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 30, 2001
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 [_].
As of September 30, 2001, SMTC Corporation had 22,380,820 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 30, 2001, SMTC Corporation's
subsidiary, SMTC Manufacturing Corporation of Canada, had 6,308,959 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 3
Item 1. Financial Statements 3
Consolidated Balance Sheets as of September 30, 2001
and December 31, 2000 3
Consolidated Statements of Earnings (Loss) for the three months ended
and the nine months ended September 30, 2001 and October 1, 2000 4
Consolidated Statement of Changes in Shareholders' Equity for the
nine months ended September 30, 2001 5
Consolidated Statements of Cash Flows for the three months ended
and the nine months ended September 30, 2001 and October 1, 2000 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 39
PART II Other Information 41
Item 3. Defaults Upon Senior Securities 41
Item 5. Other Information 41
Item 6. Exhibits and Reports on Form 8-K 41
Signatures 42
2
SMTC CORPORATION
Consolidated Balance Sheets
(Expressed in thousands of U.S. dollars)
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2001 2000
- -------------------------------------------------------------------------------------------------------------------
(unaudited)
Assets
Current assets:
Cash and short-term investments $ 31,346 $ 2,698
Accounts receivable 90,260 194,749
Inventories (note 2) 92,907 191,821
Prepaid expenses 5,333 5,233
Income taxes recoverable 1,599 -
Deferred income taxes - 1,044
- -------------------------------------------------------------------------------------------------------------------
221,445 395,545
Capital assets 62,935 58,564
Goodwill 73,940 80,149
Other assets 11,257 9,859
Deferred income taxes 29,180 3,359
- -------------------------------------------------------------------------------------------------------------------
$ 398,757 $ 547,476
===================================================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 57,380 $ 141,574
Accrued liabilities 40,323 51,695
Income taxes payable - 5,458
Current portion of long-term debt (note 3) 11,250 7,500
Current portion of capital lease obligations 198 995
- -------------------------------------------------------------------------------------------------------------------
109,151 207,222
Long-term debt (note 3) 126,218 108,305
Capital lease obligations 457 1,242
Deferred income taxes 2,221 2,221
Shareholders' equity:
Capital stock 77,431 77,427
Warrants - 367
Loans receivable (13) (27)
Additional paid-in-capital 152,072 151,396
Deficit (68,780) (677)
- -------------------------------------------------------------------------------------------------------------------
160,710 228,486
- -------------------------------------------------------------------------------------------------------------------
$ 398,757 $ 547,476
===================================================================================================================
See accompanying notes to consolidated financial statements.
3
SMTC CORPORATION
Consolidated Statements of Earnings (Loss)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
(Unaudited)
- -------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
-------------------------------- --------------------------------
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
Revenue $ 126,921 $ 231,492 $ 479,711 $ 522,961
Cost of sales (including restructuring
and other charges) (note 7) 147,543 211,957 502,963 478,475
- ---------------------------------------------------------------------------------------------------------------------
Gross profit (loss) (20,622) 19,535 (23,252) 44,486
Selling, general and
administrative expenses (note 7) 16,945 9,335 34,991 24,279
Amortization 2,359 1,663 7,064 4,165
Restructuring charges (note 7) 7,939 - 23,693 -
- ---------------------------------------------------------------------------------------------------------------------
Operating income (loss) (47,865) 8,537 (89,000) 16,042
Interest 1,900 2,665 7,353 10,569
- ---------------------------------------------------------------------------------------------------------------------
Earnings (loss) before income taxes (49,765) 5,872 (96,353) 5,473
Income tax expense (recovery) (15,548) 2,567 (28,250) 3,492
- ---------------------------------------------------------------------------------------------------------------------
Earnings (loss) before
extraordinary loss (34,217) 3,305 (68,103) 1,981
Extraordinary loss, net of tax
recovery of $1,640 - 2,678 - 2,678
- ---------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (34,217) $ 627 $ (68,103) $ (697)
=====================================================================================================================
Earnings (loss) per share:
Basic earnings (loss) per share
before extraordinary item $ (1.19) $ 0.14 $ (2.38) $ (1.14)
Extraordinary loss per share - (0.13) - (0.32)
- ---------------------------------------------------------------------------------------------------------------------
Basic net earnings (loss) per share $ (1.19) $ 0.01 $ (2.38) $ (0.46)
=====================================================================================================================
Diluted earnings (loss) per share $ (1.19) $ 0.01 $ (2.38) $ (0.46)
=====================================================================================================================
Weighted average number of common
shares used in the calculations of
earnings (loss) per share:
Basic 28,689,779 20,334,099 28,580,537 8,349,896
Diluted 28,689,779 21,098,232 28,580,537 8,349,896
=====================================================================================================================
See accompanying notes to consolidated financial statements.
4
SMTC CORPORATION
Consolidated Statement of Changes in Shareholders' Equity
(Expressed in thousands of U.S. dollars)
Nine months ended September 30, 2001
(Unaudited)
- -------------------------------------------------------------------------------------------------------------------
Additional
Capital paid-in Loans Shareholders'
stock Warrants capital receivable Deficit equity
- -------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 $ 77,427 $ 367 $ 151,396 $ (27) $ (677) $ 228,486
Warrants exercised 4 (367) 363 - - -
Options exercised - - 313 - - 313
Repayment of loans receivable - - - 14 - 14
Loss for the period - - - - (68,103) (68,103)
- -------------------------------------------------------------------------------------------------------------------
Balance, September 30, 2001 $ 77,431 $ - $ 152,072 $ (13) $ (68,780) $ 160,710
===================================================================================================================
See accompanying notes to consolidated financial statements.
5
SMTC CORPORATION
Consolidated Statements of Cash Flows
(Expressed in thousands of U.S. dollars)
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
--------------------------- ---------------------------
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in):
Operations:
Net earnings (loss) $ (34,217) $ 627 $ (68,103) $ (697)
Items not involving cash:
Amortization 2,359 1,663 7,064 4,165
Depreciation 3,150 2,819 8,946 7,659
Deferred income tax provision (benefit) (9,872) (2,140) (24,777) (1,662)
Loss on disposition of capital assets - - - (44)
Impairment of assets - - 5,023 -
Write-off of deferred financing costs - 2,461 - 2,461
Change in non-cash operating working capital:
Accounts receivable 21,346 (90,498) 104,489 (139,441)
Inventories 33,490 (83,713) 98,914 (145,100)
Prepaid expenses 1,094 (960) (842) (2,430)
Accounts payable, accrued liabilities and
income taxes payable (19,613) 81,682 (100,777) 156,277
- -------------------------------------------------------------------------------------------------------------------------
(2,263) (88,059) 29,937 (118,812)
Financing:
Increase in long-term debt 35,643 - 21,663 -
Decrease in long-term debt - (63,599) - (33,045)
Principal payments on capital leases (50) (427) (303) (1,148)
Proceeds from warrants - - - 2,500
Issuance of demand notes - 9,925 - 9,925
Repayment of demand notes - (9,925) - (9,925)
Issuance of subordinated notes - (5,200) - -
Loans to shareholders - - (5,236) -
Proceeds from issuance of common stock - 182,623 313 182,623
Repayment of loans receivable - 15 14 15
Debt issuance costs - (1,450) - (1,450)
- -------------------------------------------------------------------------------------------------------------------------
35,593 111,962 16,451 149,495
Investments:
Purchase of capital assets (3,398) (5,370) (17,598) (12,524)
Purchase of other assets, net (18) (933) (18) (933)
Acquisition of Pensar Corporation - (18,000) - (18,000)
Other (124) - (124) -
Proceeds from sale of capital assets - - - 44
- -------------------------------------------------------------------------------------------------------------------------
(3,540) (24,303) (17,740) (31,413)
- -------------------------------------------------------------------------------------------------------------------------
Decrease in cash and cash equivalents 29,790 (400) 28,648 (730)
Cash and cash equivalents, beginning of period 1,556 1,753 2,698 2,083
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 31,346 $ 1,353 $ 31,346 $ 1,353
========================================================================================================================
See accompanying notes to consolidated financial statements.
6
SMTC CORPORATION
Consolidated Statements of Cash Flows (continued)
(Expressed in thousands of U.S. dollars)
(Unaudited)
- -------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
--------------------------- ---------------------------
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
Supplemental disclosures:
Cash paid during the period:
Income taxes $ - $ 1,440 $ 3,502 $ 3,042
Interest 1,973 2,272 7,217 10,167
Non-cash investing and financing activities:
Cash released from escrow - - 3,125 -
Shares issued on acquisition of
Pensar Corporation - 19,019 - 19,019
Acquisition of equipment under
capital lease - - - 541
Value of warrants issued in excess of
proceeds received - - - 1,098
===================================================================================================================
Cash and cash equivalents is defined as cash and short-term investments.
See accompanying notes to consolidated financial statements.
7
SMTC CORPORATION
Consolidated Notes to Financial Statements
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(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 30,
2001, the unaudited consolidated statements of earnings (loss) for the
three and nine month periods ended September 30, 2001 and October 1,
2000, the unaudited consolidated statement of changes in shareholders'
equity for the nine month period ended September 30, 2001, and the
unaudited consolidated statements of cash flows for the three and nine
month periods ended September 30, 2001 and October 1, 2000 have been
prepared on substantially the same basis as the annual consolidated
financial statements. Management believes the 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 30, 2001 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, 2000.
2. Inventories:
-------------------------------------------------------------------------------------------------------
September 30, December 31,
2001 2000
-------------------------------------------------------------------------------------------------------
Raw materials $ 61,199 $ 107,767
Work in process 18,035 56,521
Finished goods 12,494 25,493
Other 1,179 2,040
-------------------------------------------------------------------------------------------------------
$ 92,907 $ 191,821
=======================================================================================================
8
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
3. Long-term debt:
The Company has incurred recent operating losses resulting in its
non-compliance with certain financial covenants contained in its current
credit agreement. On November 19, 2001, the Company and its 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. The revised terms would 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 would bear interest at US base rate plus 2.5%.
In connection with the amended agreement, the Company has agreed to issue
to the lenders warrants to purchase common stock of the Company at an
exercise price equal to the market value at the date of the grant for
1.5% of the total outstanding shares on the effective date of the
amendment and 0.5% of the total outstanding shares on December 31, 2002.
If an event of default has occurred during the period from the amendment
date to December 31, 2002, and has been continuing for more than 30 days,
the lenders will receive on December 31, 2002 warrants to purchase an
additional 1% of the total outstanding shares at an exercise price equal
to the market value at such date. If all amounts outstanding under the
credit agreement are repaid in full on or before March 31, 2003, all
warrants received by the lenders, other than the warrants received on the
amendment date, 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 will also pay amendment fees of 0.5% of the outstanding debt
as at the amendment date and may be required to pay default fees if it
violates certain covenants after the effective date of the amendment. The
amendment fees and the fair value of the warrants issued in connection
with amending the agreement will be accounted for as deferred financing
fees and will be deferred and amortized over the remaining term of the
facility.
9
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(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 30, October 1, September 30, October 1,
2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------
Numerator:
Net earnings (loss) before
extraordinary loss $ (34,217) $ 3,305 $ (68,103) $ 1,981
Less Class L preferred
entitlement - (390) - (3,164)
-------------------------------------------------------------------------------------------------------------
Earnings (loss) before extraordinary item
available to common shareholders $ (34,217) $ 2,915 $ (68,103) $ (1,183)
=============================================================================================================
Denominator:
Weighted-average shares -
basic 28,689,779 20,334,099 28,580,537 8,349,896
Effect of dilutive securities:
Employee stock options - 332,125 - -
Warrants - 432,008 - -
-------------------------------------------------------------------------------------------------------------
Weighted-average shares -
diluted 28,689,779 21,098,232 28,580,537 8,349,896
=============================================================================================================
Earnings (loss) per share before
extraordinary item:
Basic $ (1.19) $ 0.14 $ (2.38) $ (0.14)
Diluted $ (1.19) $ 0.14 $ (2.38) $ (0.14)
=============================================================================================================
For the three and nine month periods ended September 30, 2001 and the
nine month period ended October 1, 2000 options and warrants to purchase
common stock were outstanding during those periods 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 period.
10
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
5. Income taxes:
The Company's effective tax rate differs from the statutory rate
primarily due to non-deductible goodwill amortization and operating
losses not tax effected in certain jurisdictions.
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 nine 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. Prior to 2001, the
Company had not incurred any restructuring charges. 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 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 5,611 (288) 5,323 20,607 (1,239) 19,368
Mexico 36,526 (34,177) 2,349 85,114 (60,658) 24,456
-------------------------------------------------------------------------------------------------------------
$ 164,148 $ (37,227) $ 126,921 $ 584,304 $ (104,593) $ 479,711
=============================================================================================================
EBITA (before restructuring charges):
United States $ (18,711) $ (17,024)
Canada (4,226) (4,014)
Europe (765) (1,331)
Mexico (6,703) (12,768)
-------------------------------------------------------------------------------------------------------------
(30,405) (35,137)
Interest 1,900 7,353
Amortization 2,359 7,064
-------------------------------------------------------------------------------------------------------------
Loss before income taxes
and restructuring charges (34,664) (49,554)
Restructuring charges (note 7) 15,101 46,799
-------------------------------------------------------------------------------------------------------------
Loss before income taxes $ (49,765) $ (96,353)
=============================================================================================================
Capital expenditures:
United States $ 1,915 $ 10,136
Canada 8 1,573
Europe 303 546
Mexico 1,172 5,343
-------------------------------------------------------------------------------------------------------------
$ 3,398 $ 17,598
=============================================================================================================
11
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S. dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
6. Segmented information (continued):
---------------------------------------------------------------------------------------------------------------
Three months ended October 1, 2000 Nine months ended October 1, 2000
------------------------------------------ -----------------------------------------
Net Net
Total Intersegment external Total Intersegment external
revenue revenue revenue revenue revenue revenue
---------------------------------------------------------------------------------------------------------------
United States $ 188,680 $ (2,130) $ 186,577 $ 428,700 $ (5,672) $ 423,028
Canada 18,998 (1,541) 17,457 49,003 (3,963) 45,040
Europe 5,530 (449) 5,081 14,895 (2,610) 12,285
Mexico 27,144 (4,767) 22,377 48,614 (6,006) 42,608
---------------------------------------------------------------------------------------------------------------
$ 240,352 $ (8,860) $ 231,492 $ 541,212 $ (18,251) $ 522,961
===============================================================================================================
EBITA:
United States $ 7,104 $ 16,181
Canada 2,802 5,030
Europe (246) (1,468)
Mexico 540 464
-----------------------------------------------------------------------------------------------------------
10,200 20,207
Interest 2,665 10,569
Amortization 1,663 4,165
---------------------------------------------------------------------------------------------------------------
Earnings (loss) before
income taxes $ 5,872 $ 5,473
===============================================================================================================
Capital expenditures:
United States $ 2,474 $ 6,439
Canada 964 1,821
Europe 513 732
Mexico 1,419 4,073
---------------------------------------------------------------------------------------------------------------
$ 5,370 $ 13,065
===============================================================================================================
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 30, October 1, September 30, October 1,
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------
Geographic revenue:
United States $ 102,936 $ 206,926 $ 403,679 $ 465,510
Canada 5,522 4,725 29,266 13,219
Europe 11,640 14,635 34,320 33,085
Asia 6,823 5,206 12,446 11,147
---------------------------------------------------------------------------------------------------------------
$ 126,921 $ 231,492 $ 479,711 $ 522,961
===============================================================================================================
12
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S.dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
6. Segmented information (continued):
-------------------------------------------------------------------------
September 30, December 31,
2001 2000
-------------------------------------------------------------------------
Long-lived assets:
United States $ 76,132 $ 79,136
Canada 22,643 24,540
Europe 19,049 20,410
Mexico 19,051 14,627
-------------------------------------------------------------------------
$ 136,875 $ 138,713
=========================================================================
13
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S.dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
7. Restructuring and other charges:
Restructuring charges:
During the first quarter of 2001, in response to the slowing technology
end market, the Company announced that, along with other cost reduction
initiatives, it would close its assembly facility in Denver, Colorado. As
a result, the Company recorded restructuring charges of $22,654 pre-tax
during the first quarter and $9,044 pre-tax during the second quarter.
During the third quarter of 2001, the Company recorded restructuring
charges of $15,101 pre-tax related to inventory exposures, the cost of
exiting equipment and facility leases, additional severance costs and
other facility exit costs. Of the total third quarter restructuring
charge, $9,372 pre-tax relates to further costs associated with exiting
the Denver facility, and $1,289 pre-tax relates to the closure of our
Haverhill, Massachusetts facility. The following tables detail the
components of the restructuring charges, and the related amounts included
in accrued liabilities:
Three months Three months Three months Nine months
ended ended ended ended
April 1, July 1, September 30, September 30,
2001 2001 2001 2001
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Inventory reserves included in cost of sales $ 6,900 $ 9,044 $ 7,162 $ 23,106
-------------------------------------------------------------------------------------------------------------
Lease and other contract obligations 5,178 - 3,443 8,621
Severance 2,526 - 1,370 3,896
Asset impairment 5,023 - - 5,023
Other 3,027 - 3,126 6,153
-------------------------------------------------------------------------------------------------------------
15,754 - 7,939 23,693
-------------------------------------------------------------------------------------------------------------
$ 22,654 $ 9,044 $ 15,101 $ 46,799
=============================================================================================================
Amounts included in accrued liabilities:
Restructuring Additions for Payments for Restructuring
reserve three months three months reserve
as at ended ended as at
July 1, September 30, September 30, September 30,
2001 2001 2001 2001
--------------------------------------------------------------------------------------------------------
Lease and other contract obligations $ 4,765 $ 3,443 $ (1,023) $ 7,185
Severance 241 1,370 (368) 1,243
Other 1,966 415 (1,323) 1,058
--------------------------------------------------------------------------------------------------------
$ 6,972 $ 5,228 $ (2,714) $ 9,486
========================================================================================================
14
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S.dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
7. Restructuring and other charges (continued):
First quarter restructuring charges include the costs associated with the
closure of the assembly facility in Denver and severance costs associated
with restructuring activities in Cork, Ireland and Chihuahua, Mexico. The
closure of the assembly facility in Denver involved the severance of
employees, the disposition of assets and the decommissioning, exiting and
subletting of the facility. The severance costs related to Denver
included all 429 employees. First quarter restructuring charges also
include the severance costs related to 847 plant and operational
employees at our Mexico facility and 45 plant and operational employees
at our Cork, Ireland facility.
The asset impairment recorded in the first quarter reflects 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 first quarter facility exit costs include personnel costs and other
fees directly related to exit activities at the Denver location.
Second quarter restructuring charges include costs associated with the
closure of the Denver facility.
Third quarter restructuring charges include further costs associated with
the closure of the Denver facility, costs associated with the closure of
the Haverhill facility, costs of exiting equipment and facility leases at
various locations and severance costs. The severance costs relate to 68
plant and operational employees at our Donegal, Ireland facility, 2 plant
and operational employees at our Cork, Ireland facility, 26 plant and
operational employees at our Haverhill facility and 68 plant and
operational employees at our Mexico facility.
Other third quarter restructuring charges include accounts receivable
charges associated with exiting the Denver facility of $2,210 and other
costs of $916 related to the closure of the Haverhill facility.
The major components of the restructuring are estimated to be complete in
the first half of fiscal year 2002.
15
SMTC CORPORATION
Consolidated Notes to Financial Statements (continued)
(Expressed in thousands of U.S.dollars, except share quantities and per share
amounts)
Three and nine months ended September 30, 2001 and October 1, 2000
(Unaudited)
- --------------------------------------------------------------------------------
7. Restructuring and other charges (continued):
Other charges:
During the third quarter the Company recorded other charges totaling
$20,923 pre-tax related to accounts receivable and inventory exposures,
resulting from the current downturn in the technology sector. Included in
cost of sales are other charges of $12,768 related to inventory exposures
and included in selling, general and administrative expenses are other
charges of $8,155 related to accounts receivable exposures, at various
facilities other than the Denver facility (see foregoing discussion under
restructuring charges).
8. Implementation of Recently Issued Accounting Standards:
In July 2001 the FASB issued SFAS No. 141 and SFAS No. 142. The new
standards mandate the purchase method of accounting for business
combinations and require that goodwill no longer be amortized but instead
be tested for impairment at least annually. Upon adoption of the
standards beginning January 1, 2002, the Company will discontinue
amortization of goodwill and test for impairment using the new standards.
Effective July 1, 2001 and for the remainder of the fiscal year, goodwill
acquired in business combinations completed after June 30, 2001, will not
be amortized and impairment testing will be based on existing standards.
The Company is currently determining the impact of the new standards. It
is likely that the elimination of the amortization of goodwill will have
a material impact on the Company's financial statements.
In October 2001, the FASB issued Statement No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", which retains the
fundamental provisions of SFAS 121 for assets held for use, provides
guidance on the accounting for long-lived assets to be disposed of other
than by sale, clarifies the accounting for long-lived assets to be
disposed of by sale, and resolves various implementation issues that have
arisen subsequent to the issuance of SFAS 121. Statement 144 also
broadens the definition of discontinued operations to include all
distinguishable components of an entity that will be eliminated from
ongoing operations. This Statement is effective for fiscal years
beginning after December 15, 2001, to be applied prospectively. The
Company is currently determining the impact of the new standard.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
SELECTED CONSOLIDATED FINANCIAL DATA
The consolidated financial statements of SMTC are prepared in accordance with
United States GAAP.
Consolidated Statement of Operations Data (including $15.1 million of pre-tax
restructuring charges for the three months ended September 30, 2001 and $46.8
million of pre-tax restructuring charges for the nine months ended September 30,
2001):
(in millions, except share and per share amounts)
Three Months Ended Nine months ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Revenue $ 126.9 $ 231.5 $ 479.7 $ 523.0
Cost of sales (including restructuring
charges of $7.2 million for the
three months ended September 30,
2001 and $23.1 million for the nine
months ended September 30, 2001) 147.5 211.9 502.9 478.5
-----------------------------------------------------------------------
Gross profit (loss) (20.6) 19.6 (23.2) 44.5
Selling, general and administrative
Expenses 16.9 9.3 34.9 24.2
Amortization 2.4 1.7 7.1 4.2
Restructuring charge 7.9 - 23.7 -
-----------------------------------------------------------------------
Operating income (loss) (47.8) 8.6 (88.9) 16.1
Interest 1.9 2.7 7.4 10.6
-----------------------------------------------------------------------
Earnings (loss) before income taxes (49.7) 5.9 (96.3) 5.5
Income tax expense (recovery) (15.5) 2.6 (28.2) 3.5
-----------------------------------------------------------------------
Earnings (loss) before extraordinary loss (34.2) 3.3 (68.1) 2.0
Extraordinary loss - 2.7 - 2.7
-----------------------------------------------------------------------
Net earnings (loss) $ (34.2) $ 0.6 $ (68.1) $ (0.7)
=======================================================================
Net earnings (loss) per common share:
Basic before extraordinary loss $ (1.19) $ 0.14 $ (2.38) $ (0.14)
Extraordinary loss - (0.13) - (0.32)
-----------------------------------------------------------------------
Basic $ (1.19) $ 0.01 $ (2.38) $ (0.46)
Diluted $ (1.19) $ 0.01 $ (2.38) $ (0.46)
=======================================================================
Weighted average number of shares
outstanding:
Basic 28,689,779 20,334,099 28,580,537 8,349,896
Diluted 28,689,779 21,098,232 28,580,537 8,349,896
=======================================================================
17
Other Financial Data - Consolidated Adjusted Net Earnings (Loss):
(in millions, except share and per share amounts)
Three months ended Nine Months Ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (34.2) $ 0.6 $ (68.1) $ (0.7)
Adjustments:
Extraordinary loss - 2.7 - 2.7
Amortization of goodwill 2.1 1.5 6.3 3.5
Restructuring charges 15.1 - 46.8 -
Other charges 20.9 - 20.9 -
Income tax effect (11.4) (0.4) (21.3) (0.7)
-----------------------------------------------------------------------
Adjusted net earnings (loss) $ (7.5) $ 4.4 $ (15.4) $ 4.8
=======================================================================
Adjusted net earnings (loss) per common share:
Basic $ (0.26) $ 0.22 $ (0.54) $ 0.57
Diluted $ (0.26) $ 0.21 $ (0.54) $ 0.57
=======================================================================
Weighted average number of shares outstanding:
Basic 28,689,779 20,334,099 28,580,537 8,349,896
Diluted 28,689,779 21,098,232 28,580,537 8,349,896
=======================================================================
As a result of the combination of Surface Mount and HTM and a number of
subsequent acquisitions, we use consolidated adjusted net earnings (loss) as a
measure of our operating performance. Consolidated adjusted net earnings (loss)
is consolidated net earnings (loss) adjusted for acquisition related charges
such as the amortization of goodwill, restructuring charges, other charges
relating to inventory and accounts receivable exposures resulting from the
current downturn in the technology sector, and the related income tax effect of
these adjustments. Consolidated adjusted net earnings (loss) is not a measure of
performance under United States GAAP or Canadian GAAP. Consolidated adjusted net
earnings (loss) should not be considered in isolation or as a substitute for net
earnings prepared in accordance with United States GAAP or Canadian GAAP or as
an alternative measure of operating performance or profitability.
18
Consolidated Statement of Operations Data (excluding $15.1 million of pre-tax
restructuring charges for the three months ended September 30, 2001 and $46.8
million of pre-tax restructuring charges for the nine months ended September 30,
2001):
(in millions, except share and per share amounts)
Three Months Ended Nine months ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------------
Revenue $ 126.9 $ 231.5 $ 479.7 $ 523.0
-----------------------------------------------------------------------
Cost of sales 140.3 211.9 479.8 478.5
-----------------------------------------------------------------------
Gross profit (loss) (13.4) 19.6 (0.1) 44.5
Selling, general and administrative
Expenses 16.9 9.3 34.9 24.2
Amortization 2.4 1.7 7.1 4.2
-----------------------------------------------------------------------
Operating income (loss) (32.7) 8.6 (42.1) 16.1
Interest 1.9 2.7 7.4 10.6
-----------------------------------------------------------------------
Earnings (loss) before income taxes (34.6) 5.9 (49.5) 5.5
Income tax expense (recovery) (10.9) 2.6 (14.5) 3.5
-----------------------------------------------------------------------
Earnings (loss) before extraordinary loss (23.7) 3.3 (35.0) 2.0
Extraordinary loss - 2.7 - 2.7
-----------------------------------------------------------------------
Net earnings (loss) $ (23.7) $ 0.6 $ (35.0) $ (0.7)
=======================================================================
Net earnings (loss) per common share:
Basic before extraordinary loss $ (0.83) $ 0.14 $ (1.23) $ (0.14)
Extraordinary loss - (0.13) - (0.32)
-----------------------------------------------------------------------
Basic $ (0.83) $ 0.01 $ (1.23) $ (0.46)
Diluted $ (0.83) $ 0.01 $ (1.23) $ (0.46)
=======================================================================
Weighted average number of shares
outstanding:
Basic 28,689,779 20,334,099 28,580,537 8,349,896
Diluted 28,689,779 21,098,232 28,580,537 8,349,896
=======================================================================
Consolidated statement of operating data excluding restructuring charges is not
a measure of performance under US GAAP and has been presented as supplemental
information only and should not be considered in isolation or as a substitute
for net earnings (loss) prepared in accordance with US GAAP or as an alternative
measure of operating performance or profitability.
19
Other Financial Data - Consolidated Adjusted Net Earnings (Loss):
(in millions, except share and per share amounts)
Three months ended Nine Months Ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Net earnings (loss) before $ (23.7) $ 0.6 $ (35.0) $ (0.7)
restructuring charges
Adjustments:
Extraordinary loss - 2.7 - 2.7
Amortization of goodwill 2.1 1.5 6.3 3.5
Other charges 20.9 - 20.9 -
Income tax effect (6.8) (0.4) (7.6) (0.7)
-----------------------------------------------------------------------
Adjusted net earnings (loss) $ (7.5) $ 4.4 $ (15.4) $ 4.8
=======================================================================
Adjusted net earnings (loss) per common share:
Basic $ (0.26) $ 0.22 $ (0.54) $ 0.57
Diluted $ (0.26) $ 0.21 $ (0.54) $ 0.57
=======================================================================
Weighted average number of shares outstanding:
Basic 28,689,779 20,334,099 28,580,537 8,349,896
Diluted 28,689,779 21,098,232 28,580,537 8,349,896
=======================================================================
As a result of the combination of Surface Mount and HTM and a number of
subsequent acquisitions, we use consolidated adjusted net earnings (loss) as a
measure of our operating performance. Consolidated adjusted net earnings (loss)
is consolidated net earnings (loss) adjusted for acquisition related charges
such as the amortization of goodwill, restructuring charges, other charges
relating to inventory and accounts receivable exposures resulting from the
current downturn in the technology sector, and the related income tax effect of
these adjustments. Consolidated adjusted net earnings (loss) is not a measure of
performance under United States GAAP or Canadian GAAP. Consolidated adjusted net
earnings (loss) should not be considered in isolation or as a substitute for net
earnings prepared in accordance with United States GAAP or Canadian GAAP or as
an alternative measure of operating performance or profitability.
Consolidated Balance Sheet Data:
(in millions)
As at As at
September 30, December 31,
2001 2000
- ----------------------------------------------------------------------------------------
Cash and short-term investments $ 31.3 $ 2.7
Working capital 112.3 188.3
Total assets 398.8 547.5
Total debt, including current maturities 138.1 118.0
Shareholders' equity 160.7 228.5
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a leading provider of advanced electronics manufacturing services, or
EMS, to electronics industry original equipment manufacturers, or OEM's,
worldwide. Our full range of value-added services include product design,
procurement, prototyping, advanced 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.
SMTC Corporation, or SMTC, is the result of the July 1999 combination of the
former SMTC Corporation, or Surface Mount, and HTM Holdings, Inc., or HTM. Upon
completion of the combination and concurrent recapitalization, the former
stockholders of HTM held approximately 58.0% of the outstanding shares of SMTC.
We have accounted for the combination under the purchase method of accounting as
a reverse acquisition of Surface Mount by HTM. As HTM acquired Surface Mount for
accounting purposes, HTM's assets and liabilities are included in our
consolidated financial statements at their historical cost. The results of
operations of Surface Mount are included in our consolidated financial
statements from the date of the combination. Surface Mount was established in
Toronto, Ontario in 1985. HTM was established in Denver, Colorado in 1990. SMTC
was established in Delaware in 1998.
The July 1999 combination of Surface Mount and HTM provided us with increased
customer relationships. Collectively, since 1995 we have completed the following
seven acquisitions:
. Radian Electronics' operations, which enabled our expansion into
Austin, Texas, and established our relationship with Dell, in 1996;
. Ogden Atlantic Design's operations in Charlotte, North Carolina, which
provided us with a facility in a major technology center in the
Southeastern United States, in 1997;
. Ogden International Europe's operations in Cork, Ireland, which
expanded our global presence into Europe, in 1998;
. Zenith Electronics' facility in Chihuahua, Mexico, which expanded our
cost-effective manufacturing capabilities;
. W.F. Wood, based outside Boston, Massachusetts, which provided us with
a manufacturing presence in the Northeastern United States, expanded
our value-added services to include high precision enclosures
capabilities, and added EMC and Sycamore Networks as customers, in
September 1999;
. Pensar Corporation, located in Appleton, Wisconsin, which provided us
with a wide range of electronics and design manufacturing services, on
July 27, 2000 and concurrent with the closing of the initial public
offering; and
21
. Qualtron Teoranta, with sites in both Donegal, Ireland and Haverhill,
Massachusetts (which has subsequently been closed), which allowed us
to expand our ability to provide customers with a broad range of
services focusing on fiber optic connector assemblies and volume cable
assemblies, on November 22, 2000.
In addition, we completed the following financing activities in 2000:
Initial Public Offering
. On July 27, 2000, we completed an initial public offering of our
common stock in the United States and the exchangeable shares of our
subsidiary, SMTC Manufacturing Corporation of Canada, in Canada,
raising net proceeds (not including proceeds from the sale of shares
upon the exercise of the underwriters' over-allotment option) of
$157.1 million;
. Concurrent with the effectiveness of the initial public offering, we
completed a share capital reorganization;
. In connection with the initial public offering, we entered into an
amended and restated credit agreement with our lenders, which provided
for an initial term loan of $50.0 million and revolving credit loans,
swing line loans and letters of credit up to $100.0 million;
. On July 27, 2000, we paid a fee of $1.8 million to terminate a
management agreement under which we paid quarterly fees of
approximately $0.2 million; and
. On August 18, 2000, we sold additional shares of common stock upon
exercise of the underwriters' over-allotment option, raising net
proceeds of $24.6 million.
Pre Initial Public Offering
. In May 2000, we issued senior subordinated notes to certain
shareholders for proceeds of $5.2 million, which were repaid with the
proceeds of our initial public offering;
. On May 18, 2000, we issued 41,667 warrants for $2.5 million cash
consideration in connection with the May 2000 issue of $5.2 million in
senior subordinated notes; and
. On July 3, 2000, we issued demand notes in the aggregate principal
amount of $9.9 million, which were repaid with the proceeds of our
initial public offering.
With the continued economic downturn in the technology sectors, we expect that
we will be unable in the near term to maintain the historic growth we have
achieved to date.
22
During the first quarter of 2001, in response to the slowing technology end
market, we announced that we would close our Denver, Colorado facility, leaving
in place a sales and marketing presence to service the Rocky Mountain region.
During the second quarter of 2001, production at the Denver facility, one of the
last remaining sites not recently refurbished, was migrated to SMTC facilities
closer to customer locations, and to our recently retrofitted and expanded,
lower cost Chihuahua facility. In connection with the closure of the Denver
facility, and other cost realignment initiatives, we recorded a restructuring
charge of $22.7 million pre-tax for the three months ended April 1, 2001 and
$9.0 million pre-tax for the three months ended July 1, 2001. For the three
months ended September 30, 2001, the Company recorded restructuring charges and
other charges of $15.1 million pre-tax and $20.9 million pre-tax, respectively,
related to inventory and accounts receivable exposures, the cost of exiting
equipment and facility leases, additional severance costs and other facility
exit costs. Of the total third quarter 2001 charge, $9.4 million pre-tax relates
to further costs associated with exiting the Denver facility and $1.3 million
relates to the closure of our Haverhill, Massachusetts facility. The major
components of the restructuring are estimated to be complete in the first half
of fiscal year 2002.
We used approximately $143.7 million of the proceeds from our initial public
offering to reduce indebtedness under our credit facility. On July 27, 2000, we
entered into an amended and restated credit facility with our lenders, which
provided for an initial term loan of $50.0 million and revolving credit loans,
swing line loans and letters of credit up to $100.0 million. As at September 30,
2001, we had borrowed $137.5 million under this facility. The Company has
incurred recent operating losses resulting in its non-compliance with certain
financial covenants contained in its current credit agreement. On November 19,
2001, the Company and its 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. The
revised terms would 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 would bear interest at US base rate plus
2.5%.
In connection with the amended agreement, the Company has agreed to issue to the
lenders warrants to purchase common stock of the Company at an exercise price
equal to the market value at the date of the grant for 1.5% of the total
outstanding shares on the effective date of the amendment and 0.5% of the total
outstanding shares on December 31, 2002. If an event of default has occurred
during the period from the amendment date to December 31, 2002, and has been
continuing for more than 30 days, the lenders will receive on December 31, 2002
warrants to purchase an additional 1% of the total outstanding shares at an
exercise price equal to the market value at such date. If all amounts
outstanding under the credit agreement are repaid in full on or before March 31,
2003, all warrants received by the lenders, other than the warrants received on
the amendment date, 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 will also pay amendment fees of 0.5% of
the outstanding debt as at the amendment date and may be required to pay default
fees if it violates certain covenants after the effective date of the amendment.
The amendment fees and the fair value of the warrants issued in connection with
amending the agreement will be accounted for as deferred financing fees and will
be deferred and amortized over the remaining term of the facility.
We currently provide turnkey manufacturing services to the majority of our
customers. Turnkey
23
manufacturing services typically result in higher revenue and higher gross
profits but lower gross profit margins when compared to consignment services.
With our turnkey manufacturing customers, we generally operate under contracts
that provide a general framework for our business relationship. Our actual
production volumes are based on purchase orders under which our customers do not
commit to firm production schedules more than 30 to 90 days in advance. In order
to minimize customers' 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 causes a corresponding delay in our revenue recognition.
Ultimately, however, our customers are generally responsible for all goods
manufactured on their behalf.
We service our customers through a total of nine facilities located in the
United States, Canada, Europe and Mexico. In the third quarter of 2001,
approximately 69.1% of our revenue was generated from operations in the United
States, approximately 22.2% from Mexico, approximately 5.3% from Canada and
approximately 3.4% from Europe. We expect to continue to increase revenue from
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.
Our fiscal year end is December 31. The consolidated financial statements of
SMTC are prepared in accordance with United States GAAP.
24
SMTC Corporation
Results of Operations
The following table sets forth certain operating data expressed as a percentage
of revenue for the periods indicated:
(Excluding $15.1 million of pre-tax restructuring charges for the three months
ended September 30, 2001 and $46.8 million of pre-tax restructuring charges for
the nine months ended September 30, 2001):
Three months ended Nine months ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of sales 110.6 91.5 100.0 91.5
--------------------------------------------------------------------------
Gross profit (loss) (10.6) 8.5 0.0 8.5
Selling, general and administrative
expenses 13.3 4.0 7.3 4.6
Amortization 1.9 0.7 1.5 0.8
--------------------------------------------------------------------------
Operating income (loss) (25.8) 3.8 (8.8) 3.1
Interest 1.5 1.2 1.5 2.0
--------------------------------------------------------------------------
Earnings (loss) before income taxes (27.3) 2.6 (10.3) 1.1
Income tax expense (recovery) (8.6) 1.1 (3.0) 0.7
--------------------------------------------------------------------------
Earnings (loss) before extraordinary loss (18.7) 1.5 (7.3) 0.4
Extraordinary loss - 1.2 - 0.5
--------------------------------------------------------------------------
Net earnings (loss) (18.7)% 0.3% (7.3)% (0.1)%
==========================================================================
(Including $15.1 million of pre-tax restructuring charges for the three months
ended September 30, 2001 and $46.8 million of pre-tax restructuring charges for
the nine months ended September 30, 2001):
Three months ended Nine months ended
September 30, October 1, September 30, October 1,
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of sales (including restructuring
charges of $7.2 million for the three
months ended September 30, 2001 and
$23.1 million for the nine months
ended September 30, 2001) 116.2 91.5 104.8 91.5
-----------------------------------------------------------------------
Gross profit (loss) (16.2) 8.5 (4.8) 8.5
Selling, general and administrative
expenses 13.3 4.0 7.3 4.6
Amortization 1.9 0.7 1.5 0.8
Restructuring charge 6.3 - 5.0 -
-----------------------------------------------------------------------
Operating income (loss) (37.7) 3.8 (18.6) 3.1
Interest 1.5 1.2 1.5 2.0
-----------------------------------------------------------------------
Earnings (loss) before income taxes (39.2) 2.6 (20.1) 1.1
Income tax expense (recovery) (12.2) 1.1 (5.9) 0.7
-----------------------------------------------------------------------
Earnings (loss) before extraordinary loss (27.0) 1.5 (14.2) 0.4
Extraordinary loss - 1.2 - 0.5
-----------------------------------------------------------------------
Net earnings (loss) (27.0)% 0.3% (14.2)% (0.1)%
=======================================================================
25
Quarter ended September 30, 2001 compared to the quarter ended October 1, 2000
Revenue
Revenue decreased $104.6 million, or 45.2%, from $231.5 million in the third
quarter of 2000 to $126.9 million in the third quarter of 2001. The decrease in
revenue is due to the impact of the technology market slowdown across the
customer base. We recorded approximately $7.0 million of sales of raw materials
inventory to customers, which carried no margin, during the third quarter of
2001, compared to $15.6 million in the third quarter of 2000.
Revenue from IBM of $25.9 million, Alcatel of $18.4 million and Dell of $12.9
million for the third quarter of 2001 was 20.4%, 14.5% and 10.2%, respectively,
of total revenue. In the third quarter of 2000, revenue from Dell of $31.0
million and Alcatel of $40.2 million represented 13.4% and 17.4%, respectively,
of total revenue. No other customers represented more than 10% of revenue in
either period.
In the third quarter of 2001, 69.1% of our revenue was generated from operations
in the United States, 22.2% from Mexico, 5.3% from Canada and 3.4% from Europe.
In the third quarter of 2000, 78.5% of our revenue was generated from operations
in the United States, 11.3% from Mexico, 7.9% from Canada and 2.3% from Europe.
Gross Profit
Gross profit, excluding a $7.2 million restructuring charge related to a
write-down of inventory in connection with the closure of our Denver facility,
decreased $33.0 million from $19.6 million in the third quarter of 2000 to a
loss of $13.4 million in the third quarter of 2001. The decline in the gross
profit was due to $12.8 million of charges related to inventory recorded during
the third quarter of 2001 in response to the decline in the technology markets,
coupled with the lower sales base and an under-absorption of fixed production
overhead costs.
Gross profit including $7.2 million of the total restructuring charge was a loss
of $20.6 million in the third quarter of 2001.
Selling, General & Administrative Expenses
Selling, general and administrative expenses increased $7.6 million from $9.3
million in the third quarter of 2000 to $16.9 million in the third quarter of
2001 because during the third quarter of 2001, $8.1 million of charges related
to accounts receivable were recorded in response to the decline in the
technology markets. Excluding the charges related to accounts receivable,
selling general and administrative expenses declined $0.5 million from $9.3
million in the third quarter of 2000 to $8.8 million for the same period in
2001. As a percentage of revenue, excluding the charges related to accounts
receivable, selling general and administrative expenses increased from 4.0% in
the third quarter of 2000 to 6.9% in the third quarter of 2001 due to the lower
sales base.
Amortization
26
Amortization of intangible assets of $2.4 million in 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 in 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 $0.1 million of deferred equipment lease costs.
Amortization of $1.7 million in the third quarter of 2000 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,
$0.4 million related to the acquisition of Pensar, $0.2 million of deferred
finance costs related to the establishment of our senior credit facility in July
2000 and $0.1 million of deferred equipment lease costs.
Restructuring Charge
In response to the economic slowdown, we announced during the first quarter of
2001 that along with other cost realignment initiatives, we would close our
assembly facility located in Denver, Colorado. As such, an aggregate
restructuring charge of $22.7 million pre-tax was recorded during the first
quarter of 2001, consisting of an inventory write-down of $6.9 million, lease
and other contractual obligations of $5.2 million, severance costs of $2.5
million, asset impairment charges of $5.0 million and other facility exit
charges of $3.1 million. During the second quarter of 2001, a $9.0 million
pre-tax charge was recorded relating to a further inventory write-down at our
Denver facility. During the third quarter of 2001, an additional $15.1 million
pre-tax charge was recorded consisting of a further inventory write-down of $7.2
million related the closure of our Denver facility, lease and other contractual
obligations of $3.4 million, severance costs of $1.4 million and other
restructuring charges of $3.1 million. Of the third quarter restructuring charge
of $15.1 million pre-tax, $9.4 million pre-tax relates to the closure of the
Denver facility and $1.3 million pre-tax relates to the closure of our
Haverhill, Massachusetts facility.
The cash component of the restructuring charge accrued for at the end of the
second quarter of $7.0 million was increased $5.2 million for the third quarter
restructuring charges, consisting of lease and other contractual obligations of
$3.4 million, severance of $1.4 million and other of $0.4 million, and was drawn
down by $2.7 million during the third quarter, consisting of $1.0 million in
lease and other contract obligation payments, $0.4 million in severance payments
and $1.3 million in other payments. We believe the restructuring accrual
remaining of $9.5 million at September 30, 2001 will be sufficient to satisfy
the remaining obligations associated with these restructuring activities.
The major components of the restructuring are estimated to be complete in the
first half of fiscal year 2002.
Interest Expense
Interest expense decreased $0.8 million from $2.7 million in the third quarter
of 2000 to $1.9 million in the third quarter of 2001. The weighted average
interest rates with respect to the debt for the third quarter of 2000 and the
third quarter of 2001 were 9.3% and 6.7%, respectively.
27
Income Tax Expense
In the third quarter of 2001, an income tax recovery of $15.5 million was
recorded on a pre-tax loss of $49.7 million resulting in an effective tax
recovery rate of 31.2%, as losses in certain jurisdictions were not tax effected
due to the uncertainty of our ability to utilize such losses. We are also unable
to deduct $1.0 million of goodwill related to the combination of Surface Mount
and HTM and the acquisition of Qualtron.
In the third quarter of 2000, an income tax expense of $2.6 million was recorded
on a pre-tax income of $5.9 million resulting in an effective income tax rate of
44.1%, as we were not able to claim a recovery on losses of $0.2 million
incurred by our Irish subsidiary or deduct $0.6 million of goodwill expense
related to the combination of Surface Mount and HTM.
Extraordinary Item
Approximately $143.7 million of the proceeds of the initial public offering were
used to reduce our indebtedness under our credit facility. In connection with
the initial public offering, we entered into an amended and restated credit
agreement with our lenders. As a result, an extraordinary loss of $2.7 million
($4.3 million before tax), related to early payment penalties, write-off of a
portion of the unamortized deferred financing fees and the write-off of the
value of the warrants issued in excess of the proceeds received, was recorded
for the third quarter of 2000.
Nine months ended September 30, 2001 compared to nine months ended October 1,
2000
Revenue
Revenue decreased $43.3 million, or 8.3%, from $523.0 million for the nine month
period ended October 1, 2000 to $479.7 million for the nine month period ended
September 30, 2001. The decrease in revenue is due to the effects of the general
decline in the technology market. We recorded approximately $29.6 million of
sales of raw materials inventory to customers, which carried no margin, during
the first nine months of 2001, compared to $36.1 million during the first nine
months of 2000.
Revenue from IBM of $78.5 million and Dell of $51.3 million for the nine month
period ended September 30, 2001 was 16.4% and 10.7%, respectively, of total
revenue for the period. Revenue from Dell for the nine months ended October 1,
2000 was $96.3 million, or 18.4% of total revenue for the period. No other
customers represented more than 10% of revenue in either period.
For the nine month period ended September 30, 2001, 73.1% of our revenue was
generated from operations in the United States, 14.6% from Mexico, 8.8% from
Canada and 3.5% from Europe. During the nine month period ended October 1, 2000,
79.2% of our revenue was generated from operations in the United States, 9.1%
from Canada, 9.0% from Mexico and 2.7% from Europe.
Gross Profit
Gross profit, excluding the $23.1 million portion of our restructuring charge
that related to a write-down of inventory in connection with the closure of our
Denver facility, decreased $44.6 million from $44.5 million for the nine months
ended October 1, 2000 to a loss of $0.1 million for the nine months ended
September 30, 2001. The decline in the gross profit was due to $12.8 million of
charges related to inventory recorded
28
during the third quarter of 2001 in response to the decline in the technology
markets, coupled with the lower sales base and an under-absorption of fixed
production overhead costs.
Gross profit for the first nine months of 2001, including the $23.1 million
restructuring charge, was a loss of $23.2 million.
Selling, General & Administrative Expenses
Selling, general and administrative expenses increased $10.7 million from $24.2
million for the nine months ended October 1, 2000 to $34.9 million for the nine
months ended September 30, 2001. During the nine months ended September 30,
2001, $8.1 million of charges related to accounts receivable were recorded in
response to the decline in the technology markets. Excluding the charges related
to accounts receivable, selling general and administrative expenses increased
$2.6 million from $24.2 million in the nine months ended October 1, 2000 to
$26.8 million for the nine months ended September 30, 2001 due to the
acquisitions of Pensar and Qualtron. As a percentage of revenue, excluding the
charges related to accounts receivable, selling general and administrative
expenses increased from 4.6% for the nine months ended October 1, 2000 to 5.6%
for the nine months ended September 30, 2001 due to the acquisitions of Pensar
and Qualtron and to the lower sales base.
Amortization
Amortization of intangible assets of $7.1 million in 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 in 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 $0.3 million of deferred equipment lease costs.
Amortization of $4.2 million in the first nine months of 2000 included the
amortization of $1.7 million of goodwill related to the combination of Surface
Mount and HTM, $1.3 million of goodwill related to the acquisition of W.F. Wood,
$0.4 million related to the acquisition of Pensar, $0.5 million of deferred
finance costs related to the establishment of our senior credit facility in July
2000 and $0.3 million of deferred equipment lease costs.
Restructuring Charge
In response to the economic slowdown, we announced during the first quarter of
2001 that along with other cost realignment initiatives, we would close our
assembly facility located in Denver, Colorado. During the third quarter of 2001,
we also closed our Haverhill, Massachusetts facility. As such, an aggregate
restructuring charge of $46.8 million pre-tax was recorded, consisting of an
inventory write-down of $23.1 million, lease and other contractual obligations
of $8.6 million, severance costs of $3.9 million, asset impairment charges of
$5.0 million and other facility exit charges of $6.2 million. Of the total
restructuring charge, $37.5 million relates to the closure of our Denver
facility. The closure of the assembly facility in Denver involves the severance
of employees, the disposition of assets and the decommissioning, exiting and
subletting of the facility. The severance costs related to Denver include all
429 employees. The severance costs also include 68 plant and operational
employees at our Donegal,
29
Ireland facility, 47 plant and operational employees at our Cork, Ireland
facility, 26 plant and operational employees at our Haverhill facility and 915
plant and operational employees at our Mexico facility.
The asset impairment reflects 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 include
personnel costs and other fees directly related to exit activities at the Denver
and Haverhill locations.
The non-cash component of the write-down is $30.3 million.
We recorded an income tax recovery of $13.7 million related to the restructuring
charge at an effective rate of 29.3%. The after-tax restructuring charge was
$33.1 million.
The cash component of the restructuring charge of $16.5 million consists of
lease and other contract obligations of $8.6 million, severance costs of $3.9
million and other of $3.5 million. To September 30, 2001, $6.5 million has been
paid out, including lease and other contract obligation payments of $1.4
million, severance payments of $2.7 million and other payments of $2.4 million.
We believe the restructuring accrual remaining of $9.5 million at September 30,
2001 will be sufficient to satisfy the remaining obligations associated with
these restructuring activities.
The major components of the restructuring are estimated to be complete in the
first half of fiscal year 2002.
Interest Expense
Interest expense decreased $3.2 million from $10.6 million for the nine months
ended October 1, 2000 to $7.4 million for the nine months ended September 30,
2001 due to a reduction of debt as a result of the initial public offering and
lower levels of inventory and receivables, combined with lower interest rates.
The weighted average interest rates with respect to the debt for the nine months
ended October 1, 2000 and the nine months ended September 30, 2001 were 9.5% and
7.6%, respectively.
Income Tax Expense
For the nine month period ended September 30, 2001 an income tax recovery of
$28.2 million was recorded on a pre-tax loss of $96.4 million resulting in an
effective tax recovery rate of 29.3%, 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 $3.0 million of goodwill related to the combination
of Surface Mount and HTM and the acquisition of Qualtron.
For the nine month period ended October 1, 2000, we recorded an income tax
expense of $3.5 million on earnings of $5.5 million, which produced an effective
tax rate of 63.6% as we were not able to claim a recovery on losses of $1.4
million incurred by our Irish subsidiary or deduct $1.7 million of goodwill
expense related to the combination of Surface Mount and HTM.
30
Extraordinary Item
Approximately $143.7 million of the proceeds of the initial public offering were
used to reduce our indebtedness under our credit facility. In connection with
the initial public offering, we entered into an amended and restated credit
agreement with our lenders. As a result, an extraordinary loss of $2.7 million
($4.3 million before tax), related to early payment penalties, write-off of a
portion of the unamortized deferred financing fees and the write-off of the
value of the warrants issued in excess of the proceeds received, was recorded
for the third quarter of 2000.
Liquidity and Capital Resources
Our principal sources of liquidity are cash provided from operations and from
borrowings under our senior credit facility and 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.
Net cash used for operating activities for the nine month period ended October
1, 2000 was $118.8 million compared to net cash generated from operating
activities of $29.9 million for the nine month period ended September 30, 2001.
Lower levels of activity and our continued focus on improving our accounts
receivable and inventory levels during the period led to the reduced use of
working capital.
Net cash provided by financing activities for the nine month period ended
October 1, 2000 was $149.5 million due to the proceeds from issuance of capital
stock of $182.6 million and proceeds from the issue of warrants of $2.5 million,
which was offset by repayment of long-term debt and capital leases and debt
issuance costs of $33.0 million, $1.1 million and $1.5 million respectively. Net
cash provided by financing activities for the nine month period ended September
30, 2001 was $16.5 million due to the increase in long-term debt of $21.7
million and proceeds from issuance of capital stock on the exercise of options
of $0.3 million, both of which were offset by repayment of capital leases of
$0.3 million and loans issued to shareholders of $5.2 million. As at September
30, 2001, we had borrowed $137.5 million under our credit facility. We intend to
continue to borrow under our credit facility to finance working capital.
Net cash used in investing activities for the nine months ended October 1, 2000
was $31.4 million due to net purchases of capital and other assets of $13.4
million and the acquisition of Pensar of $18.0 million. Net cash used in
investing activities for the nine months ended September 30, 2001 was $17.7
million due to the net purchase of capital and other assets.
The Company has incurred recent operating losses resulting in its non-compliance
with certain financial covenants contained in its current credit agreement. On
November 19, 2001, the Company and its 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. The revised terms would 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 would bear interest at US
base rate plus 2.5%.
31
In connection with the amended agreement, the Company has agreed to issue to the
lenders warrants to purchase common stock of the Company at an exercise price
equal to the market value at the date of the grant for 1.5% of the total
outstanding shares on the effective date of the amendment and 0.5% of the total
outstanding shares on December 31, 2002. If an event of default has occurred
during the period from the amendment date to December 31, 2002, and has been
continuing for more than 30 days, the lenders will receive on December 31, 2002
warrants to purchase an additional 1% of the total outstanding shares at an
exercise price equal to the market value at such date. If all amounts
outstanding under the credit agreement are repaid in full on or before March 31,
2003, all warrants received by the lenders, other than the warrants received on
the amendment date, 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 will also pay amendment fees of 0.5% of
the outstanding debt as at the amendment date and may be required to pay default
fees if it violates certain covenants after the effective date of the amendment.
The amendment fees and the fair value of the warrants issued in connection with
amending the agreement will be accounted for as deferred financing fees and will
be deferred and amortized over the remaining term of the facility.
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 levels of operations and organic growth, although no assurance can be
given in this regard, particularly with respect to amounts available under our
credit facility, as discussed above. 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 SFAS No. 141 and SFAS No. 142. The new standards
mandate the purchase method of accounting for business combinations and require
that goodwill no longer be amortized but instead be tested for impairment at
least annually. Upon adoption of the standards beginning January 1, 2002, the
Company will discontinue amortization for goodwill and test for impairment using
the new standards. Effective July 1, 2001 and for the remainder of the fiscal
year, goodwill acquired in business combinations completed after June 30, 2001,
will not be amortized and impairment testing will be based on existing
standards. The Company is currently determining the impact of the new standards.
It is likely that the elimination of the amortization on goodwill will have a
material impact on the Company's financial statements.
In October 2001, the FASB issued Statement No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", which retains the fundamental
provisions of SFAS 121 for assets held for use, provides guidance on the
accounting for long-lived assets to be disposed of other than by sale, clarifies
the accounting for long-lived assets to be disposed of by sale, and resolves
various implementation issues that have arisen subsequent to the issuance of
SFAS 121. Statement 144 also broadens the definition of discontinued operations
to include all distinguishable components of an entity that will be eliminated
from ongoing operations. This Statement is effective for fiscal years beginning
after December 15, 2001, to be applied prospectively. The Company is currently
determining the impact of the new standard.
32
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 report on 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 consummate business acquisitions on attractive terms; (4)
the loss or retirement of key members of management; (5) increases in SMTC's
cost of borrowings or lack of availability of additional debt or equity capital
on terms considered reasonable by management; (6) further credit agreement
covenant violations; (7) adverse state, federal or foreign legislation or
regulation or adverse determinations by regulators; (8) changes in general
economic conditions in the markets in which SMTC may compete and fluctuations in
demand in the electronics industry; (9) the inability to manage inventory levels
efficiently in light of changes in market conditions; and (10) 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
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 largest customer in the nine months ended September 30, 2001 was IBM, which
represented approximately 16.4% of our total revenue for such period. Our next
five largest customers collectively represented an additional 48.9% of our total
revenue in the first nine months of 2001. We expect to continue to depend on a
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.
33
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., SCI Systems, Inc. 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. 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;
. 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. 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
34
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
currently experiencing a substantial downturn. The downturn in the electronics
industry that began in the first quarter of 2001 has materially adversely
affected us. A future recession or a continuation or worsening of the downturn
in the electronics industry would also 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 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 in a short period of time and may have
trouble integrating acquired businesses and managing our expansion.
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 goodwill and
other intangible assets involved in any transactions that are accounted for
35
using the purchase method of accounting, and possible adverse tax and accounting
effects. 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 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 this growth effectively, it may have a material adverse
effect on our business, financial condition and results of operations.
We may not be able to finance future acquisitions, and even if we are able to do
so, our acquisition strategy may not succeed.
As part of our business strategy, we would like to continue to grow by pursuing
acquisitions of other companies, assets or product lines that complement or
expand our existing business. Competition for attractive companies in our
industry is substantial. We cannot assure you that we will be able to identify
suitable acquisition candidates or finance and complete transactions that we
select. Our inability or failure to execute our acquisition strategy may have a
material adverse effect on our business, financial condition and results of
operations. Also, if we are not able to successfully complete acquisitions, we
may not be able to compete with larger EMS providers who are able to provide a
total customer solution.
If we do not effectively manage the expansion of our operations, our business
may be harmed.
We have grown rapidly in the past few years, and this growth may be difficult to
support or sustain. Internal growth and further expansion of services may
require us to expand our existing operations and relationships. Expansion has
caused, and may continue to cause, strain on our infrastructure, including our
managerial, technical, financial and other resources. Our ability to manage any
future growth effectively will require us to attract, train, motivate and manage
new employees successfully, to integrate new employees into our operations and
to continue to improve our operational and information systems. We may
experience inefficiencies as we integrate new operations and manage
geographically dispersed operations. We may incur cost overruns. We may
encounter construction delays, equipment delays or shortages, labor shortages
and disputes, and production start-up problems that could adversely affect our
growth and our ability to meet customers' delivery schedules. We may not be able
to obtain funds for this expansion on acceptable terms or at all. In addition,
we would incur new fixed operating expenses associated with any expansion
efforts, including increases in depreciation expense and rental expense. If our
revenue were not to increase sufficiently to offset these expenses, our
business, financial condition and results of operations would be materially
adversely affected.
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.
Further, there can be no assurance that capital will be available 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, Derrick D'Andrade and Frank Burke. Our business
also depends on our ability to continue to
36
recruit, train and retain skilled employees, particularly executive management,
engineering and sales personnel. Recruiting personnel in our industry is highly
competitive. In addition, our ability to successfully integrate any acquired
companies depends in part on our ability to retain key management and existing
employees both at the time of the acquisition and thereafter. 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 the first nine months of 2001, we responded to the downturn in the
electronics industry by reducing our workforce from 6,173 at December 31, 2000
to approximately 2,500 at September 30, 2001. If demand for our products and
services grows, we may find it difficult to expand our workforce to meet that
demand.
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 12% in 2000. 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; and
. trade restrictions.
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
37
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.
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 30, 2001 we had $137.5 million of indebtedness under our senior
credit facility. We may incur additional indebtedness from time to time to
finance working capital requirements, capital expenditures or for other
purposes. 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 additional 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.
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, 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
financial condition tests, which further restrict our ability to operate as we
choose. The Company has incurred recent operating losses resulting in its
non-compliance with certain financial covenants contained in its current credit
agreement. On November 19, 2001, the Company and its 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. The
38
revised terms would establish amended financial and other covenants covering the
period up to December 31, 2002, based on the Company's current business plan.
Substantially all of our assets and those of our subsidiaries are pledged as
security under our senior credit facility.
We have been unable to comply with certain covenants under our credit facility
in the past, and we may be unable to do so in the future.
In the past, we have been unable to comply with certain EBITDA-based covenants
contained in our credit agreement. On November 19, 2001, we agreed with our
lending group to a definitive term sheet, which outlines an amendment to the
terms of the credit agreement. The amendment would contain new covenants,
including financial covenants based on our current business plan, that we must
comply with. Certain of these covenants must be met on a weekly basis, on a
monthly basis, and/or on a quarterly basis. If we violate any of these new
covenants (or any of the existing covenants contained in the credit agreement)
and we are considered to be in default under the credit agreement, we are at
risk for the lenders to call in the entire amount outstanding under the
facility, which at September 30, 2001 was $137.5 million.
Investment funds affiliated with Bain Capital, Inc., 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, Inc., 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 13.2%,
respectively, of our outstanding shares as of September 30, 2001. In addition,
two of the nine directors who serve on our board are, or were, representatives
of the Bain funds, two are representatives of the Celerity funds, two are
representatives 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.
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 DISCLOSURES ABOUT MARKET RISK
Interest Rate
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 30, 2001 was 6.7%. Our debt of $137.5 million bore interest at 5.3% on
September 30, 2001 based on the Eurodollar base rate. If the Eurodollar base
rate increased by 10% our interest rate would rise to 5.6% and our interest
expense would have increased by approximately $0.1 million for the third quarter
of 2001.
Foreign Currency Exchange Risk
39
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.
40
PART II OTHER INFORMATION
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
The Company maintains a credit facility, under which it had borrowed $137.5
million at September 30, 2001. The Company failed to comply with certain
EBITDA-based covenants contained in the credit agreement at the end of the third
quarter and was unable to cure such default with thirty days thereafter.
The Company and its lenders have agreed to a term sheet for waivers of those
EBITDA-based covenants and for amendments of the covenants that would apply for
the period up to December 31, 2002 to correspond to the Company's current
business plan.
ITEM 5. OTHER INFORMATION
The Company announced in a press release on October 2, 2001 that it has hired
Frank Burke as the Company's Chief Financial Officer. Mr. Burke's employment
offer letter is attached hereto as Exhibit 10.1.
On October 26, 2001, the Board appointed William Brock to the Board of Directors
to fill the vacancy created by the resignation of Prescott Ashe from the Board
for the remainder of Mr. Ashe's term, which expires at the annual meeting of
stockholders in 2002. The Board also appointed Mr. Brock to the Audit Committee
of the Board.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) List of Exhibits:
----------------
10.1 Employment offer letter from the Company to Frank Burke dated
July 26, 2001.
10.2 Lease agreement between Flextronics International USA, Inc. and
SMTC Manufacturing Corporation of Texas.
(b) Reports on Form 8-K: None.
--------------------
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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 19, 2001
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EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
10.1 Employment offer letter from the Company to Frank Burke dated
July 26, 2001.
10.2 Lease agreement between Flextronics International USA, Inc. and
SMTC Manufacturing Corporation of Texas.
43