - 3,125
Non-cash financing activities:
Issuance of warrants - - 659 -
====================================================================================================================
Cash and cash equivalents is defined as cash and short-term investments.
See accompanying notes to consolidated financial statements.
8
SMTC CORPORATION
Notes to Consolidated Financial Statements
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
1. BASIS OF PRESENTATION:
The Company's accounting principles are in accordance with accounting
principles generally accepted in the United States.
The accompanying unaudited consolidated balance sheet as at September 29,
2002, the unaudited consolidated statements of operations for the three and
nine month periods ended September 29, 2002 and September 30, 2001, the
unaudited consolidated statement of changes in shareholders' equity for the
nine month period ended September 29, 2002, and the unaudited consolidated
statements of cash flows for the three and nine month periods ended
September 29, 2002 and September 30, 2001 have been prepared on
substantially the same basis as the annual consolidated financial
statements, except as described below. Management believes the consolidated
financial statements reflect all adjustments, consisting only of normal
recurring accruals, which are, in the opinion of management, necessary for a
fair presentation of the Company's financial position, operating results and
cash flows for the periods presented. The results of operations for the
three and nine month periods ended September 29, 2002 are not necessarily
indicative of results to be expected for the entire year. These unaudited
interim consolidated financial statements should be read in conjunction with
the annual consolidated financial statements and notes thereto for the year
ended December 31, 2001.
The unaudited interim consolidated financial statements are based upon
accounting principles consistent with those described in the December 31,
2001 audited consolidated financial statements except as follows:
In July 2001, the FASB issued Statement No. 141, "Business Combinations"
("Statement 141"), and Statement No. 142, "Goodwill and Other Intangible
Assets" ("Statement 142"). Statement 141 requires that the purchase method
of accounting be used for all business combinations. Statement 141 also
specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill.
Statement 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at
least annually in accordance with the provisions of Statement 142. Statement
142 also requires that intangible assets with definite useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with Statement
121. Upon adoption of Statements 141 and 142 in their entirety on January 1,
2002, the Company determined that there are no intangible assets relating to
previous acquisitions that need to be reclassified and accounted for apart
from goodwill under the provisions of those Statements.
9
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
1. BASIS OF PRESENTATION (CONTINUED):
In connection with the transitional goodwill impairment evaluation,
Statement 142 requires the Company to perform an assessment of whether there
is an indication that goodwill is impaired as of January 1, 2002. To
accomplish this, the Company was required to identify its reporting units
and determine the carrying value of each reporting unit by assigning the
assets and liabilities, including the existing goodwill to those reporting
units as of January 1, 2002. The Company has identified its reporting units
to be consistent with its business units as defined in note 6, with the
exception of the Boston, Massachusetts facility. This facility is not
economically similar to the other US facilities and as a result, is a
separate reporting unit. In connection with the implementation of new
accounting standards, the Company has completed the transitional goodwill
impairment test resulting in a goodwill impairment charge of $55,560, which
comprises the goodwill in the Canadian, US and Boston reporting units. The
fair value of each reporting unit was determined using the discounted cash
flows of the reporting unit. The transitional impairment loss was recognized
as the cumulative effect of a change in accounting principle in the
Company's statement of operations as at January 1, 2002.
Effective January 1, 2002, the Company had unamortized goodwill of $55,560,
which is no longer being amortized and has been written off effective
January 1, 2002 as a cumulative effect of a change in accounting policy.
This change in accounting policy is not applied retroactively and the
amounts presented for prior periods have not been restated for this change.
The impact of this change is as follows:
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------------
Net loss $ (13,416) $ (34,217) $ (83,458) $ (68,103)
Add back goodwill amortization,
net of tax - 1,692 - 5,076
----------------------------------------------------------------------------------------------------------------
Net loss before goodwill amortization $ (13,416) $ (32,525) $ (83,458) $ (63,027)
================================================================================================================
Basic and diluted loss per share:
Net loss $ (0.47) $ (1.19) $ (2.91) $ (2.38)
Net loss before goodwill
amortization $ (0.47) $ (1.13) $ (2.91) $ (2.21)
================================================================================================================
10
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
1. BASIS OF PRESENTATION (CONTINUED):
In October 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("Statement 144"), which
supersedes both Statement 121 and the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions" ("Opinion 30"), for the
disposal of a segment of a business (as previously defined in that Opinion).
Statement 144 retains the fundamental provisions in Statement 121 for
recognizing and measuring impairment losses on long-lived assets held for
use and long-lived assets to be disposed of by sale. Statement 144 retains
the basic provisions of Opinion 30 on how to present discontinued operations
in the income statement but broadens that presentation to include a
component of an entity (rather than a segment of a business). The Company
adopted Statement 144 for the quarter ending March 31, 2002 and presented
the closure of its Cork facility and the related charges as discontinued
operations.
In August 2001, the FASB issued Statement No. 143 "Accounting for Asset
Retirement Obligations" which requires that the fair value of an asset
retirement obligation be recorded as a liability, at fair value, in the
period in which the Company incurs the obligation. The Statement is
effective for fiscal 2003 and the Company expects no material effect as a
result of this Statement.
In April 2002, the FASB issued Statement No. 145, "Recission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and
Technical Corrections" ("Statement 145"), which provides for the recission
of several previously issued accounting standards, new accounting guidance
for the accounting for certain lease modifications and various technical
corrections that are not substantive in nature to existing pronouncements.
In addition, gains and losses from extinguishment of debt will no longer be
classified as an extraordinary item. The Statement will be effective for
fiscal 2003, with early adoption of the provisions related to the
classification of gains and losses on extinguishment of debt encouraged.
Upon adoption, enterprises must reclassify prior period items that do not
meet the extraordinary item classification criteria in APB 30. The Company
plans to adopt the provisions of Statement 145 in fiscal 2003 and expects no
material effect as a result of this Statement except for the
reclassification of prior period extraordinary items to ordinary income. In
fiscal 1999 and 2000, $1,247 and $2,678 respectively, was booked as an
extraordinary loss. These amounts will be reclassified to ordinary income.
11
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
1. BASIS OF PRESENTATION (CONTINUED):
In July 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("Statement 146"). Statement
146 addresses financial accounting and reporting for costs associated with
exit or disposal activities, and is effective for exit or disposal
activities initiated after December 31, 2002 with early application
encouraged. Statement 146 nullifies Emerging Issues Task Force Issue No.
94-3 ("EITF 94-3") "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in Restructuring)". The principal difference between Statement 146
and EITF 94-3 relates to the recognition of a liability for a cost
associated with an exit or disposal activity. FAS 146 requires that the cost
associated with an exit or disposal activity be recognized when the
liability is incurred at its fair value, whereas under EITF 94-3 the
liability was recognized at the date of an entity's commitment to an exit
plan. The Company is currently assessing the impact of this Statement.
2. INVENTORIES:
September 29, December 31,
2002 2001
-------------------------------------------------------------------------
Raw materials $ 19,498 $ 38,289
Work in process 17,570 24,984
Finished goods 11,069 16,230
Other 1,266 1,397
-------------------------------------------------------------------------
$ 49,403 $ 80,900
=========================================================================
3. LONG-TERM DEBT:
The Company incurred operating losses, which resulted in its non-compliance
with certain financial covenants contained in its credit agreement as at
September 30, 2001. On November 19, 2001, the Company and its lending group
signed a definitive term sheet for an agreement under which certain terms of
the credit facility would be revised and the non-compliance as at September
30, 2001 would be waived. The final amended agreement was signed on February
11, 2002 and is consistent with the terms and conditions in the term sheet.
The revised terms establish amended financial and other covenants covering
the period up to December 31, 2002, based on the Company's current business
plan. During this time period, the facility bears interest at the U.S. base
rate plus 2.5%.
12
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
3. LONG-TERM DEBT (CONTINUED):
Prior to taking steps to place the subsidiary that operates the Cork
facility in voluntary liquidation (note 8), the Company and its lending
group executed an amendment to the credit facility to waive the default that
would have been caused by this action and amend the agreement to permit such
facility closure.
The Company's activity levels have exceeded the plan that served as the
basis for the Company's amended financial covenants. The Company and its
lending group agreed in April 2002 to further amend the credit agreement to
increase the Company's permitted loan balances to correspond to its higher
working capital needs.
The Company was in compliance with the amended financial covenants at
September 29, 2002 and accordingly the related debt is classified as
long-term debt. Effective January 1, 2003, the Company reverts back to the
covenants under the original credit agreement and at that time it is
unlikely the Company will have earned sufficient EBITDA (earnings before
interest expense, income taxes, depreciation and amortization), using a
twelve month trailing formula, to satisfy the requirements of that
agreement. In the event of non-compliance, the Company's lenders have the
ability to demand repayment of the outstanding amounts under the credit
facility. The Company has maintained a positive working relationship with
its lending group and has received a proposed term sheet under which the
lending group would revise the covenants that apply for the period from
December 31, 2002 through June 30, 2004 to correspond to the Company's
current business plan.
13
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
4. LOSS PER SHARE:
The following table sets forth the calculation of basic and diluted loss per
common share:
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------------
Numerator:
Net loss before discontinued
operations and the
cumulative effect of a change
In accounting policy $ (13,416) $ (32,718) $ (17,701) $ (64,527)
Net loss (13,416) (34,217) (83,458) (68,103)
================================================================================================================
Denominator:
Weighted-average shares -
basic 28,689,779 28,689,779 28,689,779 28,580,537
Effect of dilutive securities:
Employee stock options - - - -
Warrants - - - -
----------------------------------------------------------------------------------------------------------------
Weighted-average shares -
diluted 28,689,779 28,689,779 28,689,779 28,580,537
================================================================================================================
Loss per share:
Basic and diluted, before
discontinued operations
and the cumulative effect of
a change in accounting policy $ (0.47) $ (1.14) $ (0.62) $ (2.26)
Basic and diluted $ (0.47) $ (1.19) $ (2.91) $ (2.38)
================================================================================================================
Options and warrants to purchase common stock were outstanding during the
three and nine month periods ended September 29, 2002 and September 30, 2001
but were not included in the computation of diluted loss per share because
their effect would be anti-dilutive on the loss per share for the periods.
5. INCOME TAXES:
The Company's effective tax rate differs from the statutory rate primarily
due to losses not tax effected in certain jurisdictions and the effects of
the valuation reserve for the loss carry-forwards. 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. Based upon consideration of these factors,
management believes the recorded valuation allowance related to the loss
carryforwards is appropriate. However, in the event that actual results
differ from estimates or management adjusts these estimates in future
periods, the
14
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
Company may need to establish an additional valuation allowance, which
could materially impact its financial position and results of operations.
15
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
6. SEGMENTED INFORMATION:
The Company derives its revenue from one dominant industry segment, the
electronics manufacturing services industry. The Company is operated and
managed geographically and has eight facilities in the United States,
Canada, Europe and Mexico. The Company monitors the performance of its
geographic operating segments based on EBITA (earnings before interest,
taxes and amortization) before restructuring charges, discontinued
operations and the effect of changes in accounting policies. Discontinued
operations in the first quarter of 2002 relates to the Cork, Ireland
facility (note 8), which was previously included in the results of the
European segment. Intersegment adjustments reflect intersegment sales
that are generally recorded at prices that approximate arm's-length
transactions. Information about the operating segments is as follows:
Three months ended September 29, 2002 Nine months ended September 29, 2002
------------------------------------------- -----------------------------------------
Net Net
Total Intersegment external Total Intersegment external
revenue revenue revenue revenue revenue revenue
-------------------------------------------------------------------------------------------------------
United States $ 126,831 $ (2,047) $ 124,784 $ 392,731 $ (15,361) $ 377,370
Canada 30,184 (3,289) 26,895 78,584 (9,236) 69,348
Europe 1,090 - 1,090 4,050 (501) 3,549
Mexico 53,582 (53,408) 174 148,056 (144,882) 3,174
-------------------------------------------------------------------------------------------------------
$ 211,687 $ (58,744) $ 152,943 $ 623,421 $ (169,980) $ 453,411
=======================================================================================================
EBITA (before discontinued operations, restructuring charges and the
cumulative effect of a change in accounting policy):
United States $ 2,744 $ 332
Canada (579) (59)
Europe 925 519
Mexico (962) 1,781
---------------------------------------------------------------------------------------------------
2,128 2,573
Interest 1,929 6,633
Amortization 639 1,695
Restructuring charges 12,819 12,819
-------------------------------------------------------------------------------------------------------
Loss before income taxes,
discontinued operations and
the cumulative effect of a change
in accounting policy $ (13,259) $ (18,574)
-------------------------------------------------------------------------------------------------------
Capital expenditures:
United States $ 9 $ 1,419
Canada 135 678
Europe - 26
Mexico 56 387
-------------------------------------------------------------------------------------------------------
$ 200 $ 2,510
=======================================================================================================
16
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
6. SEGMENTED INFORMATION (CONTINUED):
Three months ended September 30, 2001 Nine months ended September 30, 2001
------------------------------------------- -----------------------------------------
Net Net
Total Intersegment external Total Intersegment external
revenue revenue revenue revenue revenue revenue
-------------------------------------------------------------------------------------------------------
United States $ 113,415 $ (1,831) $ 111,584 $ 427,307 $ (40,245) $ 387,062
Canada 8,596 (931) 7,665 51,276 (2,451) 48,825
Europe 4,353 (288) 4,065 14,299 (1,239) 13,060
Mexico 36,526 (34,177) 2,349 85,114 (60,658) 24,456
-------------------------------------------------------------------------------------------------------
$ 162,890 $ (37,227) $ 125,663 $ 577,996 $ (104,593) $ 473,403
=======================================================================================================
EBITA (before discontinued operations and restructuring charges):
United States $ (18,711) $ (17,024)
Canada (4,226) (4,014)
Europe 634 1,950
Mexico (6,703) (12,768)
---------------------------------------------------------------------------------------------------
(29,006) (31,856
Interest 1,900 7,353
Amortization 2,359 7,064
Restructuring charges 15,001 46,504
-------------------------------------------------------------------------------------------------------
Loss before income taxes
and discontinued operations $ (48,266) $ (92,777)
=======================================================================================================
Capital expenditures:
United States $ 1,915 $ 10,136
Canada 8 1,573
Europe 303 546
Mexico 1,172 5,343
-------------------------------------------------------------------------------------------------------
$ 3,398 $ 17,598
=======================================================================================================
17
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
6. SEGMENTED INFORMATION (CONTINUED):
The following enterprise-wide information is provided. Geographic revenue
information reflects the destination of the product shipped. Long-lived
assets information is based on the principal location of the asset.
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
-------------------------------------------------------------------------------------------
Geographic revenue:
United States $ 115,135 $ 102,579 $ 349,752 $ 403,216
Canada 8,421 5,522 28,922 29,266
Europe 14,994 10,382 40,253 28,012
Asia 10,087 6,823 24,197 12,446
Mexico 4,306 357 10,317 463
-------------------------------------------------------------------------------------------
$ 152,943 $ 125,663 $ 453,411 $ 473,403
===========================================================================================
September 29, December 31,
2002 2001
-------------------------------------------------------------------------------------------
Long-lived assets:
United States $ 29,257 $ 73,269
Canada 4,726 21,832
Europe 434 1,998
Mexico 18,163 18,877
-------------------------------------------------------------------------------------------
$ 52,580 $ 115,976
===========================================================================================
18
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
7. RESTRUCTURING AND OTHER CHARGES:
The following table details the components of the restructuring and other
charges:
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------
Inventory write-downs included in
cost of sales $ 6,286 $ 7,162 $ 6,286 $ 23,106
Lease and other contract obligations 5,790 3,400 5,790 8,578
Reversal of previously recorded lease
and other contract obligations (393) - (393) -
Severance 1,136 1,313 1,136 3,644
Asset impairment - - - 5,023
Other facility exit costs - 3,126 - 6,153
----------------------------------------------------------------------------------------------------------
6,533 7,839 6,533 23,398
----------------------------------------------------------------------------------------------------------
12,819 15,001 12,819 46,504
Other charges included in cost
of sales 900 12,651 900 12,651
Other charges included in selling
general and administrative expenses - 8,155 - 8,155
----------------------------------------------------------------------------------------------------------
$ 13,719 $ 35,807 $ 13,719 $ 67,310
==========================================================================================================
2001:
During fiscal year 2001, in response to excess capacity caused by the
slowing technology end market, the Company commenced a restructuring
program aimed at reducing its cost structure. Accordingly, the Company
recorded restructuring and other charges for the three and nine months
ended September 30, 2001 of $35,807 and $67,310, respectively, consisting
of the costs associated with exiting or re-sizing facilities.
The following table details the related amounts included in accrued
liabilities as at September 29, 2002:
Accrual at Accrual at
June 30, Cash September 29,
2002 payments Adjustments 2002
----------------------------------------------------------------------------------------------------------
Lease and other contract obligations $ 3,897 (1,627) (393) $ 1,877
Severance 90 (90) - -
Other facility exit costs 621 (107) - 514
----------------------------------------------------------------------------------------------------------
$ 4,608 (1,824) $ (393) $ 2,391
==========================================================================================================
19
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
7. RESTRUCTURING AND OTHER CHARGES (CONTINUED):
The reversal of previously recorded lease and other contract obligations
represents the excess accrual due to the Company negotiating a final
settlement on a facility lease.
2002:
In response to the continuing industry economic downturn, the Company is
taking further steps to realign its cost structure and plant capacity and
announced third quarter restructuring charges of $12,819 related to the
cost of exiting equipment leases and a facility lease, severance costs
and inventory exposures and other charges of $900 related to the costs
associated with the disengagement of a customer coupled with the effects
of the continued downturn in the technology sector.
The write-down of inventory represents further costs associated with the
closure of the assembly facility in Denver. Lease and other contract
obligations represent the costs of exiting equipment leases at various
locations and a facility lease. The severance costs related to 317 plant
and operational employees, largely at our Mexican facility. The major
components of the current restructuring are estimated to be complete by
the end of the fiscal year.
Other charges, included in cost of sales, relate to inventory charges
resulting from the disengagement with a customer, coupled with the
effects of the continued downturn in the technology sector.
The Company anticipates fourth quarter 2002 restructuring charges of
between $11,000 and $21,000.
The following table details the related amounts included in accrued
liabilities as at September 29, 2002:
2002 Accrual at
Cash Cash September 29,
charges payments 2002
------------------------------------------------------------------------------------------
Lease and other contract obligations $ 5,790 $ (232) $ 5,558
Severance 1,136 (1,082) 54
------------------------------------------------------------------------------------------
$ 6,926 $ (1,314) $ 5,612
==========================================================================================
20
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
8. DISCONTINUED OPERATIONS:
In February, 2002 the main customer of the Cork, Ireland facility was
placed into administration as part of a financial restructuring. As a
result, on March 19, 2002, the Company announced that it was closing the
Cork, Ireland facility and that it was taking steps to place the
subsidiary that operates that facility in voluntary administration.
During the first quarter of 2002, the Company recorded a charge of $9,717
related to the closure of the facility. The Company placed the subsidiary
in voluntary administration by the end of the first quarter.
The following amounts are included in the loss from discontinued
operations:
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------
Revenue $ - $ 1,258 $ 5,035 $ 6,308
==========================================================================================================
Three months ended Nine months ended
------------------------------ ------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------
Loss from discontinued operations:
Operating loss before
restructuring and other charges $ - $ 1,282 $ 480 $ 3,164
Restructuring charges - 100 - 295
Other charges - 117 - 117
Cost of closing the facility - - 9,717 -
----------------------------------------------------------------------------------------------------------
Loss from discontinued operations $ - $ 1,499 $ 10,197 $ 3,576
==========================================================================================================
Included in the cost of closing the facility of $9,717 are the write-off
of the net assets of $6,717 (comprised of capital assets of $1,129 and
net working capital of $5,588) and other costs associated with exiting
the facility of $3,000. Included in the other costs is severance of
$1,350 related to the termination of all employees.
21
SMTC CORPORATION
Notes to Consolidated Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 29, 2002 and September 30, 2001
(Unaudited)
8. DISCONTINUED OPERATIONS (CONTINUED):
The following table details the related amounts included in accrued
liabilities as at September 29, 2002:
Accrual at Accrual at
June 30, Cash September 29,
2002 payments 2002
----------------------------------------------------------------------------
Lease and other contract obligations $ 323 - $ 323
Severance 295 - 295
Other facility exit costs 1,206 (1,138) 68
----------------------------------------------------------------------------
$ 1,824 (1,138) $ 686
============================================================================
9. COMPARATIVE FIGURES:
Certain 2001 comparative figures have been restated to separately
disclose the results of discontinued operations of the Cork, Ireland
facility.
22
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
SELECTED CONSOLIDATED FINANCIAL DATA
The consolidated financial statements and our selected consolidated financial
data have been prepared in accordance with United States GAAP.
Consolidated Statement of Operations Data:
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(Unaudited)
Three months ended Nine months ended
------------------------------------------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
------------------------------------------------------------------
Revenue $ 152.9 $ 125.7 $ 453.4 $ 473.4
Cost of sales (including restructuring
charges of $6.3 for the three and nine
months ended September 29, 2002 and
$7.2 million and $23.1 million for
the three and nine months ended
September 30, 2001)(a) 151.3 145.2 438.1 494.3
------------------------------------------------------------------
Gross profit (loss) 1.6 (19.5) 15.3 (20.9)
Selling, general and administrative
expenses 5.8 16.6 19.1 34.0
Amortization 0.6 2.4 1.6 7.1
Restructuring charges (a) 6.5 7.8 6.5 23.4
------------------------------------------------------------------
Operating loss (11.3) (46.3) (11.9) (85.4)
Interest 1.9 1.9 6.6 7.3
------------------------------------------------------------------
Loss before income taxes, discontinued
operations and the cumulative effect
of a change in accounting policy (13.2) (48.2) (18.5) (92.7)
Income tax expense (recovery) 0.2 (15.5) (0.8) (28.2)
------------------------------------------------------------------
Loss before discontinued operations and
the cumulative effect of a change in
accounting policy (13.4) (32.7) (17.7) (64.5)
Loss from discontinued operations (b) - (1.5) (10.2) (3.6)
Cumulative effect in a change in
accounting policy (c) - - (55.6) -
==================================================================
Net loss $ (13.4) $ (34.2) $ (83.5) $ (68.1)
==================================================================
Net loss per common share:
Basic before discontinued operations and
the cumulative effect of a change in
accounting policy $ (0.47) $ (1.14) $ (0.62) $ (2.26)
Loss from discontinued operations - (0.05) (0.36) (0.12)
Cumulative effect of a change in
accounting policy - - (1.93) -
------------------------------------------------------------------
Basic $ (0.47) $ (1.19) $ (2.91) $ (2.38)
Diluted $ (0.47) $ (1.19) $ (2.91) $ (2.38)
==================================================================
Weighted average number of shares
outstanding:
Basic 28.7 28.7 28.7 28.6
Diluted 28.7 28.7 28.7 28.6
==================================================================
23
Consolidated Statement of Operations Data (continued):
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(a) During fiscal year 2001, in response to excess capacity caused by the
slowing technology end market, the Company commenced a restructuring program
aimed at reducing its cost structure. Accordingly, the Company recorded
restructuring charges of $15.0 million and $46.5 million for the three and
nine months ended September 30, 2001 consisting of the costs associated with
exiting or re-sizing facilities. In response to the continuing industry
economic downturn, the Company is taking further steps to realign its cost
structure and plant capacity and announced third quarter 2002 restructuring
charges of $12.8 million related to the cost of exiting equipment and
facility leases, severance costs and inventory exposures. Refer to note 7 to
our consolidated financial statements. The Company anticipates fourth
quarter 2002 restructuring charges of between $11.0 million and $21.0
million.
(b) In February, 2002 the main customer of the Cork, Ireland facility was
placed into administration as part of a financial restructuring. As a
result, on March 19, 2002, the Company announced that it was closing the
Cork, Ireland facility and that it was taking steps to place the subsidiary
that operates that facility in voluntary administration. Refer to note 8 to
our consolidated financial statements.
(c) The Company has completed the transitional goodwill impairment test
resulting in a goodwill impairment charge of $55.6 million. Refer to note 1
to our consolidated financial statements.
Consolidated Adjusted Net Earnings (Loss):
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(Unaudited)
Three months ended Six months ended
--------------------------------------------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
--------------------------------------------------------------------
Net loss $ (13.4) $ (34.2) $ (83.5) $ (68.1)
Adjustments:
Discontinued operations - 1.5 10.2 3.6
Amortization of goodwill - 2.1 - 6.3
Restructuring and other charges 13.7 35.8 69.3 67.3
Income tax effect - (11.4) - (21.3)
--------------------------------------------------------------------
Adjusted net earnings (loss) $ 0.3 $ (6.2) $ (4.0) $ (12.2)
====================================================================
Adjusted net loss per common share:
Basic
Diluted $ 0.01 $ (0.22) $ (0.14) $ (0.43)
$ 0.01 $ (0.22) $ (0.14) $ (0.43)
====================================================================
Weighted average number of shares
outstanding:
Basic 28.7 28.7 28.7 28.6
Diluted 28.7 28.7 28.7 28.6
====================================================================
The Company has provided information on adjusted net earnings to supplement its
GAAP financial information. Adjusted net earnings do not have any standardized
meaning prescribed by GAAP and are not necessarily comparable to similar
measures presented by other issuers. The Company believes that adjusted net
earnings is a meaningful measure of operating performance due to the history of
acquisitions and recent restructurings. Adjusted net earnings exclude the
effects of discontinued operations, amortization of intangible assets and
goodwill, restructuring and other charges (most significantly the write-down of
goodwill, the cost associated with closing facilities, inventory and accounts
receivable exposures and severance costs) and the income tax effects of the
foregoing. Adjusted net earnings are not a measure of operating performance or
profitability under U.S. GAAP or Canadian GAAP and should not be considered in
isolation or as a substitute for net earnings prepared in accordance with U.S.
GAAP or Canadian GAAP.
24
CONSOLIDATED BALANCE SHEET DATA:
(in millions)
-----------------------------------------
September 29, 2002 December 31, 2001
(Unaudited)
-----------------------------------------
Cash $ 0.7 $ 12.1
Working capital 17.4 75.3
Total assets 223.5 341.4
Total debt, including current maturities 90.2 122.8
Shareholders' equity 41.2 124.7
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
We provide advanced electronics manufacturing services, or EMS, to
electronics industry original equipment manufacturers, or OEMs, primarily in the
networking, industrial and communications market segments. We service our
customers through eight manufacturing and technology centers strategically
located in key technology corridors in the United States, Canada, Europe and the
cost-effective location of Mexico. Our full range of value-added supply chain
services include product design, procurement, prototyping, cable and harness
interconnect, high precision enclosures, printed circuit board assembly, test,
final system build, comprehensive supply chain management, packaging, global
distribution and after-sales support.
We have customer relationships with industry leading OEMs such as IBM and
Alcatel. We developed these relationships by capitalizing on the continuing
trend of OEMs to outsource manufacturing services to consolidate their supply
base and to form long-term strategic partnerships with selected high quality EMS
providers. We work closely with our customers and are highly responsive to them
throughout the design, manufacturing and distribution process, providing
services that allow them to focus on their core competencies of sales, marketing
and research and development. We seek to grow our business through the addition
of new, high quality customers and the expansion of our relationships with
existing customers.
During fiscal year 2001, in response to excess capacity caused by the
slowing technology end market, we commenced a restructuring program aimed at
reducing our cost structure. Actions taken by management to improve capacity
utilization included closing our Denver, Colorado assembly facility and our
Haverhill, Massachusetts interconnect facility, re-sizing our Mexico and Ireland
facilities and addressing our excess equipment. Accordingly, we recorded
restructuring charges of $67.6 million pre-tax (consisting of a write-down of
goodwill and other intangible assets and the costs associated with exiting or
re-sizing facilities) and other charges of $27.3 million pre-tax (consisting of
accounts receivable, inventory and asset impairment charges).
In response to the continuing industry economic downturn, the Company took
further steps to realign its cost structure and plant capacity. In February,
2002 the main customer of our Cork, Ireland facility was placed into
administration as part of a financial restructuring. As a result, on March 19,
2002, we announced that we were closing our Cork, Ireland facility and that we
were taking steps to place the subsidiary that operates that facility in
voluntary administration. During the first quarter of 2002, we recorded a charge
of $9.7 million related to the closure of the facility. Prior to taking steps to
place the subsidiary that operates the Cork facility in voluntary liquidation,
we and our lending group executed an amendment to our credit facility to waive
the default that would have been caused by this action and amend the agreement
to permit such facility closure. In addition, the Company announced third
quarter 2002 restructuring charges of $12.8 million related to the cost of
exiting equipment leases and a facility lease, severance costs and inventory
exposures and other charges of $0.9 million related to inventory charges
resulting from the disengagement with a customer, coupled with the effects of
the continued downturn in the technology sector.
The Company anticipates fourth quarter 2002 restructuring charges of
between $11 million and $21 million.
As a result of restructuring actions and market conditions we incurred a
significant operating loss during 2001, which resulted in our non-compliance
with certain financial covenants contained in our credit agreement as at
September 30, 2001. On November 19, 2001, we and our lending group signed a
definitive term sheet for an agreement under which certain terms of the current
credit facility would be revised and the non-compliance as at September 30, 2001
would be waived. In February 2002, we and our lending group executed an
amendment to our credit facility, substantially consistent with the term sheet,
to waive the September 30, 2001 defaults and to revise the covenant tests to be
consistent with both current revenues and the forecast for 2002.
The Company's activity levels have exceeded the plan that served as the
basis for the Company's amended financial covenants. The Company and its lending
group agreed in April 2002 to further amend the credit agreement to increase the
Company's permitted loan balances to correspond to its higher working capital
needs. The Company was in compliance with the amended financial covenants at
September 29, 2002. Effective January 1, 2003, the Company reverts back to the
covenants under the original credit agreement and at that time it is unlikely
the Company will have earned sufficient EBITDA (earnings before interest
expense, income taxes,
26
depreciation and amortization), using a twelve month trailing formula, to
satisfy the requirements of that agreement. The Company has maintained a
positive working relationship with its lending group and has received a proposed
term sheet under which the lending group would revise the covenants that apply
for the period from December 31, 2002 through June 30, 2004 to correspond to the
Company's current business plan. There can be no assurance that the Company and
its lenders will agree to revise the Company's credit agreement covenants. (See
Liquidity and Capital Resources).
CORPORATE HISTORY
SMTC Corporation is the result of the July 1999 combination of the former
SMTC Corporation, or Surface Mount, and HTM Holdings, Inc., or HTM. Surface
Mount was established in Toronto, Ontario in 1985. HTM was established in
Denver, Colorado in 1990. SMTC was established in Delaware in 1998. After the
combination, we purchased Zenith Electronics' facility in Chihuahua, Mexico,
which expanded our cost-effective manufacturing capabilities in an important
geographic region. In September 1999, we established a manufacturing presence in
the Northeastern United States and expanded our value-added services to include
high precision enclosure capabilities by acquiring Boston, Massachusetts based
W.F. Wood. In July 2000, we acquired Pensar Corporation, an EMS company
specializing in design engineering and headquartered in Appleton, Wisconsin. In
November 2000, we acquired Qualtron Teoranta, a provider of specialized cable
and harness interconnect assemblies, based in Donegal, Ireland and with a
subsidiary in Haverhill, Massachusetts.
On July 27, 2000, we consummated an initial public offering of 6,625,000
shares of our common stock and 4,375,000 exchangeable shares of our subsidiary
SMTC Manufacturing Corporation of Canada, or SMTC Canada. Each exchangeable
share of SMTC Canada is exchangeable at the option of the holder at any time
into one share of our common stock, subject to compliance with applicable
securities laws.
On August 18, 2000, we sold an additional 1,650,000 shares of common stock
upon exercise of the underwriters' over-allotment option.
RESULTS OF OPERATIONS
We currently provide turnkey manufacturing services to the majority of our
customers. Turnkey manufacturing services typically result in higher revenue and
higher gross profits but lower gross profit margins when compared to consignment
services.
Our contractual arrangements with our key customers generally provide a
framework for our overall relationship with our customer. Revenue is recognized
upon shipment to the customer as performance has occurred, all customer
specified acceptance criteria have been tested and met, and the earnings process
is considered complete. Actual production volumes are based on purchase orders
for the delivery of products. These orders typically do not commit to firm
production schedules for more than 30 to 90 days in advance. In order to
minimize inventory risk, we generally order materials and components only to the
extent necessary to satisfy existing customer forecasts or purchase orders.
Fluctuations in material costs are typically passed through to customers. We may
agree, upon request from our customers, to temporarily delay shipments, which
caused a corresponding delay in our revenue recognition.
Our fiscal year end is December 31. The consolidated financial statements
of SMTC, are prepared in accordance with United States GAAP.
27
The following table sets forth certain operating data expressed as a
percentage of revenue for the periods ended:
(Unaudited)
Three months ended Nine months ended
-----------------------------------------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
-----------------------------------------------------------------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of sales (including
restructuring charges of $6.3 for the
three and nine months ended September
29, 2002 and $7.2 million and $23.1
million for the three and nine months
ended September 30, 2001) 99.0 115.5 96.6 104.4
-----------------------------------------------------------------
Gross profit (loss) 1.0 (15.5) 3.4 (4.4)
Selling, general and administrative
expenses 3.8 13.2 4.2 7.2
Amortization 0.4 1.9 0.4 1.5
Restructuring charges 4.2 6.2 1.4 4.9
-----------------------------------------------------------------
Operating loss (7.4) (36.8) (2.6) (18.0)
Interest 1.2 1.5 1.5 1.6
-----------------------------------------------------------------
Loss before income taxes,
discontinued operations and the
cumulative effect of a change in
accounting policy (8.6) (38.3) (4.1) (19.6)
Income tax expense (recovery) 0.2 (12.3) (0.2) (6.0)
-----------------------------------------------------------------
Loss before discontinued operations
and the cumulative effect of a
change in accounting policy (8.8) (26.0) (3.9) (13.6)
-----------------------------------------------------------------
Loss from discontinued operations - (1.2) (2.2) (0.8)
Cumulativ effect of a change in
accounting policy - - (12.3) -
-----------------------------------------------------------------
Net loss (8.8)% (27.2)% (18.4)% (14.4)%
=================================================================
QUARTER ENDED SEPTEMBER 29, 2002 COMPARED TO THE QUARTER ENDED SEPTEMBER 30,
2001
Revenue
Revenue increased $27.2 million, or 21.6%, from $125.7 million in the third
quarter of 2001 to $152.9 million in the third quarter of 2002 due primarily to
the acceleration of shipments to Dell coupled with the effects of the new
program wins with existing and new customers. During the third quarter of 2002,
we recorded approximately $8.4 million of sales of raw materials inventory to
customers, which carried no margin, compared to $7.0 million of such sales for
the same period in 2001.
Revenue from Dell of $32.6 million, IBM of $29.1 million and Alcatel of
$17.2 million for the third quarter of 2002 was 21.3%, 19.0% and 11.2%,
respectively, of total revenue for the period. Revenue from Dell of $12.9
million, IBM of $25.9 million and Alcatel of $18.4 million for the third quarter
of 2001 was 10.3%, 20.6% and 14.6%, respectively, of total revenue for the
period. No other customers represented more than 10% of revenue in either
period.
During the second quarter of 2002, the Company informed Dell of its
intention to terminate its supply agreement with Dell, and to end production
over the third quarter. The Company's decision was taken after a review of the
Company's return on capital requirements indicated that the customer's programs
were not generating sufficient returns and, at the same time, were utilizing a
disproportionate amount of working capital.
28
The Company expects lower revenues in the fourth quarter of 2002, as the Company
completes its exit of Dell, which is expected to be offset by reduced expenses
and reduced working capital requirements.
In the third quarter of 2002, 59.9% of our revenue was generated from
operations in the United States, 25.3% from Mexico, 14.3% from Canada and 0.5%
from Europe. In the third quarter of 2001, 69.6% of our revenue was generated
from operations in the United States, 22.4% from Mexico, 5.3% from Canada, and
2.7% from Europe. We expect to continue to increase the portion of revenue
attributable to our Chihuahua facility, with the transfer of certain production
from other facilities and with the addition of new business and increased volume
from our current business.
Gross Profit
Gross profit increased $21.1 million from a loss of $19.5 million for the
third quarter of 2001 to $1.6 million, or 1.0% of revenue, for the third quarter
of 2002. Gross profit for the third quarter of 2001 includes restructuring
charges of $7.2 million related to a write-down of inventory in connection with
the closure of our Denver facility and $12.6 million of other inventory related
charges. Gross profit for the third quarter of 2002 includes restructuring
charges of $6.3 million related to related to an additional write-down of
inventory in connection with the closure of our Denver facility and other
inventory related charges of $0.9 million resulting from the costs associated
with the disengagement of a customer, coupled with the effects of the continued
downturn in the technology sector.
Gross profit, excluding restructuring and other charges, increased $8.5
million from $0.3 million or 0.2% for the third quarter of 2001 to $8.8 million
or 5.8% for the third quarter of 2002. The improvement in the gross profit,
excluding restructuring and other charges, is due to a reduction in both fixed
and variable manufacturing expenses, including fixed operating lease expenses
and variable labor costs . The improvement in gross margin, excluding
restructuring and other charges, is due to improved utilization of the fixed
manufacturing expenses and lower labor costs as a percentage of revenue, due to
the continued focus on expense management.
The Company writes down estimated obsolete or excess inventory for the
difference between the cost of inventory and estimated market value based on
customer forecasts and the ability to sell back inventory to customers or
suppliers. If actual market conditions or our customers' product demands are
less favorable than those projected, additional provisions may be required.
Selling, General & Administrative Expenses
Selling, general and administrative expenses decreased $10.8 million from
$16.6 million for the third quarter of 2001 to $5.8 million for the third
quarter of 2002. Selling, general and administrative expenses for the third
quarter of 2001 include $8.2 million related to accounts receivable exposures
recorded in response to the decline in the technology markets. Excluding the
charges related to accounts receivable, selling general and administrative
expenses decreased $2.6 million from $8.4 million or 6.7% of revenue for the
third quarter of 2001 to $5.8 million or 3.8% of revenue for the third quarter
of 2002 due to our continued focus on reducing selling, general and
administrative expenses.
Amortization
Amortization of intangible assets of $0.6 million for the third quarter of
2002 included the amortization of $0.5 million of deferred finance costs related
to the establishment of our senior credit facility in July 2000 and subsequent
amendments, and $0.1 million of deferred equipment lease costs. The costs
associated with our amended and restated senior credit facility are being
amortized over the remaining term of the debt.
Amortization of intangible assets of $2.4 million for the third quarter of
2001 included the amortization of $0.6 million of goodwill related to the
combination of Surface Mount and HTM, $0.4 million of goodwill related to the
acquisition of W.F. Wood, $0.7 million related to the acquisition of Pensar and
$0.4 million related to the acquisition of Qualtron. Amortization of intangible
assets for the third quarter of 2001 also included the amortization of $0.2
million of deferred finance costs related to the establishment of our senior
credit facility in July 2000 and subsequent amendments, and $0.1 million of
deferred equipment lease costs.
29
Recent accounting pronouncements have changed the way we account for
goodwill by requiring us to no longer amortize goodwill. (See Recent Accounting
Pronouncements).
Restructuring Charges
During fiscal year 2001, in response to excess capacity caused by the
slowing technology end market, the Company commenced a restructuring program
aimed at reducing its cost structure. Accordingly, the Company recorded
restructuring charges of $15.0 million and other charges of $20.8 million during
the third quarter of 2001, consisting of the costs associated with exiting or
re-sizing facilities.
During the third quarter of 2002, in response to the continuing industry
economic downturn, the Company took further steps to realign its cost structure
and plant capacity. Accordingly, the Company recorded third quarter 2002
restructuring charges of $12.8 million related to the cost of exiting equipment
leases and a facility lease, severance costs and inventory exposures and other
inventory charges of $0.9 million resulting from the costs associated with the
disengagement of a customer, coupled with the effects of the continued downturn
in the technology sector.
The following table details the components of the restructuring charge
recorded:
Three months ended
September 29, September 30,
(in millions) 2002 2001
-----------------------------------------------------------------------------
Inventory write-downs included in
cost of sales $ 6.3 $ 7.2
Lease and other contract obligations 5.8 3.4
Reversal of previously recorded lease and
other contract obligations (0.4) -
Severance 1.1 1.3
Other facility exit costs - 3.1
-----------------------------------------------------------------------------
$ 6.5 $ 7.8
-----------------------------------------------------------------------------
12.8 15.0
Other charges included in cost of sales 0.9 12.6
Other charges included in selling, general
and administrative expenses - 8.2
-----------------------------------------------------------------------------
$ 13.7 $ 35.8
=============================================================================
2001 restructuring and other charges:
The write-down of inventory of $7.2 million is associated with the closure
of the assembly facility in Denver. Lease and other contract obligations of $3.4
million include the costs of exiting equipment and facility leases at various
locations. Severance costs of $1.3 million are associated with closure of our
Haverhill interconnect facility and the re-sizing of the Mexico and Ireland
facilities. Other facility exit costs of $3.1 million include personnel costs
and other fees directly related to exit activities at the Denver and Haverhill
locations.
Other charges included in cost of sales of $12.6 million related to
inventory exposures at various facilities. Other charges included in selling,
general and administrative expenses include $8.2 million related to accounts
receivable exposures at various facilities, other than the Denver and Haverhill
facilities.
2002 restructuring and other charges:
The write-down of inventory of $6.3 million represents further costs
associated with the closure of the assembly facility in Denver. Lease and other
contract obligations of $5.8 million represents the costs of exiting equipment
leases at various locations and a facility lease. The reversal of previously
recorded lease and other contract obligations of $0.4 million represents the
excess accrual due to the Company negotiating a final settlement on a facility
lease. The severance costs of $1.1 million related to 317 plant and operational
30
employees, largely at our Mexican facility. The major components of the current
restructuring are estimated to be complete by the end of the fiscal year.
Other charges, included in cost of sales of $0.9 million, relate to
inventory charges resulting from the costs associated with the disengagement of
a customer, coupled with the effects of the continued downturn in the technology
sector.
The Company anticipates fourth quarter 2002 restructuring charges of
between $11.0 million and $21.0 million.
The restructuring charges are based on certain estimates and assumptions
using the best available information at the time and are subject to change.
Interest Expense
Interest expense remained unchanged at $1.9 million for the third quarter
of 2001 and 2002. Lower average debt outstanding during the third quarter of
2002 was offset by higher interest rates. The weighted average interest rates
with respect to the debt for the third quarter of 2001 and 2002 were 6.7% and
7.4%, respectively.
Income Tax Expense
For the third quarter of 2002, an income tax expense of $0.2 million was
recorded on a pre-tax loss before discontinued operations and the cumulative
effect of a change in accounting policy of $13.2 million, as losses in certain
jurisdictions were not tax effected due to the uncertainty of our ability to
utilize such losses and the effects of the valuation reserve for the loss
carryforwards. 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. Based upon consideration of these factors, management
believes the recorded valuation allowance related to the loss carryforwards is
appropriate. However, in the event that actual results differ from estimates or
management adjusts these estimates in future periods, the Company may need to
establish an additional valuation allowance, which could materially impact its
financial position and results of operations.
For the third quarter of 2001, an income tax recovery of $15.5 million on a
pre-tax loss before discontinued operations of $48.2 million, resulted in an
effective tax rate of 32.2% as losses in certain jurisdictions were not tax
effected due to the uncertainty of our ability to utilize such losses.
Discontinued Operations
In February, 2002 the main customer of our Cork, Ireland facility was
placed into administration as part of a financial restructuring. As a result, on
March 19, 2002, we announced that we were closing our Cork, Ireland facility and
that we were taking steps to place the subsidiary that operates that facility in
voluntary administration. During the first quarter of 2002, we recorded a charge
of $9.7 million related to the closure of the facility. The Company placed the
subsidiary in voluntary administration by the end of the first quarter. Facility
exit costs of $1.1 million were paid out during the third quarter of 2002.
Included in the loss from discontinued operations for the three months
ended September 30, 2001 is revenue of $1.3 million.
NINE MONTHS ENDED SEPTEMBER 29, 2002 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2001
Revenue
Revenue decreased $20.0 million, or 4.2%, from $473.4 million for the nine
months ended September 30, 2001 to $453.4 million for the nine months ended
September 29, 2002. The decrease in revenue is due
31
primarily to the effects of the general decline in the technology market. During
the first nine months of 2002, we recorded approximately $26.4 million of sales
of raw materials inventory to customers, which carried no margin, compared to
$29.0 million of such sales for the same period in 2001.
Revenue from IBM of $91.6 million, Dell of $84.9 million and Alcatel of
$53.1 million for the first nine months of 2002 was 20.2%, 18.7% and 11.7%,
respectively, of total revenue for the period. Revenue from IBM of $78.5
million, Dell of $51.3 million and Alcatel of $51.0 million for the first nine
months of 2001 was 16.6%, 10.9% and 10.8%, respectively, of total revenue for
the period. No other customers represented more than 10% of revenue in either
period. During the second quarter of 2002, the Company informed Dell of its
intention to terminate its supply agreement with Dell, and to end production
over the next quarter. The Company's decision was taken after a review of the
Company's return on capital requirements indicated that the customer's programs
were not generating sufficient returns and, at the same time, were utilizing a
disproportionate amount of working capital. The Company expects lower revenues
in the fourth quarter of 2002, as the Company completes its exit with Dell,
which is expected to be offset by reduced expense levels and reduced working
capital usage.
In the first nine months of 2002, 63.0% of our revenue was generated from
operations in the United States, 23.7% from Mexico, 12.6% from Canada and 0.7%
from Europe. In the first nine months of 2001, 73.9% of our revenue was
generated from operations in the United States, 14.7% from Mexico, 8.9% from
Canada, and 2.5% from Europe. We expect to continue to increase the portion of
revenue attributable to our Chihuahua facility, with the transfer of certain
production from other facilities and with the addition of new business and
increased volume from our current business.
Gross Profit
Gross profit increased $36.2 million from a loss of $20.9 million for the
nine months ended September 30, 2001 to $15.3 million, or 3.4% of revenue, for
the nine months ended September 29, 2002. Gross profit for the first three
quarters of 2001 includes restructuring charges of $23.1 million related to a
write-down of inventory in connection with the closure of our Denver facility
and other inventory related charges of $12.6 million recorded during the third
quarter of 2001 in response to the decline in the technology markets. Gross
profit for the first three quarters of 2002 includes restructuring charges of
$6.3 million related to related to an additional write-down of inventory in
connection with the closure of our Denver facility and other inventory related
charges of $0.9 million resulting from the costs associated with the
disengagement of a customer, coupled with the effects of the continued downturn
in the technology sector.
Gross profit, excluding restructuring and other charges, increased $7.7
million from $14.8 million or 3.1% for the first three quarters of 2001 to $22.5
million or 5.0% for the first three quarters of 2002. The improvement in the
gross profit, excluding restructuring and other charges, is due to a reduction
in both the fixed and variable manufacturing expenses, including fixed operating
lease expenses and variable labor costs . The improvement in gross margin,
excluding restructuring and other charges is due to improved utilization of the
fixed manufacturing expenses and lower labour costs as a percentage of revenue,
due to the continued focus on expense management.
The Company writes down estimated obsolete or excess inventory for the
difference between the cost of inventory and estimated market value based on
customer forecasts and the ability to sell back inventory to customers or
suppliers. If actual market conditions or our customers' product demands are
less favorable than those projected, additional provisions may be required.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased $14.9 million from $34.0
million for the nine months ended September 30, 2001 to $19.1 million for the
nine months ended September 29, 2002. Selling, general and administrative
expenses for the third quarter of 2001 include $8.2 million related to accounts
receivable exposures recorded in response to the decline in the technology
markets. Excluding the charges related to accounts receivable, selling general
and administrative expenses decreased $6.7 million from $25.8 million or 5.4% of
revenue for the nine months ended September 30, 2001 to $19.1 million or 4.2% of
revenue for the nine months ended September 29, 2002 due to the closure of our
Denver and Haverhill facilities during 2001 and our continued focus on reducing
selling, general and administrative expenses.
32
Amortization
Amortization of intangible assets of $1.6 million for the first nine months
of 2002 included the amortization of $1.4 million of deferred finance costs
related to the establishment of our senior credit facility in July 2000 and
subsequent amendments, and $0.2 million of deferred equipment lease costs. The
costs associated with our amended and restated senior credit facility are being
amortized over the remaining term of the debt.
Amortization of intangible assets of $7.1 million for the first nine months
of 2001 included the amortization of $1.8 million of goodwill related to the
combination of Surface Mount and HTM, $1.2 million of goodwill related to the
acquisition of W.F. Wood, $2.1 million related to the acquisition of Pensar and
$1.2 million related to the acquisition of Qualtron. Amortization of intangible
assets for the first nine months of 2001 also included the amortization of $0.5
million of deferred finance costs related to the establishment of our senior
credit facility in July 2000 and subsequent amendments, and $0.3 million of
deferred equipment lease costs.
Recent accounting pronouncements have changed the way we account for
goodwill by requiring us to no longer amortize goodwill. (See Recent Accounting
Pronouncements).
Restructuring Charges
During fiscal year 2001, in response to excess capacity caused by the
slowing technology end market, the Company commenced a restructuring program
aimed at reducing its cost structure. Accordingly, the Company recorded
restructuring charges of $46.5 million and other charges of $20.8 million during
the first nine months of 2001, consisting of the costs associated with exiting
or re-sizing facilities.
During the third quarter of 2002, in response to the continuing industry
economic downturn, the Company took further steps to realign its cost structure
and plant capacity. Accordingly, the Company recorded third quarter 2002
restructuring charges of $12.8 million related to the cost of exiting equipment
leases and a facility lease, severance costs and inventory exposures and other
inventory charges of $0.9 million resulting from the costs associated with the
disengagement of a customer, coupled with the effects of the continued downturn
in the technology sector.
33
The following table details the components of the restructuring charge
recorded in the first nine months of 2001:
Nine months ended
September 29, September 30,
(in millions) 2002 2001
-------------------------------------------------------------------------------------------------------
Inventory write-downs included in
cost of sales $ 6.3 $ 23.1
Lease and other contract obligations 5.8 8.6
Reversal of previously recorded lease and other contract obligations (0.4) -
Severance 1.1 3.6
Asset impairment - 5.0
Other facility exit costs - 6.2
-------------------------------------------------------------------------------------------------------
$ 6.5 $ 23.4
-------------------------------------------------------------------------------------------------------
12.8 46.5
Other charges included in cost of sales 0.9 12.6
Other charges included in selling, general and administrative expenses - 8.2
-------------------------------------------------------------------------------------------------------
$ 13.7 $ 67.3
=======================================================================================================
2001 restructuring and other charges:
The write-down of inventory of $23.1 million is associated with the closure
of the assembly facility in Denver. Lease and other contract obligations of $8.6
million include the costs of exiting equipment and facility leases at various
locations. Severance costs of $3.6 million are associated with the closure of
our Denver assembly facility and Haverhill interconnect facility and the
re-sizing of the Mexico and Ireland facilities. Asset impairment charges of $5.0
million reflect the write-down of certain long-lived assets, primarily at the
Denver location, that became impaired as a result of the rationalization of
facilities. The asset impairment was determined based on undiscounted projected
future net cash flows relating to the assets resulting in a write-down to
estimated salvage values. Other facility exit costs of $6.2 million include
personnel costs and other fees directly related to exit activities at the Denver
and Haverhill locations.
Other charges included in cost of sales of $12.6 million related to
inventory exposures at various facilities. Other charges included in selling,
general and administrative expenses include $8.2 million related to accounts
receivable exposures at various facilities, other than the Denver and Haverhill
facilities.
2002 restructuring and other charges:
The write-down of inventory of $6.3 million represents further costs
associated with the closure of the assembly facility in Denver. Lease and other
contract obligations of $5.8 million represents the costs of exiting equipment
leases at various locations and a facility lease. The reversal of previously
recorded lease and other contract obligations of $0.4 million represents the
excess accrual due to the Company negotiating a final settlement on a facility
lease. The severance costs of $1.1 million related to 317 plant and operational
employees, largely at our Mexican facility. The major components of the current
restructuring are estimated to be complete by the end of the fiscal year.
Other charges, included in cost of sales of $0.9 million, relate to
inventory charges resulting from the costs associated with the disengagement of
a customer, coupled with the effects of the continued downturn in the technology
sector.
34
The Company anticipates fourth quarter 2002 restructuring charges of
between $11.0 million and $21.0 million.
The restructuring charges are based on certain estimates and assumptions
using the best available information at the time and are subject to change.
Interest Expense
Interest expense decreased $0.7 million from $7.3 million for the nine
months ended September 30, 2001 to $6.6 million for the nine months ended
September 29, 2002 due to lower average debt outstanding during the first three
quarters of 2002 combined with lower interest rates. The weighted average
interest rates with respect to the debt for the first nine months of 2001 and
2002 were 8.3% and 7.2%, respectively.
Income Tax Expense
For the nine months ended September 29, 2002, an income tax recovery of
$0.8 million was recorded on a pre-tax loss before discontinued operations and
the cumulative effect of a change in accounting policy of $18.5 million, as
losses in certain jurisdictions were not tax effected due to the uncertainty of
our ability to utilize such losses and the effects of the valuation reserve for
the loss carryforwards. 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. Based upon consideration of these factors,
management believes the recorded valuation allowance related to the loss
carryforwards is appropriate. However, in the event that actual results differ
from estimates or management adjusts these estimates in future periods, the
Company may need to establish an additional valuation allowance, which could
materially impact its financial position and results of operations.
For the nine months ended September 30, 2001, an income tax recovery of
$28.2 million on a pre-tax loss before discontinued operations of $92.7 million,
resulted in an effective tax rate of 28.5% as losses in certain jurisdictions
were not tax effected due to the uncertainty of our ability to utilize such
losses. We also are unable to deduct $2.0 million of goodwill amortization.
Discontinued Operations
In February, 2002 the main customer of our Cork, Ireland facility was
placed into administration as part of a financial restructuring. As a result, on
March 19, 2002, we announced that we were closing our Cork, Ireland facility and
that we were taking steps to place the subsidiary that operates that facility in
voluntary administration. During the first quarter of 2002, we recorded a charge
of $9.7 million related to the closure of the facility. The Company placed the
subsidiary in voluntary administration by the end of the first quarter.
35
The following amounts are included in the loss from discontinued operations:
Nine months ended
September 29, September 30,
2002 2001
(in millions)
-------------------------------------------------------------------------------------------------------
Revenue $ 5.0 $ 6.3
=======================================================================================================
Loss from discontinued operations:
Operating loss before restructuring charges $ 0.5 $ 3.2
Restructuring charges - 0.3
Other charges - 0.1
Cost of closing the facility 9.7 -
-------------------------------------------------------------------------------------------------------
Loss from discontinued operations $ 10.2 $ 3.6
=======================================================================================================
Included in the cost of closing the facility of $9.7 million are the
write-off of the net assets of $6.7 million (comprised of capital assets of $1.1
million and net working capital of $5.6 million) and other costs associated with
exiting the facility of $3.0 million. Included in the other costs is severance
of $1.3 million related to the termination of all employees. Facility exit costs
of $1.1 million were paid out during the third quarter of 2002.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash provided from operations and
borrowings under our senior credit facility. In the past, we have also relied on
our access to the capital markets. Our principal uses of cash have been to
finance mergers and acquisitions, to meet debt service requirements and to
finance capital expenditures and working capital requirements. We anticipate our
principal uses of cash in the future will be to meet debt service requirements
and to finance capital expenditures and working capital requirements.
During the second quarter of 2002, the Company informed Dell of its
intention to terminate its supply agreement with Dell, and to end production
over the next quarter. The Company's decision was taken after a review of the
Company's return on capital requirements indicated that the customer's programs
were not generating sufficient returns and, at the same time, were utilizing a
disproportionate amount of working capital. The Company expects lower revenues
in the fourth quarter of 2002, as the Company exits Dell, which is expected to
be offset by reduced expense levels and reduced working capital usage.
Nine months ended September 29, 2002 Liquidity:
Net cash provided by operating activities for the first nine months of 2002
was $25.4 million. Our net cash cycle improved from 63 days for the third
quarter of 2001 and 33 days for the second quarter of 2002 to 15 days for the
third quarter of 2002. Accounts receivable days sales outstanding improved from
65 days in the third quarter of 2001 to 46 days in the second quarter of 2002 to
42 days in the third quarter of 2002.
Net cash used in financing activities for the nine months ended September
29, 2002 was $34.8 million due to the repayment of long-term debt of $32.7
million, the repayment of capital leases of $0.1 million and the costs
associated with the amendment to our credit agreement of $2.0 million.
Net cash used in investing activities for the nine months ended September
29, 2002 was $2.1 million due to the purchase of capital assets of $2.5 million,
offset by proceeds from the sale of capital assets of $0.2 million and other
assets of $0.2 million.
Nine months ended September 30, 2001 Liquidity:
36
Net cash generated from operating activities for the nine months ended
September 30, 2001 was $29.9 million.
Net cash generated in financing activities for the nine months ended
September 30, 2001 was $16.5 million due to the increase in long-term debt of
$21.7 million and proceeds from the issuance of common stock on the exercise of
options of $0.3 million, offset by the repayment of capital leases of $0.3
million and the funding of loans to shareholders of $5.2 million.
Net cash used in investing activities for the nine months ended September
30, 2001 was $17.7 million due to the purchase of capital and other assets.
Capital Resources
As a result of restructuring actions and market conditions we incurred a
significant operating loss during 2001, which resulted in our non-compliance
with certain financial covenants contained in our credit agreement as at
September 30, 2001. On November 19, 2001, we and our lending group signed a
definitive term sheet for an agreement under which certain terms of the credit
facility would be revised and the non-compliance as at September 30, 2001 would
be waived. In February 2002, we and our lending group executed an amendment to
our credit facility, substantially consistent with the term sheet, to waive the
September 30, 2001 defaults and to revise the covenant tests to be consistent
with both current revenues and the forecast for 2002.
The amended financial covenants included in the revised credit facility
include monthly and quarterly minimum cumulative consolidated EBITDA (earnings
before interest, taxes, depreciation and amortization) targets, a maximum daily
and monthly revolving credit loan balance based on accounts receivable and
inventory levels and maximum quarterly capital expenditures. The Company's
activity levels have exceeded the plan that served as the basis for these
amended financial covenants. Accordingly, the Company and its lending group
agreed in April 2002 to further amend the credit agreement to increase the
Company's permitted loan balances to correspond to its higher working capital
needs. The Company was in compliance with the amended financial covenants at
December 31, 2001, and for each of the nine months ended September 29, 2002.
Continued compliance with the financial covenants is dependent on the Company
achieving its forecasts inherent in its business plan. The Company believes the
forecasts are based on reasonable assumptions and are achievable, however, the
forecasts are dependent on a number of factors, some of which are outside the
control of the Company. These include, but are not limited to, general economic
conditions and specifically the strength of the electronics industry and the
related demand for products and services by the Company's customers.
Effective January 1, 2003, the Company reverts back to the financial
covenants under the original credit agreement and at that time it is unlikely
the Company will have earned sufficient EBITDA (earnings before interest
expense, income taxes, depreciation and amortization), using a twelve month
trailing formula, to satisfy the requirements of the agreement. In the event of
non-compliance, the Company's lenders have the ability to demand repayment of
the outstanding amounts under the credit facility. The Company has maintained a
positive working relationship with its lending group and has received a proposed
term sheet under which the lending group would revise the covenants that apply
for the period from December 31, 2002 through June 30, 2004 to correspond to the
Company's current business plan. There can be no assurance that the Company and
its lenders will agree to revise the Company's credit agreement covenants.
During the amendment period, the facility bears interest at the U.S. base
rate as defined in the credit agreement plus 2.5%. As at September 29, 2002, we
had borrowed $90.2 million under this facility.
In connection with the February amendment, the Company agreed to issue to
the lenders warrants to purchase common stock of the Company at an exercise
price equal to the fair market value (defined as average of the last reported
sales price of the common stock of the company for twenty consecutive trading
days commencing 22 trading days before the date in question) at the date of the
grant for 1.5% of the total outstanding shares on February 11, 2002 and 0.5% of
the total outstanding shares on December 31, 2002. If an event of default occurs
during the period from the effective amendment date to December 31, 2002, and
has been continuing for more than 30 days, the lenders will receive warrants to
purchase an additional 1% of the total outstanding shares at an exercise price
equal to the fair market value (as defined above) at the date of grant. In
connection with the April 30, 2002 amendment, the Company agreed to accelerate
the grant date of the 0.5%
37
warrants that were to be issued on December 31, 2002 to April 30, 2002. If all
amounts outstanding under the credit agreement are repaid in full on or before
March 31, 2003, the 1% warrants (if issued) shall be returned to the Company.
The warrants will not be tradable separate from the related debt until the later
of December 31, 2002 or nine months after the issuance of the warrants being
transferred. After the debt under the credit agreement has been paid in full,
the Company may repurchase the warrants or warrant shares at a price that values
the warrant shares at three times the exercise price.
The Company also paid amendment fees of $1.5 million comprised of $0.7
million representing 0.5% of the lender's commitments under the revolving credit
facilities and term loans outstanding at February 11, 2002 and other amendment
related fees of $0.8 million. The Company may be required to pay default fees if
it violates certain covenants after the effective date of the February 2002
amendment. The amendment fees and the fair value of the warrants in connection
with amending the agreement have been accounted for as deferred financing fees.
In March 2002, we and our lenders executed an amendment to our credit
facility to waive the default that would have been caused by placing the
subsidiary that operates the Cork, Ireland facility in voluntary liquidation. We
paid $0.1 million in amendment fees in connection with such amendment.
In connection with the April 30, 2002 amendment, we paid approximately $0.1
million in amendment fees.
Our management believes that cash generated from operations, available cash
and amounts available under our senior credit facility will be adequate to meet
our debt service requirements, capital expenditures and working capital needs at
our current level of operations and organic growth through the next twelve
months, although no assurance can be given in this regard, particularly with
respect to amounts available under our credit facility, as discussed above.
These sources of cash will continue to be adequate after the end of the year
only if we are able to successfully negotiate an amendment to the credit
agreement that will adjust covenant levels to our current business plan. The
Company has maintained a positive working relationship with its lending group
and has received a proposed term sheet under which the lending group would
revise the covenants that apply for the period from December 31, 2002 through
June 30, 2004 to correspond to the Company's current business plan. There can be
no assurance that the Company and its lenders will agree to revise the Company's
credit agreement covenants. Further, there can be no assurance that our business
will generate sufficient cash flow from operations or that future borrowings
will be available to enable us to service our indebtedness. Our future operating
performance and ability to service or refinance indebtedness will be subject to
future economic conditions and to financial, business and other factors, certain
of which are beyond our control.
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued Statement No. 141, "Business Combinations"
("Statement 141"), and Statement No. 142, "Goodwill and Other Intangible Assets"
("Statement 142"). Statement 141 requires that the purchase method of accounting
be used for all business combinations. Statement 141 also specifies criteria
intangible assets acquired in a purchase method business combination must meet
to be recognized and reported apart from goodwill. Statement 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of Statement 142. Statement 142 also requires that
intangible assets with definite useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment in accordance with Statement 121. Upon adoption of Statements 141 and
142 in their entirety on January 1, 2002, the Company determined that there are
no intangible assets relating to previous acquisitions that need to be
reclassified and accounted for apart from goodwill under the provisions of those
Statements.
In connection with the transitional goodwill impairment evaluation,
Statement 142 requires the Company to perform an assessment of whether there is
an indication that goodwill is impaired as of January 1, 2002. To accomplish
this, the Company was required to identify its reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill to those reporting units as of January 1, 2002.
The Company has identified its reporting units to be consistent with its
business units as defined in note 6, with the exception of the Boston,
Massachusetts facility. This facility is not economically similar to the other
US facilities and as a result, is a separate reporting unit. In connection with
the implementation of new accounting standards, the Company has completed the
transitional goodwill impairment test resulting in a goodwill impairment charge
of $55.6 million, which comprises the goodwill in the
38
Canadian, US and Boston reporting units. The fair value of each reporting unit
was determined using the discounted cash flows of the reporting unit. The
transitional impairment loss was recognized as the cumulative effect of a change
in accounting principle in the Company's statement of operations as at January
1, 2002.
Effective January 1, 2002, the Company had unamortized goodwill of $55.6
million, which is no longer being amortized. This change in accounting policy is
not applied retroactively and the amounts presented for prior periods have not
been restated for this change. The impact of this change is as follows:
Three months ended Nine months ended
Sept 29, Sept 30, Sept 29, Sept 30,
(in millions, except per share amounts) 2002 2001 2002 2001
---------------------------------------------------------------------------------------------------
Net loss $ (13.4) $ (34.2) $ (83.5) $ (68.1)
Add back goodwill amortization,
net of tax - 1.7 - 5.1
---------------------------------------------------------------------------------------------------
Net loss before goodwill amortization $ (13.4) $ (32.5) $ (83.5) $ (63.0)
===================================================================================================
Basic and diluted loss per share:
Net loss $ (0.47) $ (1.19) $ (2.91) $ (2.38)
Net loss before goodwill
amortization $ (0.47) $ (1.13) $ (2.91) $ (2.21)
===================================================================================================
In October 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("Statement 144"), which supersedes
both Statement 121 and the accounting and reporting provisions of APB Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" ("Opinion 30"), for the disposal of a segment
of a business (as previously defined in that Opinion). Statement 144 retains the
fundamental provisions in Statement 121 for recognizing and measuring impairment
losses on long-lived assets held for use and long-lived assets to be disposed of
by sale. Statement 144 retains the basic provisions of Opinion 30 on how to
present discontinued operations in the income statement but broadens that
presentation to include a component of an entity (rather than a segment of a
business). The Company adopted Statement 144 for the quarter ending March 31,
2002 and presented the closure of its Cork facility and the related charges as
discontinued operations.
In August 2001, the FASB issued Statement No. 143 "Accounting for Asset
Retirement Obligations" which requires that the fair value of an asset
retirement obligation be recorded as a liability, at fair value, in the period
in which the Company incurs the obligation. The Statement is effective for
fiscal 2003 and the Company expects no material effect as a result of this
Statement.
In April 2002, the FASB issued Statement No. 145, "Recission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections" ("Statement 145"), which provides for the recission of several
previously issued accounting standards, new accounting guidance for the
accounting for certain lease modifications and various technical corrections
that are not substantive in nature to existing pronouncements. In addition,
gains and losses from extinguishment of debt will not longer be classified as an
extraordinary item. The Statement will be effective for fiscal 2003, with early
adoption of the provisions related to the classification of gains and losses on
extinguishment of debt encouraged. Upon adoption, enterprises must reclassify
prior period items that do not meet the extraordinary item classification
criteria in APB 30. The Company plans to adopt the provisions of Statement 145
in fiscal 2003 and expects no material effect as a result of this Statement
except for the reclassification of prior period extraordinary items to ordinary
income. In fiscal 1999 and 2000, $1,247 and 2,678 respectively, was booked as an
extraordinary loss. These amounts will be reclassified to ordinary income.
In July 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("Statement 146"). Statement 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities, and is effective for exit or disposal activities initiated
after December 31, 2002 with early application encouraged. Statement 146
nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3") "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in Restructuring)". The principal
difference between Statement 146
39
and EITF 94-3 relates to the recognition of a liability for a cost associated
with an exit or disposal activity. FAS 146 requires that the cost associated
with an exit or disposal activity be recognized when the liability is incurred,
whereas under EITF 94-3 the liability was recognized at the date of an entity's
commitment to an exit plan. The Company is currently assessing the impact of
this Statement.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management 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 2 to the Consolidated Financial Statements in our Annual Report on Form
10-K for the fiscal year ended December 31, 2001 describes the significant
accounting policies and methods used in the preparation of our consolidated
financial statements. The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of
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.
Allowance for Doubtful Accounts
The Company determines the allowance for doubtful accounts for estimated credit
losses based on the financial condition of its customers, concentration of
credit risk, historical experience, industry conditions and the age of past due
receivables. Unanticipated changes in the liquidity or financial position of our
customers may require additional provisions for doubtful accounts.
Inventory Valuation
Inventories are valued on a first-in, first-out basis at the lower of cost and
replacement cost for raw materials and at the lower of cost and net realizable
value for work in progress and finished goods. Inventories include an
application of relevant overhead. Our industry is characterized by rapid
technological change, short-term customer commitments and rapid changes in
demand. The Company writes down estimated obsolete or excess inventory for the
difference between the cost of inventory and estimated market value based on
customer forecasts and the ability to sell back inventory to customers or
suppliers. If actual market conditions or our customers' product demands are
less favorable than those projected, additional provisions may be required.
Restructuring and Other Charges
In response to excess capacity caused by the slowing technology end market, the
Company recorded restructuring and other charges aimed at reducing its cost
structure. In connection with exit activities, the Company recorded charges for
inventory write-downs, employee termination costs, lease and other contractual
obligations, long-lived asset impairment and other exit-related costs. These
charges were incurred pursuant to formal plans developed by management. The
recognition of restructuring and other charges required the Company to make
certain judgments and estimates regarding the nature, timing and amount of costs
associated with the planned exit activities. The estimates of future liabilities
may change, requiring the recording of additional charges or the reduction of
liabilities already recorded. At the end of each reporting period, the Company
evaluates the remaining accrued balances to ensure that no excess accruals are
retained and the utilization of the provision are for their intended purposed in
accordance with the developed exit plans.
Long-lived Assets
The Company reviews property and equipment for impairment whenever events or
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of property and equipment is measured by comparing
the carrying amount of the assets to the projected discounted cash flows the
assets are expected to generate. If such assets are considered to be impaired,
the impairment to be recognized is measured by the amount by which the carrying
amount of the asset exceeds its fair market value.
In accordance with Statement of Accounting Standards ("SFAS") No. 142, "Goodwill
and Other Intangible Assets", we evaluate goodwill for impairment, on at least
an annual basis and whenever events or circumstances
40
indicate that the carrying amount may not be recoverable from its estimate
future cash flows. Recoverability of goodwill is measured at the reporting unit
level by comparing the reporting unit's carrying amount, including goodwill, to
the fair value of the reporting unit, based on projected discounted future cash
flows. The Company must make estimates in the calculation of projected
discounted future cash flows including estimates of future economic and business
conditions, changes in technology and customer orders. If the carrying amount of
the reporting unit exceeds its fair value, goodwill is considered impaired and a
second test is performed to measure the amount of impairment loss, if any.
Adverse changes in the technology end market, customer demand and other market
conditions has resulted in the impairmant of goodwill.
Tax asset
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. Based upon consideration of these factors, management believes the
recorded valuation allowance related to the loss carryforwards is appropriate.
However, in the event that actual results differ from estimates or management
adjusts these estimates in future periods, the Company may need to establish an
additional valuation allowance, which could materially impact its financial
position and results of operations.
FORWARD-LOOKING STATEMENTS
A number of the matters and subject areas discussed in this Form 10-Q are
forward-looking in nature. The discussion of such matters and subject areas is
qualified by the inherent risks and uncertainties surrounding future
expectations generally; these expectations may differ materially from SMTC's
actual future experience involving any one or more of such matters and subject
areas. SMTC cautions readers that all statements other than statements of
historical facts included in this quarterly Form 10-Q regarding SMTC's financial
position and business strategy may constitute forward-looking statements. All of
these forward-looking statements are based upon estimates and assumptions made
by SMTC's management, which although believed to be reasonable, are inherently
uncertain. Therefore, undue reliance should not be placed on such estimates and
statements. No assurance can be given that any of such estimates or statements
will be realized, and it is likely that actual results will differ materially
from those contemplated by such forward-looking statements. Factors that may
cause such differences include: (1) increased competition; (2) increased costs;
(3) the inability to implement our business plan and maintain covenant
compliance under our credit agreement; (4) the loss or retirement of key members
of management; (5) increases in SMTC's cost of borrowings or lack of
availability of debt or equity capital on terms considered reasonable by
management; (6) adverse state, federal or foreign legislation or regulation or
adverse determinations by regulators; (7) changes in general economic conditions
in the markets in which SMTC may compete and fluctuations in demand in the
electronics industry; (8) the inability to manage inventory levels efficiently
in light of changes in market conditions; and (9) the inability to sustain
historical margins as the industry develops. SMTC has attempted to identify
certain of the factors that it currently believes may cause actual future
experiences to differ from SMTC's current expectations regarding the relevant
matter or subject area. In addition to the items specifically discussed in the
foregoing, SMTC's business and results of operations are subject to the risks
and uncertainties described under the heading "Factors That May Affect Future
Results" below. The operations and results of SMTC's business may also be
subject to the effect of other risks and uncertainties. Such risks and
uncertainties include, but are not limited to, items described from time to time
in SMTC's reports filed with the Securities and Exchange Commission.
FACTORS THAT MAY AFFECT FUTURE RESULTS
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
We are exposed to general economic conditions, which could have a material
adverse impact on our business, operating results and financial condition.
As a result of recent unfavorable economic conditions and reduced capital
spending, our sales have declined from 2001 to 2002. In particular, sales to
OEMs in the telecommunications and networking industries
41
worldwide were impacted during 2001 and the first half of 2002. If economic
conditions worsen, we may experience a material adverse impact on our business,
operating results and financial condition.
A majority of our revenue comes from a small number of customers; if we lose any
of our largest customers, our revenue could decline significantly.
Our three largest customers during the third quarter of 2002 were Dell, IBM
and Alcatel, which represented approximately 21.3%, 19.0% and 11.2%,
respectively, of our total revenue for that period. Our top ten largest
customers (including Dell, IBM and Alcatel) collectively represented
approximately 81.5% of our total revenue during the third quarter of 2002.
During the second quarter of 2002, the Company informed Dell of its intention to
terminate its supply agreement with them, and to end production with Dell over
the next quarter. The Company expects lower revenues in the fourth quarter of
2002, as the Company completes its exit with Dell. The Company's decision was
taken after a review of the Company's return on capital requirements indicated
that the customer's programs were not generating sufficient returns and, at the
same time, were utilizing a disproportionate amount of working capital. 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 limited number of
customers, we manufacture a limited number of products for each of our
customers. If we lose any of our largest customers or any product line
manufactured for one of our largest customers, we could experience a significant
reduction in our revenue. Also, 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 could decrease revenue. As many of our costs and operating expenses
are relatively fixed, a reduction in net revenue can decrease our profit margins
and adversely affect our business, financial condition and results of
operations.
Our industry is very competitive and we may not be successful if we fail to
compete effectively.
The electronics manufacturing services (EMS) industry is highly
competitive. We compete against numerous domestic and foreign EMS providers
including Celestica Inc., Flextronics International Ltd., Jabil Circuit, Inc.,
Sanmina-SCI Corp. and Solectron Corporation. In addition, we may in the future
encounter competition from other large electronics manufacturers that are
selling, or may begin to sell, electronics manufacturing services. Many of our
competitors have international operations, and some may have substantially
greater manufacturing, financial research and development and marketing
resources and lower cost structures than we do. We also face competition from
the manufacturing operations of current and potential customers, which are
continually evaluating the merits of manufacturing products internally versus
the advantages of using external manufacturers.
We may experience variability in our operating results, which could negatively
impact the price of our shares.
Our annual and quarterly results have fluctuated in the past. The reasons for
these fluctuations may similarly affect us in the future. Historically, our
calendar fourth quarter revenue has been highest and our calendar first quarter
revenue has been lowest. We expect revenues in the fourth quarter of 2002 to be
affected by the termination of our relationship with Dell. Prospective investors
should not rely on 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:
. variations in the timing and volume of customer orders relative to our
manufacturing capacity;
. variations in the timing of shipments of products to customers;
. introduction and market acceptance of our customers' new products;
. changes in demand for our customers' existing products;
. the accuracy of our customers' forecasts of future production
requirements;
. effectiveness in managing our manufacturing processes and inventory
levels;
42
. changes in competitive and economic conditions generally or in our
customers' markets;
. changes in the cost or availability of components or skilled labor;
and
. the timing of, and the price we pay for, acquisitions and related
integration costs.
In addition, most of our customers typically do not commit to firm
production schedules more than 30 to 90 days in advance. Accordingly, we cannot
forecast the level of customer orders with certainty. During 2001 and 2002, many
customers have placed orders on short notice for delivery in the last month of
each fiscal quarter. This makes it difficult to schedule production and 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
anticipated demand of our customers. Sometimes anticipated orders from certain
customers have failed to materialize, and sometimes delivery schedules have been
deferred as a result of changes in a customer's business needs. Any material
delay, cancellation or reduction of orders from our largest customers could
cause our revenue to decline significantly. In addition, as many of our costs
and operating expenses are relatively fixed, a reduction in customer demand can
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.
Any of these factors or a combination of these factors could have a
material adverse effect on our business, financial condition and results of
operations.
We are dependent upon the electronics industry, which produces technologically
advanced products with short life cycles.
Substantially all of our customers are in the electronics industry, which
is characterized by intense competition, short product life-cycles and
significant fluctuations in product demand. In addition, the electronics
industry is 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
the demand for our services could significantly decline. Our success is largely
dependent on the success achieved by our customers in developing and marketing
their products. Furthermore, this industry is subject to economic cycles and is
experiencing a significant downturn. A continued recession or downturn in the
electronics industry would likely have a material adverse effect on our
business, financial condition and results of operations.
Shortage or price fluctuation in 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 a material adverse effect on our business, financial
condition and results of operations. We are required to forecast our future
inventory needs based upon the anticipated demands of our customers.
Inaccuracies in making these forecasts or estimates could result in a shortage
or an excess of materials. In addition, delays, cancellations or reductions of
orders by our customers could result in an excess 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 productions 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. As a result, suppliers have been forced to allocate
available quantities among their customers and we have not been able to obtain
all of the materials desired. Our inability to obtain these needed 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. Accordingly, some component price increases could
increase costs and reduce operating income. Also we rely on a variety of common
carriers for materials transportation, and we
43
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 a material adverse effect on our business,
financial condition and results of operations.
We have experienced significant growth and significant retrenchment in a short
period of time.
Since 1995, we have completed seven acquisitions. Acquisitions may involve
numerous risks, including difficulty in integrating operations, technologies,
systems, and products and services of acquired companies; diversion of
management's attention and disruption of operations; increased expenses and
working capital requirements; entering markets in which we have limited or no
prior experience and where competitors in such markets have stronger market
positions; and the potential loss of key employees and customers of acquired
companies. In addition, acquisitions may involve financial risks, such as the
potential liabilities of the acquired businesses, the dilutive effect of the
issuance of additional equity securities, the incurrence of additional debt, the
financial impact of transaction expenses and the amortization of intangible
assets involved in any transactions that are accounted for using the purchase
method of accounting, and possible adverse tax and accounting effects.
In 2001 we implemented a restructuring plan that called for significant
retrenchment. We closed our Denver and Haverhill facilities and resized
operations in Mexico and Ireland in an effort to reduce our cost structure. In
February, 2002 the main customer of our Cork, Ireland facility was placed into
administration as part of a financial restructuring. As a result, on March 19,
2002, we announced that we were closing our Cork, Ireland facility and that we
were taking steps to place the subsidiary that operates that facility in
voluntary administration. During the third quarter of 2002, the Company took
further steps to realign its cost structure and plant capacity. Retrenchment has
caused, and is expected to continue to cause, strain on our infrastructure,
including our managerial, technical and other resources. We may experience
inefficiencies as we integrate operations from closed facilities to currently
operating facilities and may experience delays in meeting the needs of
transferred customers. In addition, we are reducing the geographic dispersion of
our operations, which may make it harder for us to compete and may cause us to
lose customers. The loss of customers could have a material adverse effect on
our business, financial condition and results of operations.
We have a limited history of owning and operating our acquired businesses
on a consolidated basis. There can be no assurance that we will be able to meet
performance expectations or successfully integrate our acquired businesses on a
timely basis without disrupting the quality and reliability of service to our
customers or diverting management resources. Our rapid growth and subsequent
retrenchment has placed and will continue to place a significant strain on
management, on our financial resources, and on our information, operating and
financial systems. If we are unable to manage effectively, it may have a
material adverse effect on our business, financial condition and results of
operations.
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 products and 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 maintain and enhance
our technological capabilities, to develop and market products and 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 in the future encounter competition from new or revised
technologies that render existing technology less competitive or obsolete or
that reduce the demand for our services. There can be no assurance that we will
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. There can be no assurance that capital will be available for these
purposes in the future or that investments in new technologies will result in
commercially viable technological processes.
Our business will suffer if we are unable to attract and retain key personnel
and skilled employees.
We depend on the services of our key senior executives, including Paul
Walker, Philip Woodard, Gary Walker and Derrick D'Andrade. Our business also
depends on our ability to continue to recruit, train and retain skilled
employees, particularly executive management, engineering and sales personnel.
Recruiting personnel in
44
our industry is highly competitive. In addition, our ability to successfully
implement our business plan depends in part on our ability to retain key
management and existing employees. There can be no assurance that we will be
able to retain our executive officers and key personnel or attract qualified
management in the future. In connection with our restructuring, we significantly
reduced our workforce. If we receive a significant volume of new orders, we may
have difficulty recruiting skilled workers back into our workforce to respond to
such orders and accordingly may experience delays that could adversely effect
our ability to meet customers' delivery schedules.
Risks particular to our international operations could adversely affect our
overall results.
Our success will depend, among other things, on successful expansion into
new foreign markets in order to offer our customers lower cost production
options. Entry into new foreign markets may require considerable management time
as well as start-up expenses for market development, hiring and establishing
office facilities before any significant revenue is generated. As a result,
operations in a new foreign market may operate at low profit margins or may be
unprofitable.
Revenue generated outside of the United States and Canada was approximately
11.3% in 2001. International operations are subject to inherent risks,
including:
. fluctuations in the value of currencies and high levels of inflation;
. longer payment cycles and greater difficulty in collecting amounts
receivable;
. unexpected changes in and the burdens and costs of compliance with a
variety of foreign laws;
. political and economic instability;
. increases in duties and taxation;
. inability to utilize net operating losses incurred by our foreign
operations to reduce our U.S. and Canadian income taxes;
. imposition of restrictions on currency conversion or the transfer of
funds;
. trade restrictions; and
. dependence on key customers.
We are subject to a variety of environmental laws, which expose us to potential
financial liability.
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. Compliance with
these environmental laws is a major consideration for us because we use metals
and other hazardous materials in our manufacturing processes. 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, along
with any other person who arranges for the disposal of our wastes, 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 a material adverse effect on our operations.
Environmental laws could also become more stringent over time, imposing greater
compliance costs and increasing risks and penalties associated with any
violation, which could have a material adverse effect on our business, financial
condition and results of operations.
45
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.
At September 29, 2002, we had $90.2 million of indebtedness under our
senior credit facility. This debt could have adverse consequences for our
business, including:
. We will be more vulnerable to adverse general economic conditions;
. We will be required to dedicate a substantial portion of our cash flow
from operations to repayment of debt, 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 by financial and other restrictive covenants in
our credit arrangements in our borrowing of additional funds; and
. We may fail to comply with the covenants under which we borrowed our
indebtedness which could result in 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. If we were unable to repay such amounts,
the lenders could proceed against any collateral granted to them to
secure that indebtedness.
There can be no assurance that our leverage and such restrictions will not
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 to meet our financial
and restrictive covenants and to satisfy our other debt 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, as well as the availability of revolving credit
borrowings under our senior credit facility or successor facilities.
Effective January 1, 2003, the Company reverts back to the financial
covenants under the original credit agreement and at that time it is unlikely
the Company will have earned sufficient EBITDA (earnings before interest
expense, income taxes, depreciation and amortization), using a twelve month
trailing formula, to satisfy the requirements of the agreement. In the event of
non-compliance, the Company's lenders have the ability to demand repayment of
the outstanding amounts under the credit facility. The Company has maintained a
positive working relationship with its lending group and has received a proposed
term sheet under which the lending group would revise the covenants that apply
for the period from December 31, 2002 through June 30, 2004 to correspond to the
Company's current business plan. There can be no assurance that the Company and
its lenders will agree to revise the Company's credit agreement covenants.
The terms of our credit agreement impose significant restrictions on our ability
to operate.
The terms of our current credit agreement restrict, among other things, our
ability to incur additional indebtedness, complete acquisitions, pay dividends
or make certain other restricted payments, consummate certain asset sales, enter
into certain transactions with affiliates, merge, consolidate or sell, assign,
transfer, lease, convey or otherwise dispose of all or substantially all of our
assets. We are also required to maintain specified financial ratios and satisfy
certain monthly and quarterly financial condition tests, which further restrict
our ability to operate as we choose. As at September 30, 2001, we were in
violation of financial covenants contained in our credit agreement. Such
violation was waived and the credit agreement was amended to provide financial
covenants consistent with our current revenues and our forecast for 2002.
Effective January 1, 2003, the Company reverts back to the financial covenants
under the original credit agreement and at that time it is unlikely the Company
will have earned sufficient EBITDA (earnings before interest expense, income
taxes, depreciation and amortization), using a twelve month trailing formula, to
satisfy the requirements of the
46
agreement. In the event of non-compliance, the Company's lenders have the
ability to demand repayment of the outstanding amounts under the credit
facility. The Company has maintained a positive working relationship with its
lending group and has received a proposed term sheet under which the lending
group would revise the covenants that apply for the period from December 31,
2002 through June 30, 2004 to correspond to the Company's current business plan.
There can be no assurance that the Company and its lenders will agree to revise
the Company's credit agreement covenants. As a result of our past
non-compliance, customers may lose confidence in us and reduce or eliminate
their orders with us, which may have a material adverse effect on our business,
financial condition and results of operations.
Substantially all of our assets and those of our subsidiaries are pledged
as security under our senior credit facility.
Investment funds affiliated with Bain Capital, LLC, investment funds affiliated
with Celerity Partners, Inc., Kilmer Electronics Group Limited and certain
members of management have significant influence over our business, and could
delay, deter or prevent a change of control or other business combination.
Investment funds affiliated with Bain Capital, LLC, investment funds
affiliated with Celerity Partners, Inc., Kilmer Electronics Group Limited and
certain members of management held approximately 13.4%, 12.1%, 7.1% and 16.7%,
respectively, of our outstanding shares as of September 29, 2002. In addition,
two of the nine directors who serve on our board are representatives of the Bain
funds, two are representatives of the Celerity funds, one is a representative of
Kilmer Electronics Group Limited and two are members of management. By virtue of
such stock ownership and board representation, the Bain funds, the Celerity
funds, Kilmer Electronics Group Limited and certain members of management have a
significant influence over all matters submitted to our stockholders, including
the election of our directors, and exercise significant control over our
business policies and affairs. Such concentration of voting power could have the
effect of delaying, deterring or preventing a change of control or other
business combination that might otherwise be beneficial to our stockholders.
SMTC's Common Stock May Be Delisted From The Nasdaq National Market.
SMTC has received a notification from Nasdaq Listing Qualifications that its
common stock has failed to maintain the minimum bid price of $1.00 per share
over a period of 30 consecutive trading days, as required by Nasdaq's
Marketplace Rules. Nasdaq has provided SMTC with a grace period of 90 calendar
days, or until February 3, 2003, to regain compliance with this requirement or
be delisted from trading on The Nasdaq National Market. We intend to monitor the
bid price for our common stock between the date of this report and February 3,
2003. If the stock does not trade at a level that is likely to regain
compliance, our Board of Directors will consider other options available to
regain compliance. Our failure to comply with Nasdaq's Marketplace Rules or
promptly to cure this noncompliance or any other noncompliance with such Rules
could result in our common stock being delisted, and the liquidity of our stock
could be materially impaired.
Provisions in our charter documents and state law may make it harder for others
to obtain control of us even though some stockholders might consider such a
development favorable.
Provisions in our charter, by-laws and certain provisions under Delaware
law may have the effect of delaying or preventing a change of control or changes
in our management that stockholders consider favorable or beneficial. If a
change of control or change in management is delayed or prevented, the market
price of our shares could suffer.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK
Our senior credit facility bears interest at a floating rate. The weighted
average interest rate on our senior credit facility for the quarter ended
September 29, 2002 was 7.2%. Our debt of $90.2 million bore interest at 7.3% on
September 29, 2002 based on the U.S. base rate. If the U.S. base rate increased
by 10% our interest rate would have risen to 7.7% and our interest expense would
have increased by approximately $0.1 million for the third quarter of 2002.
47
FOREIGN CURRENCY EXCHANGE RISK
Most of our sales and purchases are denominated in U.S. dollars, and as a result
we have relatively little exposure to foreign currency exchange risk with
respect to sales made.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The Company's Chief
Executive Officer and Chief Financial Officer have conducted an
evaluation of the Company's disclosure controls and procedures as of a
date within 90 days of filing this quarterly report. Based on their
evaluation, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that the Company's disclosure controls and
procedures are effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the applicable Securities
and Exchange Commission rules and forms.
(b) Changes in Internal Controls and Procedures. There were no significant
changes in the Company's internal controls or in other factors that
could significantly affect these controls subsequent to the date of the
most recent evaluation of these controls by the Company's Chief
Executive Officer and Chief Financial Officer.
48
PART II OTHER INFORMATION
ITEM 5. OTHER INFORMATION.
Accompanying this Quarterly Report on Form 10-Q are the certificates of the
Chief Executive Officer and Chief Financial Officer required by Section 1350,
Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, copies of which are furnished as exhibits to
this report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) List of Exhibits:
99.1 Certification of Paul Walker, pursuant to Section 1350, Chapter 63
of Title 18, United States Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, dated November 13, 2002.
99.2 Certification of Frank Burke, pursuant to Section 1350, Chapter 63
of Title 18, United States Code, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, dated November 13, 2002.
(b) Reports on Form 8-K: None.
49
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, SMTC
Corporation has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
SMTC CORPORATION
By: /s/ Paul Walker
------------------------------------
Name: Paul Walker
Title: President and CEO
By: /s/ Frank Burke
------------------------------------
Name: Frank Burke
Title: Chief Financial Officer
Date: November 13, 2002
50
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Paul Walker, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SMTC Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Paul Walker
-----------------
Paul Walker
Chief Executive Officer
51
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Frank Burke, certify that:
1. I have reviewed this quarterly report on Form 10-Q of SMTC Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Frank Burke
-----------------
Frank Burke
Chief Financial Officer
52
EXHIBIT INDEX
Exhibit
Number Document
- ------- --------------------------------------------------------------
99.1 Certification of Paul Walker, pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
dated November 13, 2002.
99.2 Certification of Frank Burke, pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
dated November 13, 2002.
53