UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended June 28, 2015

 

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 OF

INCORPORATION OR ORGANIZATION)

(I.R.S. EMPLOYER

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

 

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

 

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

 

Large accelerated filer    ☐        accelerated filer    ☐        Non-accelerated filer    ☐        Smaller reporting company    ☒

 

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

 

As of July 28, 2015, SMTC Corporation had 16,417,276 shares of common stock, par value $0.01 per share, outstanding.



 

 
 

 

 

SMTC CORPORATION

 

Table of Contents

 

PART I FINANCIAL INFORMATION

3

     

Item 1

Financial Statements

3

     

 

Interim Consolidated Balance Sheets (unaudited)

3

     

 

Interim Consolidated Statements of Operations and Comprehensive Income (Loss) (unaudited)

4

     

 

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

5

     

 

Interim Consolidated Statements of Cash Flows (unaudited)

6

     

 

Notes to Interim Consolidated Financial Statements (unaudited)

7

     

Item 2

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

20

     

Item 3

Quantitative and Qualitative Disclosures about Market Risk

28

     

Item 4

Controls and Procedures

29

   

PART II OTHER INFORMATION

29

     

Item 1A

Risk factors

29

     

Item 6

Exhibits

29

 

 
2

 

 

Part I FINANCIAL INFORMATION

 

Item 1 Financial Statements

 

Interim Consolidated Balance Sheets

(Expressed in thousands of U.S. dollars)

(Unaudited)

 

   

June 28, 2015

   

December 28, 2014

 

Assets

               

Current assets:

               

Cash

  $ 6,102     $ 5,447  

Accounts receivable—net (note 4)

    31,351       31,024  

Inventories (note 4)

    34,116       31,590  

Prepaid expenses and other assets

    2,142       2,135  

Income taxes receivable

    311       359  

Deferred income taxes—net

    487       428  
      74,509       70,983  

Property, plant and equipment—net (note 4)

    17,035       17,590  

Deferred financing costs—net

    85       90  
    $ 91,629     $ 88,663  

Liabilities and Shareholders’ Equity

               

Current liabilities:

               

Accounts payable

  $ 31,716     $ 29,425  

Accrued liabilities (note 4)

    7,463       7,080  

Derivative liabilities (note 10)

    2,232       2,703  

Income taxes payable

    374       449  

Revolving credit facility (note 5)

    22,080       21,370  

Current portion of capital lease obligations

    716       980  
      64,581       62,007  

Capital lease obligations

    495       866  
                 
                 

Shareholders’ equity:

               

Capital stock (note 6)

    390       390  

Additional paid-in capital

    264,214       263,996  

Deficit

    (238,051 )     (238,596 )
      26,553       25,790  
    $ 91,629     $ 88,663  
                 
Commitments (note 11)                

 

See accompanying notes to interim consolidated financial statements.

 

 
3

 

 

Interim Consolidated Statements of Operations and Comprehensive Income (Loss)

 

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

(Unaudited)

 

   

Three months ended

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

(As Revised –

See Note 2)

   

June 28, 2015

   

June 29, 2014

(As Revised –

See Note 2)

 

Revenue

  $ 57,741     $ 57,984     $ 106,455     $ 116,007  

Cost of sales (note 10)

    52,311       52,151       97,397       105,463  

Gross profit

    5,430       5,833       9,058       10,544  

Selling, general and administrative expenses

    3,961       4,504       7,626       8,747  

Loss on disposal of property, plant and equipment

    3             3        

Restructuring charges

          509             1,179  

Operating earnings

    1,466       820       1,429       618  

Interest expense (note 4)

    304       473       614       867  

Earnings (loss) before income taxes

    1,162       347       815       (249 )

Income tax expense (recovery) (note 7):

                               

Current

    157       265       329       445  

Deferred

    36       (5 )     (59 )     (2 )
      193       260       270       443  

Net earnings (loss) and comprehensive income (loss)

    969       87       545       (692 )
                                 

Earnings (loss) per share of common stock:

                               

Basic

                               

Basic

  $ 0.06     $ 0.01     $ 0.03     $ (0.04 )

Diluted

  $ 0.06     $ 0.01     $ 0.03     $ (0.04 )

Weighted average number of shares outstanding (note 8):

                               

Basic

    16,417,276       16,417,276       16,417,276       16,417,273  

Diluted

    16,417,276       16,417,276       16,417,276       16,417,273  

 

See accompanying notes to interim consolidated financial statements.

 

 
4

 

 

Interim Consolidated Statements of Changes in Shareholders’ Equity

(Expressed in thousands of U.S. dollars)

 

Six months ended June 28, 2015 and June 29, 2014

(Unaudited)

 

   

Capital stock

   

Additional

paid-in
capital

   

Deficit

   

Total

shareholders’
equity

 

Balance, December 28, 2014

  $ 390     $ 263,996     $ (238,596 )   $ 25,790  

Stock-based compensation

          218             218  

Net earnings

                545       545  

Balance, June 28, 2015

  $ 390     $ 264,214     $ (238,051 )   $ 26,553  

 

   

Capital stock

   

Additional

paid-in
capital

   

Deficit

   

Total

shareholders’
equity

 

Balance, December 29, 2013 (1)

  $ 390     $ 263,732     $ (234,718 )   $ 29,404  

Stock-based compensation

          105             105  

Net loss (1)

                (692 )     (692 )

Balance, June 29, 2014

  $ 390     $ 263,837     $ (235,410 )   $ 28,817  

 

 

(1)

Revised net loss and deficit to adjust for prior period errors. Refer to Note 2 for further details.

 

See accompanying notes to interim consolidated financial statements.

 

 
5

 

 

Interim Consolidated Statements of Cash Flows

(Expressed in thousands of U.S. dollars)

(Unaudited)

 

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

As Revised

(See Note 2)

 

Cash provided by (used in):

               

Operations:

               

Net earnings (loss)

  $ 545     $ (692 )

Items not involving cash:

               

Depreciation

    1,995       1,932  

Unrealized gain on derivative financial instruments

    (471 )     (1,094 )

Loss on sale of property, plant and equipment

    3        

Deferred income taxes

    (59 )     (2 )

Amortization of deferred financing fees

    15       240  

Stock-based compensation

    218       105  

Change in non-cash operating working capital:

               

Accounts receivable

    (327 )     313  

Inventories

    (2,526 )     (2,420 )

Prepaid expenses and other assets

    (7 )     220  

Income taxes receivable/payable

    (27 )     (351 )

Accounts payable

    2,222       2,291  

Accrued liabilities

    384       (285 )
      1,965       257  

Financing:

               

Net advances on revolving credit facility

    710       1,528  

Principal payment of capital lease obligations

    (635 )     (1,014 )

Deferred financing fees

    (10 )     (100 )
      65       414  

Investing:

               

Purchase of property, plant and equipment

    (1,378 )     (747 )

Proceeds from sale of property, plant and equipment

    3       10  
      (1,375 )     (737 )

Increase (decrease) in cash

    655       (66 )

Cash, beginning of period

    5,447       3,295  

Cash, end of the period

  $ 6,102     $ 3,229  
                 

Supplemental Information

               

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

    208       228  

 

See accompanying notes to interim consolidated financial statements.

 

 
6

 

 

Notes to Interim Consolidated Financial Statements

 

1.

Nature of the business

 

SMTC Corporation (the “Company”) is a worldwide provider of advanced electronics manufacturing services to original equipment manufacturers. The Company services its customers through manufacturing and technology centers located in the United States, Mexico and China. All facilities provide a full suite of integrated manufacturing services including assembly, testing, box build, final product integration, and expanded supply chain capabilities. In addition, the Company operates an international sourcing and procurement office in Hong Kong.

 

The accompanying unaudited interim consolidated financial statements of the Company have been prepared in accordance with the accounting principles and methods of application disclosed in the audited consolidated financial statements within the Company’s Form 10-K for the fiscal period ended December 28, 2014, (“Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2015. The accompanying unaudited interim consolidated financial statements include adjustments of a normal, recurring nature that are, in the opinion of management, necessary for a fair statement of the consolidated financial statements under generally accepted accounting principles in the United States (“U.S. GAAP”). These unaudited interim consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s Form 10-K. The consolidated balance sheet at December 28, 2014 was derived from the audited annual consolidated financial statements, but does not contain all of the footnote disclosures from the annual consolidated financial statements.

 

2.

Revisions of Previously Issued Financial Statements

 

In connection with the preparation of the consolidated financial statements of the Company for the year ended December 28, 2014, the Company identified certain errors in its previously issued consolidated financial statements for the periods ended December 29, 2013, December 30, 2012 and opening January 2, 2012. The errors related to (i) an understatement of amortization expense due to an error uncovered in the Company’s amortization schedule; (ii) an understatement of unrealized losses related to the mark to market revaluation of outstanding derivative forward contracts; (iii) an understatement of employee benefit obligations related to seniority premiums earned by Mexican employees; (iv) overstatement of deferred tax assets associated with temporary differences on certain benefit obligations in Mexico; and (v) an overstatement of cash used in investing activities related to unpaid purchases of property, plant and equipment and a corresponding understatement of accounts payable and accrued liabilities impacting cash flow from operations and (vi) reclassification of previously reported gross revenues and intersegment revenue elimination between Mexico and China.

 

The following table summarizes the selected line items from the Company’s unaudited interim consolidated financial statements illustrating the effect of these adjustments to the comparative quarter and period year to date.   

 

Impact on the Unaudited Interim Consolidated

Statements of Operations and Comprehensive Loss

 

In thousands, except per share data

 

Three months ended

June 29, 2014

As

previously filed

   

Adjustment

   

Three months ended

June 29, 2014

As

adjusted

 

Cost of sales – unrealized gain on derivative instruments (2)

  $ (797 )   $ (54

)

  $ (851 )

Gross profit

    5,779       54       5,833  

Operating earnings

    766       54       820  

Net earnings and comprehensive income

  $ 33     $ 54     $ 87  

Basic and diluted earnings per share

  $ 0.01             $ 0.01  

 

 
7

 

 

Impact on the Unaudited Interim Consolidated

Statements of Operations and Comprehensive Loss

 

In thousands, except per share data

 

Six months ended

June 29, 2014

As previously filed

   

Adjustment

   

Six months ended

June 29, 2014

As adjusted

 

Cost of sales – unrealized gain on derivative instruments (2)

  $ (889 )   $ (205

)

  $ (1,094 )

Cost of sales – depreciation (1)

    2,107       (175

)

    1,932  

Gross profit

    10,164       380       10,544  

Operating earnings

    238       380       618  

Net loss and comprehensive loss

  $ (1,072

)

  $ 380     $ (692

)

Basic and diluted loss per share

  $ (0.07

)

          $ (0.04

)

 

 

Impact on the Interim Consolidated Statement of Changes in Shareholders’ Equity

 

In thousands

 

June 29, 2014

As

previously filed

   

Adjustment

   

June 29, 2014

As

adjusted

 

Shareholders’ equity – deficit (3)

  $ (234,072

)

  $ (1,338

)

  $ (235,410

)

 

Impact on the Interim Consolidated Statement of Cash Flow

 

 

In thousands

 

Six months ended

June 29, 2014

As

previously filed

   

Adjustment

   

Six months ended

June 29, 2014

As

adjusted

 

Net loss

  $ (1,072

)

  $ 380     $ (692

)

Items not involving cash:

                       

Depreciation

    2,107       (175

)

    1,932  

Unrealized gain on derivative instruments

    (889

)

    (205

)

    (1,094

)

Accounts payable (4)

    2,369       (78 )     2,291  

Accrued liabilities (4)

    (268

)

    (17

)

    (285

)

Cash flow provided by operations

    352       (95 )     257  

Cash flow used by investing (4)

    (832

)

    95       (737

)

 

 

 

(1)

Cost of sales has been reduced by $175 for the six months ended June 29, 2014 on the unaudited interim consolidated statement of operations and comprehensive loss related to a reduction to amortization of $175 due to an error. There was no impact on the three months ended June 29, 2014 as the error occurred in the three months ended March 30, 2014.

 

 

(2)

Cost of sales has also been reduced by $54 and $205 for the three and six months ended June 29, 2014 respectively, related to the revaluation of the outstanding derivative forward contracts.

 

 

(3)

The total net change of ($1,338) to the deficit was the result of the opening, fiscal 2014 cumulative understatement of expenses of ($1,718) related to the prior period errors, which was offset by the reductions to cost of sales of $380 for the six months ended June 29, 2014 as described above.

 

 

(4)

The net change of $95 related to purchases of property, plant and equipment that were unpaid in cash as at June 29, 2014 and therefore reflect decreases to accounts payable and accrued liabilities, respectively and a corresponding reduction in cash used by investing.

 

 
8

 

 

3.

Recently Adopted Accounting Pronouncements

 

In April 2014, the FASB published ASU 2014-08 Topics 205 and 360: Presentation of Financial Statements and Property, Plant and Equipment. The amendments change the criteria for reporting discontinued operations and add new disclosure requirements for discontinued operations and individually significant components of an entity that are disposed of or classified as held for sale but do not meet the definition of discontinued operation. The amendments are effective for years beginning on/after December 15, 2014, and interim periods within those years. The adoption of ASU 2014-08 had no impact on our consolidated financial statements.

 

 

Recent Accounting Pronouncements

 

In May 2014, the FASB published ASU 2014-09 Topic 606: Revenue from Contracts with Customers, which supersedes (i) revenue recognition requirements in Topic 605 and most related industry-specific guidance, and (ii) cost guidance included in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and amends existing requirements for recognition of a gain/loss on the transfer of nonfinancial assets that are not in a contract with a customer (for example, assets within the scope of Topic 360, Property, Plant, and Equipment, and intangible assets within the scope of Topic 350, Intangibles—Goodwill and Other) to be consistent with the new requirements. The standard is effective for years beginning after December 15, 2016 including interim periods with those years. The impact of adoption of the standard has not yet been determined.

   

In June 2014, the FASB published ASU 2014-12 Topic 718: Compensation – Stock Compensation. The standard is amended to require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The standard is effective for all entities for years, and interim periods within those years, beginning after December 15, 2015. The impact of adoption of the standard has not yet been determined.

 

In August 2014, the FASB published ASU 2014-15 Topics 205-40: Presentation of Financial Statements – Going Concern. The standard provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. Effective for years ending after December 15, 2016 and for years and interim periods thereafter. The impact of adoption of the standard has not yet been determined.

 

In April 2015, the FASB published ASU 2015-03 Topics 835-30: Presentation of Debt Issuance Costs. The standard provides guidance about simplifying the presentation of debt issuance costs. Under this ASU, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense. Effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015. The impact of adoption of the standard has not yet been determined.

 

In April 2015, the FASB published ASU 2015-04: Retirement Benefits (Topic 715). The amendments intend to reduce complexity by providing a practical expedient that permits the entity to measure defined benefit plan assets and obligations using the month-end that is closest to the entity’s fiscal year-end and apply that practical expedient consistently from year to year. The amendments in this Update are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. Earlier application is permitted. The impact of adoption of the standard has not yet been determined.

 

 
9

 

 

In June 2015, the FASB published ASU 2015-10: Technical Corrections and Improvements. The amendments in this Update cover a wide range of topics in the Codification including; guidance clarification and reference corrections, simplification and minor improvements. Transition guidance varies based on the amendments in this Update. The amendments in this Update that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this Update. The impact of adoption of the standard has not yet been determined.

 

4.

Interim Consolidated financial statement details

 

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

 

Consolidated Balance Sheets

 

Accounts receivable – net:

 

   

June 28, 2015

   

December 28, 2014

 

Accounts receivable

  $ 31,614     $ 31,354  

Allowance for doubtful accounts

    (263 )     (330 )

Accounts receivable—net

  $ 31,351     $ 31,024  

  

Inventories:

 

   

June 28, 2015

   

December 28, 2014

 

Raw materials

  $ 25,659     $ 25,973  

Work in process

    5,387       2,099  

Finished goods

    2,248       2,743  

Parts

    822       775  

Inventories

  $ 34,116     $ 31,590  

  

Inventories are recorded net of a provision for obsolescence as at June 28, 2015 and December 28, 2014 of $607  and $475 respectively.

  

Property, plant and equipment – net:

 

   

June 28, 2015

   

December 28,
201
4

 

Cost (a):

               

Land

  $ 1,648     $ 1,648  

Buildings

    9,853       9,878  

Machinery and equipment (b)

    30,016       31,592  

Office furniture and equipment

    582       1,690  

Computer hardware and software (c)

    3,048       5,930  

Leasehold improvements (d)

    2,962       2,456  
      48,109       53,194  

Less accumulated depreciation (a):

               

Land

           

Buildings

    (7,487 )     (7,275 )

Machinery and equipment (b)

    (19,138 )     (20,545 )

Office furniture and equipment

    (463 )     (1,513 )

Computer hardware and software (c)

    (1,945 )     (4,774 )

Leasehold improvements (d)

    (2,041 )     (1,497 )
      (31,074 )     (35,604 )

Property, plant and equipment—net

  $ 17,035     $ 17,590  

 


(a)

During the quarter ended June 28, 2015, the Company wrote off fully depreciated assets that were no longer in use with a cost and accumulated depreciation value of $6,522.

 

(b)

Included within machinery and equipment were assets under capital leases with costs of $3,153 and $3,495 as at June 28, 2015, and December 28, 2014, respectively and associated accumulated depreciation of $988 and $916 as of June 28, 2015 and December 28, 2014, respectively. The related depreciation expense for the three months ended June 28, 2015 and June 29, 2014 were $124 and $169, respectively. The related depreciation expense for the six months ended June 28, 2015 and June 29, 2014 was $237 and $341, respectively.

 

 
10

 

 

(c)

Included within computer hardware and software were assets under capital leases with costs of $119 and $524 as at June 28, 2015 and December 28, 2014, respectively and associated accumulated depreciation of $67 and $350 as at June 28, 2015, and December 28, 2014, respectively. The related depreciation expense for the three months ended June 28, 2015 and June 29, 2014 was $19 and $44, respectively. The related depreciation for the six months ended June 28, 2015 and June 29, 2014 was $29 and $84, respectively.

 

(d)

Included within leasehold improvements were assets under capital leases with costs of $nil as at June 28, 2015 and $73 as at December 28, 2014, and associated accumulated depreciation of $nil and $42 as at June 28, 2015, and December 28, 2014, respectively. The related depreciation expense for the three and six months ended June 28, 2015 was $2. The related depreciation expense for the three and six months ended June 29, 2014 was $3 and $7, respectively.

  

Accrued liabilities:

 

   

June 28, 2015

   

December 28, 2014

 

Customer related

  $ 3,561     $ 2,074  

Payroll

    2,990       4,014  

Professional services

    286       395  

Vendor related

    368       29  

Other

    258       568  

Accrued liabilities

  $ 7,463     $ 7,080  

  

Interim consolidated statements of operations and comprehensive income (loss)

 

Interest expense:

 

   

Three months ended

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

   

June 28, 2015

   

June 29, 2014

 

Revolving credit facility

    270       289     $ 530       552  

Amortization of deferred financing fees

    7       136       15       240  

Obligations under capital leases

    27       48       69       75  

Interest expense

  $ 304     $ 473     $ 614     $ 867  

 

 
11

 

 

5.

Debt

 

(a) Revolving credit facility 

 

The Company borrows money under a Revolving Credit and Security Agreement with PNC Bank, National Association (“PNC”). On September 24, 2014, an amendment to the PNC Facility was signed and the term of the PNC Facility was extended to January 2, 2018. Advances made under the PNC Facility bear interest at the U.S. base rate plus 1.25%. Depending on the Company’s consolidated fixed charge coverage ratio, there is an opportunity to reduce the interest rate to U.S. base rate plus 0.75%. The base commercial lending rate should approximate prime rate. The effective weighted average interest rate for the three and six months ended June 28, 2015 was 4.50% compared to 4.91% and 4.46%, respectively for the three and six months ended June 29, 2014.

 

At June 28, 2015, $22,080 was outstanding under the PNC Facility, compared to $21,370 as at December 28, 2014 and is classified as a current liability based on the terms of the PNC Facility.

 

The maximum amount of funds available under the PNC Facility is $40,000. Availability under the PNC Facility is subject to certain conditions, including borrowing base conditions based on eligible inventory and accounts receivable, and certain conditions as determined by the lender. The Company is required to use a “lock-box” arrangement for the PNC Facility, whereby remittances from customers are swept daily to reduce the borrowings under this facility.

 

The PNC Facility is a joint and several obligation of the Company and its subsidiaries that are borrowers under the facility and is jointly and severally guaranteed. Repayment under the PNC Facility is secured by the assets of the Company and each of its subsidiaries.

 

(b) Covenants

 

The PNC Facility agreement contains certain financial and non-financial covenants.

 

The financial covenants require the Company to maintain minimum fixed charge coverage ratio and limit unfunded capital expenditures (all as defined in the credit agreement governing the PNC Facility).  The financial covenant relating to a minimum fixed charge coverage ratio is in effect for three months ending September 28, 2014, six months ending December 28, 2014, nine months ending March 29, 2015 and twelve months ending June 28, 2015 and thereafter on a rolling twelve month basis until December 31, 2017.  Market conditions are difficult to predict and there is no assurance that the Company will meet these covenants. A failure to comply with the covenants 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 unless the Company obtains a waiver from the lender.

 

The Company is in compliance with the financial covenants included in the PNC Facility as of June 28, 2015.

 

 
12

 

 

6.

Capital stock

 

Common shares

 

Issued and outstanding:

 

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

 

   

Number
of shares

    $  
                 

Balances at December 28, 2014 and June 28, 2015

    16,417,276     $ 390  

  

 Stock Options

 

For information regarding the Company’s stock option arrangements, see Note 6 of the consolidated financial statements within the Company’s Form 10-K for the fiscal period ended December 28, 2014. There were no stock options granted during the three and six month period ended June 28, 2015. A summary of stock option activity for the six month period ended June 28, 2015 is as follows:

 

   

Number
of options

   

Weighted
average
exercise
price

   

Aggregate
intrinsic
value

   

Weighted
average
remaining
contractual
term (years)

 

Outstanding at December 28, 2014

    817,212     $ 2.07     $       7.3  
                                 

Expired

    (66,667

)

    3.11                  

Forfeited

    (75,201

)

    2.09                  

Outstanding

    675,344       1.97             8.6  

Exercisable at June 28, 2015

    173,335     $ 2.28     $       2.8  

 

During the three month periods ended June 28, 2015 and June 29, 2014, the Company recorded stock-based compensation expense and a corresponding increase in additional paid-in capital of $44 and $28, respectively. During the six month periods ended June 28, 2015 and June 29, 2014, the Company recorded stock-based compensation expense and a corresponding increase in additional paid-in capital of $77 and $55, respectively.

 

 
13

 

 

Restricted Stock Units

 

For information regarding the Company’s Restricted Stock Units (“RSU”) arrangements, see Note 6 of the consolidated financial statements within the Company’s Form 10-K for the fiscal period ended December 28, 2014. A summary of the RSU activity for the six month period ended June 28, 2015 is as follows:

 

   

Outstanding
RSU

   

Weighted
average
stock
price

   

Weighted
average
remaining
contractual
term (years)

 

Outstanding balance at December 28, 2014

    520,433     $ 1.94       2.5  

RSU granted

    91,818       1.47          

RSU forfeited

    (59,352

)

    1.90          

Outstanding balance at June 28, 2015

    552,899     $ 1.87       2.1  

  

Stock based compensation recognized during the three month period ended June 28, 2015 and June 29, 2014 related to the restricted stock units was $84 and $33. Stock based compensation recognized during the six month period ended June 28, 2015 and June 29, 2014 related to the restricted stock units was $141 and $50, respectively. 

 

 
14

 

 

7.

Income taxes

  

During the three months ended June 28, 2015 and June 29, 2014, respectively, the Company recorded a income tax expense of $193 and $260, primarily related to minimum taxes and taxes on profits in certain jurisdictions, combined with foreign exchange revaluation. During the six months ended June 28, 2015 and June 29, 2014, respectively, the Company recorded a net income tax expense of $270 and $443, primarily related to minimum taxes and taxes on profits in certain jurisdictions, combined with foreign exchange revaluation.

 

Tax years 2010 to 2014 remain open for review by the tax authorities in Canada, U.S., Mexico and China. Tax years 2008 to 2014 remain open for Hong Kong.

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of its U.S. deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. Management considers the scheduled reversal of deferred tax liabilities, change of control limitations, projected future taxable income and tax planning strategies in making this assessment. Guidance under ASC 740, Income Taxes, (“ASC 740”) states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence, such as cumulative losses in recent years in the jurisdictions to which the deferred tax assets relate. In years 2010 through to 2012, it was determined by management that it was more likely than not that certain deferred tax assets associated with the U.S. jurisdiction would be realized and as such, no valuation allowance was recorded against these deferred tax assets. In 2013, it was determined by management that a partial valuation allowance was required to be recorded against certain deferred tax assets associated with the U.S. jurisdiction as it was not more likely than not to be realized. In 2014, it was determined by management that a full valuation allowance was required to be recorded against the remaining deferred tax assets associated with the U.S. jurisdiction as it was not likely to be realized. In 2015, the Canadian and U.S. jurisdictions continue to have a full valuation allowance recorded against the deferred tax assets.

 

 
15

 

 

8.

Earnings (loss) per common share

 

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

 

   

Three months ended

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

   

June 28, 2015

   

June 29, 2014

 

Basic weighted average shares outstanding

    16,417,276       16,417,276       16,417,276       16,417,273  

Dilutive stock options (a) (b)

                       

Diluted weighted average shares outstanding

    16,417,276       16,417,276       16,417,276       16,417,273  

  

(a)

As a result of the net earnings for the three and six months ended June 28, 2015, dilutive options were determined using the treasury stock method, using an average price of $1.62 per share. No diluted stock options were calculated as there were no outstanding vested options that were considered in-the-money.

 

(b)

As a result of the net earnings for the three months ended June 29, 2014, dilutive options were determined using the treasury stock method, using an average price of $1.76 per share. No diluted stock options were calculated as there were no outstanding vested options that were considered in-the-money. As a result of the net loss for the six months ended June 29, 2014, diluted earnings per share was calculated using the basic weighted average shares outstanding as the effect of potential common shares would have been anti-dilutive.

 

 
16

 

 

9.

Segmented information

 

General description

 

The Company is operated and managed geographically and has production facilities in the United States, Mexico and China. Commencing in the fourth quarter of 2014, the Company changed the measure it utilizes to monitor reportable segment performance from adjusted EBITDA, (which was defined as earnings before restructuring charges, interest, taxes, depreciation, amortization and unrealized foreign exchange gains and losses on unsettled forward contracts) to each reportable segment’s site contribution (which is calculated by management based on site revenues minus operating expenses, excluding unrealized foreign exchange, corporate allocations and restructuring expenses). Site contribution is utilized by the chief operating decision-maker as the indicator of reportable segment performance, as it reflects costs which our operating site management is directly responsible for, and by which the chief operating decision maker makes decisions about resources to be allocated to its operating segments. Intersegment adjustments reflect intersegment sales that are generally recorded at prices that approximate arm’s-length transactions. In assessing the performance of the reportable segments, management attributes site revenue to the reportable segment that originates the shipment of product to the end customer, irrespective of the product’s destination. Information about the reportable segments is as follows:

 

   

Three months ended

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

   

June 28, 2015

   

June 29, 2014

 

Revenues

                               

Mexico

  $ 39,155     $ 38,945     $ 74,762     $ 77,702  

China

    12,150       15,159       21,492       30,689  

U.S.

    9,008       13,849       15,586       26,541  

Total

  $ 60,313     $ 67,953     $ 111,840     $ 134,932  
                                 

Intersegment revenue

                               

Mexico

  $ (105 )   $ (142 )   $ (210 )   $ (507 )

China

    (2,426 )     (3,758 )     (5,090 )     (7,024 )

U.S.

    (41 )     (6,069 )     (85 )     (11,394 )

Total

  $ (2,572 )   $ (9,969 )   $ (5,385 )   $ (18,925 )
                                 

Net external revenue

                               

Mexico

  $ 39,050     $ 38,803     $ 74,552     $ 77,195  

China

    9,724       11,401       16,402       23,665  

U.S.

    8,967       7,780       15,501       15,147  

Total segment revenue (which also equals consolidated revenue)

  $ 57,741     $ 57,984     $ 106,455     $ 116,007  
                                 

Site Contribution

                               

Mexico

  $ 2,779     $ 2,016     $ 5,675     $ 3,489  

China

    664       1,125       485       1,840  

U.S.

    491       874       969       2,581  

Total

  $ 3,934     $ 4,015     $ 7,129     $ 7,910  

Corporate allocations

    3,257       3,537       6,171       7,207  

Unrealized gain on derivative financial instruments

    (789 )     (851 )     (471 )     (1,094 )

Interest

    304       473       614       867  

Restructuring charges

          509             1,179  

Income (loss) before income taxes

  $ 1,162     $ 347     $ 815     $ (249 )

 

Additions to property, plant and equipment

 

The following table contains additions including those acquired through capital leases, to property, plant and equipment for the three and six months ended June 28, 2015 and June 29, 2014:

 

   

Three months ended

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

   

June 28, 2015

   

June 29, 2014

 

Mexico

  $ 313     $ 2,105     $ 396     $ 2,282  

China

    252       39       627       39  

U.S.

    379       57       385       112  

Segment total

    934       2,201       1,398       2,433  

Corporate and other

    13       92       39       112  

Total

  $ 957     $ 2,293     $ 1,447     $ 2,545  

 

 
17

 

 

Property, plant and equipment (a)

 

   

June 28,

2015

   

December 28,

2014

 

Mexico

  $ 11,729     $ 12,556  

China

    3,240       3,001  

U.S.

    1,836       1,776  

Segment total

    16,805       17,333  

Corporate and other

    230       257  

Total assets

  $ 17,035     $ 17,590  

 

 

(a)

Property, plant and equipment information is based on the principal location of the asset.

 

Geographic revenues

 

The following table contains geographic revenues based on the product shipment destination, for the three and six months ended June 28, 2015 and June 29, 2014:

 

   

Three months ended

   

Six months ended

 
   

June 28, 2015

   

June 29, 2014

   

June 28, 2015

   

June 29, 2014

 

U.S.

  $ 43,548     $ 51,048     $ 79,260     $ 103,331  

Canada

    13,548       5,358       25,995       9,733  

Europe

                      284  

China

    645       1,578       1,200       2,655  

Mexico

                      4  

Total

  $ 57,741     $ 57,984     $ 106,455     $ 116,007  

  

Significant customers and concentration of credit risk:

 

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

 

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

 

During the three months ended June 28, 2015, two customers exceeded 10% of total revenues representing 17.1% and 11.3% respectively (June 29, 2014 – three customers represented 30%, 12.7% and 11%) of total revenue for the second quarter of 2015. During the six months ended June 28, 2015 two customers individually comprised 19.1% and 14.2% (June 29, 2014 – three customers individually comprised 33%, 13.1% and 10.1%) of total revenue for the six months ended June 28, 2015.

 

As of June 28, 2015, these two customers represented 16.8% and 5.6% respectively, (as of December 28, 2014, these customers represented 14.3% and 20.8% respectively) of the Company’s accounts receivable.

 

 
18

 

 

10.

Derivative financial instruments

 

The Company enters into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican Peso denominated payroll, rent and utility cash flows for the six remaining months of fiscal 2015 and first six months of fiscal 2016. These contracts are effective economic hedges but do not qualify for hedge accounting under ASC 815 “Derivatives and Hedging”. Accordingly, changes in the fair value of these derivative contracts are recognized into net earnings in the consolidated statement of operations and comprehensive income loss. The Company does not enter into forward foreign exchange contracts for trading or speculative purposes.

 

The following table presents a summary of the outstanding foreign currency forward contracts as at June 28, 2015:  

 

Currency

Buy/Sell

Foreign Currency Amount

 

Notional Contract Value in USD

 

Canadian Dollar

Buy

CAD 6,200

  $ 5,274  

Mexican Peso

Buy

MXN 300,629

  $ 21,060  

 

The unrealized gain recognized in earnings for the three month period as a result of revaluing the outstanding instruments to fair value on June 28, 2015 was $789 (June 29, 2014 – unrealized gain $851), and the unrealized gain for the six month period ended June 28, 2015 was $471 (June 29, 2014 – unrealized gain $1,094), which was included in cost of sales in the consolidated statement of operations and comprehensive income (loss). The realized loss on the settled contracts for the three months period ended June 28, 2015 was $1,028 (June 29, 2014 – realized loss $325), and the realized loss for the six month period ended June 28, 2015 was $1,882 (June 29, 2014 – realized loss $775), and is also included in cost of sales, in the consolidated statement of operations and comprehensive income (loss). Fair value was determined using the market approach with valuation based on market observables (Level 2 quantitative inputs in the hierarchy set forth under ASC 820 “Fair Value Measurements”).

 

The derivative liability as at June 28, 2015 was $2,232 (December 28, 2014 - $2,703) which reflected the fair market value of the unsettled forward foreign exchange contracts.

 

11.     Commitments

 

Purchase obligations not recorded on the balance sheet as at June 28, 2015 consist of open non-cancellable purchase orders for raw materials for $17,853 (June 29, 2014 - $31,484), which are expected to be received within 12 months of the PO issue date.

 

 
19

 

 

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

 

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

 

You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in combination with the accompanying unaudited interim consolidated financial statements and related notes as well as the audited consolidated financial statements and the accompanying notes to the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) included within the Company’s Annual Report on Form 10-K filed on March 30, 2015. The forward-looking statements in this discussion regarding the electronics manufacturing services industry, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion include numerous risks and uncertainties, some of which are as described in the “Risk Factors” section in the Annual Report on Form 10-K filed on March 30, 2015, as updated by Item 1A in Part II of this quarterly report. Certain statements in this MD&A contain words such as “could”, “expects”, “may”, “anticipates”, “believes”, “intends”, “estimates”, “plans”, “envisions”, “seeks” and other similar language and are considered forward looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we operate. These statements are subject to important assumptions, risks and uncertainties, which are difficult to predict and the actual outcome may be materially different. We may not update these forward-looking statements after the date of this Form 10-Q, even though our situation may change in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

 

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

 

Background

 

SMTC Corporation is a mid-tier provider of end-to-end electronics manufacturing services, or EMS, including product design and sustaining engineering services, printed circuit board assembly, or PCBA, production, enclosure fabrication, systems integration and comprehensive testing services. SMTC facilities span a broad footprint in the United States, Mexico, and China, with approximately 1,285 full-time employees. SMTC’s services extend over the entire electronic product life cycle from the development and introduction of new products through to growth, maturity and end-of-life phases. SMTC offers fully integrated contract manufacturing services with a distinctive approach to global original equipment manufacturers, or OEMs, and technology companies primarily within the industrial, computing and networking, communications, and medical market segments.

 

 
20

 

 

Results of Operations

 

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

 

Quarter ended June 28, 2015 compared with the quarter ended June 29, 2014:  

 

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

 

   

Three months ended
June 28, 2015

   

Three months ended
June 29, 2014

As Revised

(See Note 2)

   

Change
2015 to 2014

 
   

$

   

%

   

$

   

%

   

$

   

%

 

Revenue

    57.7       100.0       58.0       100.0       (0.3 )     (0.5 )

Cost of sales

    52.3       90.6       52.2       90.0       0.1       0.2  

Gross profit

    5.4       9.4       5.8       10.0       (0.4 )     (6.9 )

Selling, general and administrative expenses

    3.9       6.8       4.5       7.8       (0.6 )     (13.3 )

Restructuring charges

                0.5       0.9       (0.5 )     (100.0 )

Operating earnings

    1.5       2.6       0.8       1.4       0.7       87.5  

Interest expense

    0.3       0.5       0.5       0.9       (0.2 )     (40.0 )

Earnings before income taxes

    1.2       2.1       0.3       0.5       0.9       313.8  

Income tax expense

                                               

Current

    0.2       0.3       0.3       0.5       (0.1 )     (33.3 )

Deferred

                                   
      0.2       0.3       0.3       0.5       (0.1 )     (33.3 )

Net earnings

    1.0       1.7       0.0       0.0       1.0       100.0  

 

Revenue

 

Revenue decreased by $0.3 million, or 0.5%, from $58 million for the second quarter of 2014 to $57.7 million for the second quarter of 2015. The marginal decrease in revenue was predominantly the result of the reduced revenues from two long standing customers, which have expanded to other contract manufacturers. Revenues were reduced by $14.8 million from these two customers, which was partially offset by revenue from four new customers of $9.1 million. Revenues also increased by a net amount of $5.4 million from existing customers.

 

During the second quarter of 2015, revenue from the industrial sector decreased to $32.6 million compared with $42.0 million for the same period in 2014, mainly due to the decreased volumes from two long standing customers, due to the expansion with other contract manufacturers partially offset by increased volumes with one customer. Revenue from the industrial sector as a percentage of total revenue decreased to 56.5% in the second quarter of 2015 compared with 72.4% in the second quarter of 2014.

 

Revenue from the communications sector increased in the second quarter of 2015 to $13.4 million compared to $6.9 million for the second quarter of 2014. The increase was due primarily to significant increased volume from one long standing customer, in addition to two new customers ramping up during the quarter. As a percentage of total revenue this sector increased to 23.2% of revenue compared to 12.0% in the second quarter of 2014.

 

Revenue from the networking and enterprise computing sector increased to $9.5 million for the second quarter of 2015 compared with $6.2 million in 2014, which represented 16.4% of revenue in the second quarter of 2015, up from 10.7% of revenue in the second quarter of 2014. The increase in revenue was due to increased volumes with one new customer.

 

Revenue for the medical sector decreased to $2.2 million in the second quarter of 2015, compared to $2.9 million in the second quarter of 2014 due to decreased volume from one customer. However, revenue from the medical sector as a percentage of total revenue increased to 3.9% in the second quarter of 2015 compared with 4.9% in the second quarter of 2014.

 

During the second quarter of 2015 and 2014, the Company recorded approximately $1.1 million of sales of raw materials inventory to customers, which carried no margin. The Company purchases raw materials based on customer purchase orders. When a customer requires an order to be altered or changed, the customer is generally obligated to purchase the original on-order raw material at cost, to the extent the materials are not consumed within a specified period.

 

 
21

 

 

Due to changes in market conditions, the life cycle of products, the nature of specific programs and other factors, revenues from a particular customer typically varies from quarter-to-quarter and year-to-year. The Company’s ten largest customers represented 83.3% of revenue during the second quarter of 2015, compared with 92.1% in the second quarter of 2014. Revenue from the two largest customers during the second quarter of 2015 was $9.9 and $6.5 representing 17.1% and 11.3% respectively of total revenue for the second quarter of 2015. This compares with revenues from the largest customers during the second quarter of 2014 which was $17.4 million, $7.3 million and $6.4 million representing 30.0%, 12.7% and 11.0% respectively of total revenue for the second quarter of 2014. No other customers represented more than 10% of revenue in either period.

 

During the second quarter of 2015, 67.6% of our revenue was attributable to production from our operations in Mexico, 16.8% in China and 15.5% in the US. During the second quarter of 2014, 66.9% of our revenue was attributable to production from our operations in Mexico, 19.7% in China and 13.4% in the US.

 

The Company operates in a highly competitive and dynamic marketplace in which current and prospective customers from time to time seek to lower their costs through a competitive bidding process among EMS providers. This process creates an opportunity to increase revenue to the extent we are successful in the bidding process, however, there is also the potential for revenue to decline to the extent we are unsuccessful in this process. Furthermore, even if we are successful, there is potential for our margins to decline. If we lose any of our larger product lines manufactured for any one of our customers, we could experience declines in revenue.

 

Gross Profit

 

Gross profit for the second quarter of 2015 decreased by $0.4 million to $5.4 million or 9.4% of revenue compared with $5.8 million or 10.0% of revenue for the same period in 2014. The reduction in gross margin is due to reduced margins on product mix for the three months ended June 28, 2015 compared to the same period in prior year. This was offset partially by reduced expenses as a result of continued cost control efforts on labor and manufacturing efficiencies.  

 

Non-GAAP Gross Profit and Adjusted Gross Profit Reconciliation:

 

The Company presents this adjusted gross profit amount as we evaluate gross margins internally excluding the unrealized foreign exchange on forward contracts as this is not a relevant financial indicator to evaluate the Company’s operating performance. Below is the reconciliation from the U.S. GAAP measure of gross profit to adjusted gross profit:

 

   

Three months ended

June 28, 2015

   

Three months ended

June 29, 2014

As Revised

(See Note 2)

 

Gross profit

  $ 5,430     $ 5,833  

Add (deduct):

               
                 

Unrealized foreign exchange gain on forward contracts

    (789 )     (851 )

Adjusted gross profit

  $ 4,641     $ 4,982  

 

The Company entered into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican peso expenditures. These contracts were effective as hedges from an economic perspective, but did not meet the requirements for hedge accounting under ASC Topic 815 “Derivatives and Hedging”. Accordingly, changes in the fair value of these contracts were recognized into net earnings (loss) in the consolidated statement of operations and comprehensive income (loss). Included in cost of sales for the second quarter of 2015 was an unrealized gain recognized as a result of revaluing the instruments to fair value of $0.8 million, and a realized loss of $1.0 million. Included in cost of sales for the second quarter of 2014 was an unrealized loss recognized as a result of revaluing the instruments to fair value of $0.8 million, and a realized loss of $0.3 million.

  

Non-GAAP EBITDA and Adjusted EBITDA Reconciliation:

 

Management has presented EBITDA and adjusted EBITDA, as it is utilized to monitor performance against budget as well as compliance with bank covenants. We also believe EBITDA and adjusted EBITDA provides useful information to investors in understanding and evaluating our operating results in the same manner as the Board of Directors and management.

 

 
22

 

 

Below is the reconciliation of net earnings to EBITDA and adjusted EBITDA, both of which are non-GAAP measures.

 

   

Three months ended

June 28, 2015

   

Three months ended

June 29, 2014

As Revised

(See Note 2)

 

Net income

  $ 969     $ 87  

Add:

               
                 

Depreciation

    969       979  

Interest

    304       473  

Taxes

    193       260  

EBITDA

  $ 2,435     $ 1,799  
                 

Add:

               
                 

Restructuring

          509  

Stock based compensation

    128       60  

Unrealized gain on derivative financial instruments

    (788 )     (841

)

Adjusted EBITDA

  $ 1,775     $ 1,527  

  

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased by $0.6 million during the second quarter of 2015 to $3.9 million compared to $4.5 million in 2014. As a percentage of sales this represented a decrease to 6.8% from 7.8% in the second quarter of 2014. The reduced expenses were the result of reduced variable compensation, administrative salaries and professional services incurred in 2015 compared to the same period in prior year, partially offset by increased sales and marketing expenditures.

 

Restructuring Charges 

 

No restructuring charges were incurred for three months ended June 28, 2015. For the three months ended June 29, 2014, total restructuring charges of $0.5 million were recorded relating to restructuring charges of $0.3 million recorded related to the replacement of approximately 19 full-time equivalent employees (“FTEs”) in Markham that were replaced in Mexico as part of the 2014 Plan.

 

Interest Expense

 

Interest expense decreased to $0.3 million in the second quarter of 2015 from $0.5 million in the second quarter of 2014. The decrease of $0.2 million resulted from a lower average debt balance and lower weighted average interest rates. Interest expense in the second quarter of both 2015 and 2014 included amortization of deferred financing fees of $0.01 million and $0.1 million respectively. The weighted average interest rates with respect to the debt were 4.5% and 4.9% for each of the second quarters of 2015 and 2014, respectively.

 

Income Tax Expense

 

The Company recorded income tax expense of $0.2 million in the second quarter of 2015 compared to $0.3 million for the same period in 2014 due to minimum taxes and taxes on profits in certain jurisdictions combined with foreign exchange revaluation.

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of its U.S. deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. Management considers the scheduled reversal of deferred tax liabilities, change of control limitations, projected future taxable income and tax planning strategies in making this assessment. Guidance under ASC 740, Income Taxes, (“ASC 740”) states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence, such as cumulative losses in recent years in the jurisdictions to which the deferred tax assets relate. In years 2010 through to 2012, it was determined by management that it was more likely than not that certain deferred tax assets associated with the U.S. jurisdiction would be realized and as such, no valuation allowance was recorded against these deferred tax assets. In 2013, it was determined by management that a partial valuation allowance was required to be recorded against certain deferred tax assets associated with the U.S. jurisdiction as it was not more likely than not to be realized. In 2014, it was determined by management that a full valuation allowance was required to be recorded against the remaining deferred tax assets associated with the U.S. jurisdiction as it was not likely to be realized. In 2015, the Canadian and U.S. jurisdictions continue to have full valuation allowance recorded against the deferred tax assets. 

 

At December 28, 2014, the Company had total net operating loss carry forwards of $71.9 million, of which $28.6 million and $43.3 million pertains to loss carry forwards from Canadian and U.S. jurisdictions respectively. $4.1 million will expire in 2015, $1.3 million will expire in 2017, $1.1 million will expire in 2018, $13.7 million will expire in 2023, $3.4 million will expire in 2026, $0.5 million will expire in 2027, $4.3 million will expire in 2028, $19.3 million will expire in 2029 and the remainder will expire between 2030 and 2034.

 

 
23

 

 

Six months ended June 28, 2015 compared with six months ended June 29, 2014:

  

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

 

   

Six months endedJune 28, 2015

   

Six months endedJune 29, 2014

As Revised

(See Note 2)

   

Change2015 to 2014

 
       $    

%

       $    

%

       $    

%

 

Revenue

    106.4       100.0       116.0       100.0       (9.6 )     (8.3 )

Cost of sales

    97.4       91.5       105.5       90.9       (8.1 )     (7.7 )
                                                 

Gross profit

    9.0       8.5       10.5       9.1       (1.5 )     (14.3 )

Selling, general and administrative expenses

    7.6       7.1       8.7       7.5       (1.1 )     (12.6 )

Restructuring charges

                1.2       1.0       (1.2 )     (100.0 )

Operating earnings

    1.4       1.3       0.6       0.5       0.8       133.3  

Interest expense

    0.6       0.6       0.9       0.8       (0.3 )     (33.3 )

Income (loss) before income taxes

    0.8       0.8       (0.3 )     (0.3 )     1.1       366.7  

Income tax expense

                                               

Current

    0.3       0.3       0.4       0.3       (0.1 )     (25.0 )

Deferred

                                   
      0.3       0.3       0.4       0.3       (0.1 )     (25.0 )

Net income (loss)

    0.5       0.5       (0.7 )     (0.6 )     1.2       171.4  

 

Revenue

 

Revenue decreased by $9.6 million, or 8.3%, from $116.0 million for the first six months of 2014 to $106.4 million for the first six months of 2015. The decrease of $9.6 million in revenue is mainly due to decreased volumes from two long standing customers, due to expansion with other contract manufacturers which resulted in a $31.9 million decrease in revenues compared to the same period in prior year. This was partially offset by increases in volumes related to new customer ramp up, which resulted in additional revenues of $10.0 million in addition to volume increases and decreases with various customers, which resulted in additional net revenue of $12.5 million compared to the same period in prior year.

 

During the first half of 2015, revenue from the industrial sector decreased $26.3 million to $59.0 million compared with $85.3 million for the same period in 2014, mainly due to the decreased volumes from two long standing customers, due to expansion with other contract manufacturers. This was partially offset by volume increases with one customer. Revenue from the industrial sector as a percentage of total revenue decreased to 55.5% in the first half of 2015 compared with 73.6% in the first half of 2014.

 

Revenue from the communications sector significantly increased to $25.6 million for the first half of 2015 compared to $11.1 million in 2014, which represented 24.1% of revenue in the first half of 2015, compared with 9.5% of revenue in the first half of 2014. The significant increase was primarily related to increased volume from one long standing customer.

 

Revenue from the networking and enterprise computing sector decreased to $17.0 million for the first half of 2015 compared to $13.9 million in 2014, which represented 16.0% of revenue in the first half of 2015, up from 12.0% of revenue in the first half of 2014. The increase was due to volume increases with one new customer, partially offset by volume reductions with one customer.

 

Revenue for the medical sector decreased to $4.8 million in the first half of 2015, compared to $5.8 million in the first half of 2014 due to decreased volume from one customer. Revenue from the medical sector as a percentage of total revenue decreased in the first half of 2015 to 4.5% of revenue compared to 5.0% in 2014.

 

During the first half of 2015, the Company recorded approximately $2.2 million of sales of raw materials inventory to customers, which carried no margin, compared with $2.4 million in the first half of 2014. The Company purchases raw materials based on customer purchase orders. When a customer requires an order to be altered or changed, the customer is generally obligated to purchase the original on-order raw material at cost, to the extent the materials are not consumed within a specified period.

 

 
24

 

 

Due to changes in market conditions, the life cycle of products, the nature of specific programs and other factors, revenues from a particular customer typically varies from quarter to quarter and year to year. The Company’s ten largest customers represented 84.2% of revenue from continuing operations during the first half of 2015, compared with 92.3% in the first half of 2014. Revenue from the two largest customers during the first half of 2015 was $20.3 million and $15.1 million, representing 19.1% and 14.2%, respectively of total revenue for the first half of 2015, respectively. Revenue from the three largest customers during the first half of 2014 was $38.3 million, $15.2 million and 11.7 million, representing 33%, 13.1% and 10.1%, respectively of total revenue for the first half of 2014. No other customers represented more than 10% of revenue in either period.

 

During the first six months of 2015, 70.0% of our revenue was attributable to production from our operations in Mexico, 15.4% in China and 14.6% in the US. During the first half of 2014, 66.5% of our revenue was attributable to production from our operations in Mexico, 20.4% in China and 13.1% in the US.

 

The Company operates in a highly competitive and dynamic marketplace in which current and prospective customers from time to time seek to lower their costs through a competitive bidding process among EMS providers. This process creates an opportunity to increase revenue to the extent we are successful in the bidding process, however, there is also the potential for revenue to decline to the extent we are unsuccessful in this process. Furthermore, even if we are successful, there is potential for our margins to decline. If we lose any of our larger product lines manufactured for any one of our customers, we could experience declines in revenue.

 

Gross Profit

 

Gross profit for the first half of 2015 decreased by $1.5 million to $9.0 million or 8.5% of revenue compared with 9.1% of revenue for the same period in 2014. The reduction in gross margin is due to reduced margins on product mix for the six months ended June 28, 2015 compared to the same period in prior year. In addition, there was less favorable foreign exchange rates on outstanding forward contracts which resulted in reduced unrealized gains of $0.5 million compared to unrealized gains of $1.1 million for the same period in prior year. This was offset partially by reduced factory overhead as a result of continued cost control efforts on labor and manufacturing efficiencies. When removing the effects of unrealized foreign exchange gains on outstanding forward contracts, gross profit remained relatively consistent at 8.1% for the first half of 2015 compared to 8.2% for the same period in prior year.

 

Non-GAAP Gross Profit and Adjusted Gross Profit Reconciliation:

 

The Company presents this adjusted gross profit amount as we evaluate gross margins internally excluding the unrealized foreign exchange on forward contracts as this is not a relevant financial indicator to evaluate the Company’s operating performance. Below is the reconciliation from the U.S. GAAP measure of gross profit to adjusted gross profit:

 

   

Six months ended

June 28, 2015

   

Six months ended

June 29, 2014

As Revised

(See Note 2)

 

Gross profit

  $ 9,058     $ 10,544  

Add (deduct):

               
                 

Unrealized foreign exchange gain on forward contracts

    (471 )     (1,094

)

Adjusted gross profit

  $ 8,587     $ 9,450  

  

The Company entered into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican peso expenditures. These contracts were effective as hedges from an economic perspective, but did not meet the requirements for hedge accounting under ASC Topic 815 “Derivatives and Hedging”. Accordingly, changes in the fair value of these contracts were recognized into net income in the consolidated statement of operations and comprehensive income (loss). Included in cost of sales for the first half of 2015 was an unrealized gain recognized as a result of revaluing the instruments to fair value of $0.5 million, and a realized loss of $1.9 million. Included in cost of sales for the first half of 2014 was an unrealized gain recognized as a result of revaluing the instruments to fair value of $1.1 million, and a realized loss of $0.8 million.

 

 
25

 

  

Non-GAAP EBITDA and Adjusted EBITDA Reconciliation:

 

Management has presented EBITDA and adjusted EBITDA, as it is utilized to monitor performance against budget as well as compliance with bank covenants. We also believe EBITDA and adjusted EBITDA provides useful information to investors in understanding and evaluating our operating results in the same manner as the Board of Directors and management.

 

Below is the reconciliation of net earnings to EBITDA and adjusted EBITDA, both of which are non-GAAP measures.

 

   

Six months ended

June 28, 2015

   

Six months ended

June 29, 2014

As Revised

(See Note 2)

 

Net earnings (loss)

  $ 545     $ (692

)

Add:

               
                 

Depreciation

    1,995       1,932  

Interest

    614       867  

Taxes

    270       443  

EBITDA

  $ 3,424     $ 2,550  
                 

Add:

               
                 

Restructuring

          1,179  

Stock based compensation

    218       105  

Unrealized gain on derivative financial instruments

    (471 )     (1,094

)

Adjusted EBITDA

  $ 3,171     $ 2,740  

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased by $1.1 million during the first half of 2015 to $7.6 million. As a percentage of revenues, selling, general and administrative expenses has decreased to 7.1% from 7.5% in the first half of 2014. The decrease was mainly due to reduced professional, audit and legal fees which were higher in 2014 due to the investigation and remediation of the significant book to physical adjustment identified during the 2013 physical inventory count. Additional costs were reduced due to reduced variable compensation, administrative headcount reductions and professional services partially offset by increased marketing and sales expenses.

 

Restructuring Charges

 

No restructuring charges were incurred for six months ended June 28, 2015. For the six months ended June 29, 2014, total restructuring charges of $1.2 million were recorded. Restructuring charges of $0.3 million were recorded related to the replacement of approximately 19 FTEs in Markham that were replaced in Mexico as part of the 2014 Plan. In addition, approximately 340 FTEs were severed in Mexico which resulted in additional restructuring charges of $0.9 million.

 

Interest Expense

 

Interest expense decreased from $0.9 million in the first half of 2014 to $0.6 million for the first half of 2015. The decrease of $0.3 million was primarily the result of lower average debt balances. Interest expense in the first halves of 2015 and 2014 included amortization of deferred financing fees of $0.02 million and $0.2 million, respectively. The weighted average interest rates with respect to the debt were 4.5% for the first half of 2015 and 2014.

 

 
26

 

 

Income Tax Expense

 

The Company recorded income tax expense of $0.3 million in the second quarter of 2015 compared to $0.4 million for the same period in 2014 due to minimum taxes and taxes on profits in certain jurisdictions combined with foreign exchange revaluation.

 

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of its U.S. deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. Management considers the scheduled reversal of deferred tax liabilities, change of control limitations, projected future taxable income and tax planning strategies in making this assessment. Guidance under ASC 740, Income Taxes, (“ASC 740”) states that forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence, such as cumulative losses in recent years in the jurisdictions to which the deferred tax assets relate. In years 2010 through to 2012, it was determined by management that it was more likely than not that certain deferred tax assets associated with the U.S. jurisdiction would be realized and as such, no valuation allowance was recorded against these deferred tax assets. In 2013, it was determined by management that a partial valuation allowance was required to be recorded against certain deferred tax assets associated with the U.S. jurisdiction as it was not more likely than not to be realized. In 2014, it was determined by management that a full valuation allowance was required to be recorded against the remaining deferred tax assets associated with the U.S. jurisdiction as it was not likely to be realized. The Canadian and U.S. jurisdictions continue to have a full valuation allowance recorded against the deferred tax assets.

 

At December 28, 2014, the Company had total net operating loss carry forwards of $71.9 million, of which $28.6 million and $43.3 million pertains to loss carry forwards from Canadian and U.S. jurisdictions respectively. $4.1 million will expire in 2015, $1.3 million will expire in 2017, $1.1 million will expire in 2018, $13.7 million will expire in 2023, $3.4 million will expire in 2026, $0.5 million will expire in 2027, $4.3 million will expire in 2028, $19.3 million will expire in 2029 and the remainder will expire between 2030 and 2034.

 

Liquidity

 

Net cash provided from operating activities during the six months ended June 28, 2015 was $2.0 million compared to $0.3 million for six months ended June 29, 2014 driven by net earnings compared to the net loss for the same period in prior year. Accounts receivable days sales outstanding were 54 and 47 days for the six months ended June 28, 2015 and June 29, 2014, respectively. The increase was largely due to timing of revenue, as higher revenue was recorded in the final two months of the 2015 quarter compared to the same period in prior year. Inventory turnover, on an annualized basis increased from 5.4 times in the first half of 2014 to 5.7 times in the first half of 2015 due to improved inventory management. Accounts payable days outstanding remained consistent at 60 days at the end of the first six months of 2015 compared to 61 days for the same period in 2014.

 

Net cash provided by financing activities during the six months ended June 28, 2015 was $0.1 million compared to $0.4 million in the six months ended June 29, 2014. During the six months ended June 28, 2015, the Company increased revolving debt by $0.7 million, compared to an increase of $1.5 million during the same period in 2014. The Company made principal payments for capital leases of $0.6 million for the six months ended June 28, 2015 compared to $1.0 million for the same period in prior year. 

 

Net cash used in investing activities during the six months ended June 28, 2015 and June 29, 2014 was $1.4 million and $0.7 million, respectively, consisting of additions of property, plant and equipment.

 

Capital Resources

 

The Company borrows money under a Revolving Credit and Security Agreement with PNC. This PNC Facility had an ori