Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
Where we say “we”, “us”, “our”, the “Company” or “SMTC”, we mean SMTC Corporation or SMTC Corporation and its subsidiaries, as the context may require. Where we refer to the “industry”, we mean the electronics manufacturing services industry.
You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in combination with the accompanying unaudited interim consolidated financial statements and related notes as well as the audited consolidated financial statements and the accompanying notes to the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) included within the Company’s Annual Report on Form 10-K filed on March 13, 2020.
The forward-looking statements in this discussion and elsewhere in this quarterly report, including those regarding the electronics manufacturing services industry, our expectations regarding our future performance, liquidity and capital resources, the impact of accounting standards not yet adopted, compliance with financial covenants under our Credit Facilities, future response to and effects of COVID-19, including our continued operations, customer demand, supply chain availability and implementation of protective measures, our expectations regarding customer concentration, our expectations regarding timing and mitigation of the identified material weakness in internal control over financial reporting, and other non-historical statements include numerous risks and uncertainties, some of which are as described in the “Risk Factors” section in the Annual Report on Form 10-K filed on March 13, 2020, as updated by Item 1A in Part II of this quarterly report. Certain statements in this MD&A contain words such as “could”, “expects”, “may”, “anticipates”, “believes”, “intends”, “estimates”, “plans”, “envisions”, “seeks” and other similar language and are considered forward looking statements or information under applicable securities laws. These statements are based on our current expectations, estimates, forecasts and projections about the operating environment, economies and markets in which we operate. These statements are subject to important assumptions, risks and uncertainties, which are difficult to predict and the actual outcome may be materially different. Except as required by applicable law, we do not intend to update these forward-looking statements after the date of this quarterly report, even though our situation may change in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.
This MD&A contains discussion in U.S. dollars (US$) unless specifically stated otherwise.
Background
We are a provider of end-to-end electronics manufacturing services (“EMS”), including product design and engineering services, printed circuit board assembly (“PCBA”), production, enclosure, cable assembly, precision metal fabrication, systems integration and comprehensive testing services, configuration to order (“CTO”), build to order (“BTO”) and direct order fulfillment (“DOF”). We operate more than 50 manufacturing and assembly lines in over 555,000 square feet of production space worldwide at strategically located facilities in the United States and Mexico, that provide local support, flexibility, fast turn around and delivery times, and low-cost, volume manufacturing capabilities, as well as new product integration (“NPI”) services, to our global customers. Our services extend over the entire electronic product life cycle from new product development and NPI through to growth, maturity and end of life phases. As of March 29, 2020, we had 2,877 employees of which 2,436 were full time and contract employees.
COVID-19 Update
Our business operations have generally performed as expected during the first quarter of 2020. However, the fast developing COVID-19 pandemic represents significant uncertainty for the remainder of the year. So far, our business has not been significantly impacted by the COVID-19 pandemic and demand from our customers has not changed materially. The pandemic could impact our customers and may result in unpredictable reductions or increases in demand across the industry sectors we service. We do anticipate COVID-19-related disruptions, including potential materials constraints for inventory sourced from certain regions, increased shipping costs and lead-times. As at March 29, 2020, the funds available to borrow under our PNC Facility (as described and defined below) after deducting the current borrowing base conditions was $31,185.
We are taking extensive precautions intended to protect the health and safety of our employees and to ensure business continuity. Despite these efforts it is possible that an extended pandemic could disrupt the operation of one or more of our manufacturing facilities or our supply chain. Additionally, one or more of our manufacturing facilities may need to limit operations or temporarily close. Although many of the products we manufacture for our customers are deemed essential, the COVID-19 pandemic may impact demand for our customers’ products, which could impact our production schedules. These possible impacts could result from both the pandemic itself and the extensive public restrictions imposed to limit the spread of COVID-19. If one or more of our manufacturing facilities were temporarily closed or had its operations limited, or customers pushed out demand due to the pandemic, this would have a material impact on our operations.
We are actively monitoring the global COVID-19 pandemic and in continuous communication with our employees and union representatives, in addition to government and state representatives where our manufacturing facilities reside. We have initiated measures designed to protect our employees and we continue to adapt in order to maintain operations while providing a safe environment. We have experience increased workplace absenteeism as illness, potential COVID-19 exposure or personal commitments restrict the ability of some employees to come to work. The Company has modified shift schedules and hired temporary labor to help address this situation and meet our customers’ product shipping schedules. We anticipate incurring higher direct labor charges in the second quarter of 2020 as a result of this. Decisions on further measures or the continuation of these measures will depend on the impact of the COVID-19 pandemic on our operations and the requirements of each jurisdiction in which we operate.
Results of Operations
The unaudited interim consolidated financial statements of SMTC are prepared in accordance with U.S. GAAP.
Quarter ended March 29, 2020 compared with the quarter ended March 31, 2019:
The following table sets forth summarized operating results in millions of US$ for the periods indicated:
|
|
Three months ended
March 29, 2020
|
|
|
Three months ended
March 31, 2019
|
|
|
Change
2019 to 2020
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Revenue
|
|
|
95.1
|
|
|
|
100.0
|
|
|
|
102.6
|
|
|
|
100.0
|
|
|
|
(7.5
|
)
|
|
|
(7.3
|
)
|
Cost of sales
|
|
|
85.5
|
|
|
|
89.9
|
|
|
|
94.0
|
|
|
|
91.6
|
|
|
|
(8.6
|
)
|
|
|
(9.1
|
)
|
Gross profit
|
|
|
9.6
|
|
|
|
10.1
|
|
|
|
8.6
|
|
|
|
8.4
|
|
|
|
1.1
|
|
|
|
12.8
|
|
Selling, general and administrative expenses
|
|
|
7.2
|
|
|
|
7.6
|
|
|
|
6.8
|
|
|
|
6.6
|
|
|
|
0.4
|
|
|
|
5.9
|
|
Change in fair value of warrant liability
|
|
|
(0.5
|
)
|
|
|
(0.5
|
)
|
|
|
(0.1
|
)
|
|
|
(0.1
|
)
|
|
|
(0.4
|
)
|
|
|
(400.0
|
)
|
Change in fair value of contingent consideration
|
|
|
—
|
|
|
|
—
|
|
|
|
(3.1
|
)
|
|
|
(3.0
|
)
|
|
|
3.1
|
|
|
|
100.0
|
|
Restructuring charges (recovery)
|
|
|
(0.2
|
)
|
|
|
(0.2
|
)
|
|
|
0.6
|
|
|
|
0.6
|
|
|
|
(0.8
|
)
|
|
|
(133.3
|
)
|
Operating income
|
|
|
2.7
|
|
|
|
2.8
|
|
|
|
4.3
|
|
|
|
4.2
|
|
|
|
(1.6
|
)
|
|
|
(21.3
|
)
|
Change in fair value of warrant liability
|
|
|
(0.5
|
)
|
|
|
(0.5
|
)
|
|
|
(0.1
|
)
|
|
|
(0.1
|
)
|
|
|
(0.4
|
)
|
|
|
(400.0
|
)
|
Interest expense
|
|
|
2.1
|
|
|
|
2.2
|
|
|
|
2.9
|
|
|
|
2.8
|
|
|
|
(0.8
|
)
|
|
|
(27.6
|
)
|
Income before income taxes
|
|
|
1.1
|
|
|
|
1.2
|
|
|
|
1.5
|
|
|
|
1.5
|
|
|
|
(0.4
|
)
|
|
|
(26.6
|
)
|
Income tax expense (recovery)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
—
|
|
|
|
—
|
|
Deferred
|
|
|
—
|
|
|
|
—
|
|
|
|
(0.0
|
)
|
|
|
0.0
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
—
|
|
|
|
—
|
|
Net income
|
|
|
0.8
|
|
|
|
0.8
|
|
|
|
1.2
|
|
|
|
1.2
|
|
|
|
(0.4
|
)
|
|
|
(33.3
|
)
|
Revenue by Industry Sector
Industry Sector
|
|
Three months ended
March 29,
2020
|
|
|
Three months ended
March 31,
2019
|
|
|
Change
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Test and Measurement
|
|
|
29.4
|
|
|
|
30.9
|
|
|
|
32.5
|
|
|
|
31.7
|
|
|
|
(3.1
|
)
|
|
|
(9.5
|
)
|
Retail and Payment Systems
|
|
|
12.3
|
|
|
|
13.0
|
|
|
|
12.9
|
|
|
|
12.6
|
|
|
|
(0.6
|
)
|
|
|
(4.7
|
)
|
Telecom, Networking and Communications
|
|
|
7.5
|
|
|
|
7.9
|
|
|
|
10.8
|
|
|
|
10.5
|
|
|
|
(3.3
|
)
|
|
|
(30.6
|
)
|
Medical
|
|
|
11.3
|
|
|
|
11.9
|
|
|
|
12.5
|
|
|
|
12.2
|
|
|
|
(1.2
|
)
|
|
|
(9.6
|
)
|
Industrial, Power and Clean Technology
|
|
|
18.9
|
|
|
|
19.8
|
|
|
|
19.6
|
|
|
|
19.1
|
|
|
|
(0.7
|
)
|
|
|
(3.6
|
)
|
Semiconductor
|
|
|
5.3
|
|
|
|
5.6
|
|
|
|
7.3
|
|
|
|
7.1
|
|
|
|
(2.0
|
)
|
|
|
(27.4
|
)
|
Aerospace and Defense
|
|
|
10.4
|
|
|
|
10.9
|
|
|
|
7.0
|
|
|
|
6.8
|
|
|
|
3.4
|
|
|
|
48.6
|
|
Total
|
|
|
95.1
|
|
|
|
100.0
|
|
|
|
102.6
|
|
|
|
100.0
|
|
|
|
(7.5
|
)
|
|
|
(7.3
|
)
|
Revenue decreased $7.5 million to $95.1 million for the first quarter of 2020 from $102.6 million in the same period in the prior year.
Revenue decreased $3.1 million in the test and measurement section compared to the first quarter of 2019, primarily due to volume decreases for two customers (one serviced in Mexico; one serviced in the U.S.), and one customer disengaging due to the closure of our Dongguan facility in China, partially offset by volume increases for two customers serviced in Mexico.
Revenue decreased $0.6 million in the retail and payment systems sector compared to the first quarter of 2019, primarily due to decreased volume from one long-standing customer serviced in Mexico, partially offset by increased volume from a different customer serviced in Mexico.
Revenue decreased $3.3 million in the telecom, networking and communications sector compared to the first quarter of 2019, primarily due to decreased volume from one customer serviced in Mexico and one customer disengaging in China due to the Dongguan facility closure, partially offset by two customers (one serviced in Mexico; one serviced in the U.S.) with increased volumes.
Revenue decreased $1.2 million in the medical sector, compared to the first quarter of 2019, primarily due to one customer serviced in the U.S. experiencing reduced volumes due to the customer’s program transitioning to end-of-life and decreased volume from one other customer serviced in Mexico, partially offset by three customers (two serviced in Mexico; one in the U.S.) with increased volumes.
Revenue decreased $0.7 million in the industrial, power and clean technology sector compared to the first quarter of 2019, primarily due to decreased volume from two customers serviced in Mexico, partially offset by three customers (one serviced in Mexico; two serviced in the U.S.) with increased volumes.
Revenue decreased $2.0 million in the semiconductor sector compared to the first quarter of 2019, due to decreased volume from one customer serviced in Mexico.
Revenue decreased $3.4 million in the aerospace and defense sector compared to the first quarter of 2019, due to the addition of one new customer and increased volume from three other customers.
Revenue by Geography
During the first quarter of 2020, 64.1% of our revenue was attributable to production from our operations in Mexico, 35.0% of our revenue was attributable to production from our operations in the U.S. and 0.9% of our revenue was attributable to production from our operations in China. During the first quarter of 2019, 64.0% of our revenue was attributable to production from our operations in Mexico, 29.0% of our revenue was attributable to production from our operations in the U.S. and 7.0% of our revenue was attributable to production from our operations in China. Following the closure of our Dongguan manufacturing facility in China, manufacturing of certain products previously manufactured at that facility has been transferred to the Company’s other manufacturing facilities.
Additional Revenue Information
We recorded approximately $2.0 million and $2.2 million of revenue from sales of raw materials inventory to customers during the first quarter of 2020 and the first quarter of 2019. The Company purchases raw materials based on customer purchase orders. When a customer requires an order to be altered or changed, the customer is generally obligated to purchase the original on-order raw material at cost, to the extent the materials are not consumed within a specified period.
The Company’s ten largest customers represented 52.3% of revenue during the first quarter of 2020, compared with 55.7% in the first quarter of 2019. Revenue from the largest customer during the first quarter of 2020 was $12.0 million representing 12.6% of total revenue. This compares with revenue from the largest customer during the first quarter of 2019 of $13.5 million representing 13.1% of total revenue. No other customers represented more than 10% of revenue in either period.
Gross Profit
Gross profit for the first quarter of 2020 increased by $1.0 million to $9.6 million or 10.1% of revenue compared with $8.6 million or 8.4% of revenue for the same period in 2019. When excluding unrealized foreign exchange loss on unsettled forward contracts and amortization of intangible assets, the adjusted gross profit was $11.7 million or 12.3% of revenue for the first quarter of 2020 compared with $10.5 million or 10.2% of revenue for the first quarter of 2019. This was due primarily to higher gross profit due to product mix and lower variable manufacturing expenses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $7.2 million in the first quarter of 2020 from $6.8 million in the same period in 2019, mainly due to increased professional services rendered primarily related to additional compliance obligations under the Sarbanes-Oxley Act of 2002, as well as new headcount hired in the first quarter of 2020.
Change in fair value of contingent consideration
During the first quarter of 2019, it was determined that there was no fair value of the contingent consideration liability, and that no obligation existed resulting in a gain of $3.1 million being recognized. The contingent consideration liability was initially recognized at fair value in the fourth quarter of 2018 and relates to a contingent earn-out payment associated with the acquisition of MC Assembly. Fair value estimate under purchase accounting of $3.1 million was derived from a multiple of earnings based on MC Assembly’s forecasted twelve-month earnings for the period ended March 31, 2019. Based on actual earnings, the contingent consideration liability was considered resolved and no longer payable as at March 31, 2019. No contingent consideration existed as at March 29, 2020.
Restructuring Charges
During the first quarter of 2020, restructuring recoveries were recorded of $0.2 million primarily related to the cash collections of previously provisioned inventory included in the Dongguan facility. During the first quarter of 2019, restructuring charges of $0.6 million were incurred related to the reduction of 10 full-time equivalents (“FTEs”) in the U.S. and 4 FTEs in Canada and 167 FTEs and contract employees in Mexico. As at March 29, 2020, the Company had $887 of accrued restructuring charges remaining to be paid by the end of the third quarter of 2020.
Interest Expense
Interest expense decreased to $2.1 million in the first quarter of 2020 compared to $2.9 million in the same period in 2019. The decrease was primarily the result of the pay down of the Term Loan B Facility in addition to lower average debt balance in the first quarter of 2020 compared to the same period in 2019. The weighted average interest rates with respect to the debt on our PNC and TCW Facilities was 7.7%. The weighted average interest rates for the same period in the prior year was 9.4%.
Income Tax Expense
The Company recorded current income tax expense of $0.3 million for each of the first quarters of 2020 and 2019, in connection with U.S. state taxes and taxes on profits in certain foreign jurisdictions, and deferred income tax benefit of $0.1 million in the first quarter of 2019, in connection with temporary differences related to the Mexican operations.
Non-GAAP Financial Measures
To supplement our consolidated financial statements, which are prepared and presented in accordance with U.S. GAAP, we use the following non-GAAP financial measures: Adjusted Gross Margin, EBITDA, Adjusted EBITDA, Adjusted EBITDA Margin and Adjusted Net Income (collectively the “Non-GAAP Financial Measures”). We believe that these Non-GAAP Financial Measures, when used in conjunction with GAAP financial measures, provide useful information about operating results, enhance the overall understanding of past financial performance and future prospects, and allow for greater transparency with respect to the key metrics we use in our financial and operational decision making. These non-GAAP measures are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with U.S. GAAP, and they should not be construed as an inference that our future results will be unaffected by any items adjusted for in these non-GAAP measures. In evaluating these non-GAAP measures, you should be aware that in the future we may incur expenses that are the same as or similar to some of those adjusted in this presentation. The Non-GAAP Financial Measures that we use are not necessarily comparable to similarly titled measures used by other companies due to different methods of calculation.
Net Income and Adjusted Net Income Reconciliation
Adjusted Net Income, a non-GAAP financial measure, is defined as Net Income before amortization of intangible assets, restructuring charges, stock-based compensation, fair value adjustment of warrant liability, fair value adjustment to contingent consideration, merger and acquisition related expenses and unrealized foreign exchange gains and losses on unsettled forward foreign exchange contracts. Management presents Adjusted Net Income, as it is believed the information is useful to investors in understanding and evaluating our operating results as it aligns the net loss with those adjustments made to EBITDA and gross profit.
Below is the reconciliation of Net Income to Adjusted Net Income (in thousands):
|
|
March 29,
2020
|
|
|
March 31,
2019
|
|
Net Income
|
|
$
|
775
|
|
|
$
|
1,211
|
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangible assets
|
|
|
1,518
|
|
|
|
1,844
|
|
Restructuring charges (recovery)
|
|
|
(221
|
)
|
|
|
624
|
|
Stock based compensation
|
|
|
162
|
|
|
|
88
|
|
Fair value adjustment of warrant liability
|
|
|
(517
|
)
|
|
|
(101
|
)
|
Fair value adjustment of contingent consideration
|
|
|
—
|
|
|
|
(3,050
|
)
|
Merger and acquisitions related expenses
|
|
|
—
|
|
|
|
91
|
|
Unrealized foreign exchange loss on unsettled forward foreign exchange contracts
|
|
|
512
|
|
|
|
—
|
|
Adjusted Net Income
|
|
$
|
2,229
|
|
|
$
|
707
|
|
Net income decreased to $0.8 million from $1.2 million in the first quarter of 2020 and 2019. This was due primarily to change in fair value of contingent consideration resulting in a gain of $3.1 million in the first quarter of 2019, partially offset by the change of restructuring charges of $0.8 million incurred in 2020 and 2019. When excluding these items, adjusted Net Income increased $1.5 million in the first quarter of 2020 over the same period in the prior year, which is mainly due to increased gross profit, reduced interest expense due to reduction in debt and partially offset by increased selling, general and administrative expense.
Gross Profit and Adjusted Gross Profit Reconciliation
Adjusted Gross Profit, a non-GAAP financial measure, is defined as gross profit exclusive of unrealized foreign exchange gains or losses on unsettled forward foreign exchange contracts and the amortization of intangible assets. The Company calculates an adjusted gross profit amount as we consider gross profit exclusive of such unrealized foreign exchange gains or losses on unsettled forward foreign exchange contracts to be a meaningful measure as it is non-cash and management does not consider the mark-to-market valuation reflective of operating performance in the current period. Management also excludes the impact of intangible assets amortization as these charges are non-cash in nature and are not believed to be reflective of operating performance. We also believe adjusted gross profit provides useful information to investors in understanding and evaluating our operating results in the same manner as management.
Below is the reconciliation from the financial statement presentation of gross profit to the non-GAAP measure of adjusted gross profit (in thousands):
|
|
Three months
ended
March 29, 2020
|
|
|
Three months
ended
March 31, 2019
|
|
Gross profit
|
|
$
|
9,639
|
|
|
$
|
8,624
|
|
Add:
|
|
|
|
|
|
|
|
|
Unrealized foreign exchange loss on unsettled forward exchange contracts
|
|
|
512
|
|
|
|
—
|
|
Amortization of intangible assets
|
|
|
1,518
|
|
|
|
1,844
|
|
Adjusted gross profit
|
|
$
|
11,669
|
|
|
$
|
10,468
|
|
Adjusted gross profit percentage
|
|
|
12.3
|
%
|
|
|
10.2
|
%
|
EBITDA and Adjusted EBITDA Reconciliation
EBITDA and Adjusted EBITDA, non-GAAP financial measures, are defined as earnings before interest, taxes, depreciation and amortization, with Adjusted EBITDA also excluding restructuring charges, stock-based compensation, unrealized foreign exchange gains and losses on unsettled forward foreign exchange contracts, fair value adjustment of warrant liability, fair value adjustment to contingent consideration and merger and acquisition related expenses. Management presents EBITDA and Adjusted EBITDA, as it is utilized by management to monitor performance against budget as well as compliance with bank covenants. We also believe EBITDA and Adjusted EBITDA provide useful information to investors in understanding and evaluating our operating results in the same manner as management.
Below is the reconciliation of net income (loss), the closest GAAP measure, to EBITDA and Adjusted EBITDA (in thousands).
|
|
Three months
ended
March 29, 2020
|
|
|
Three months
ended
March 31, 2019
|
|
Net income
|
|
$
|
775
|
|
|
$
|
1,211
|
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation of property, plant and equipment
|
|
|
1,603
|
|
|
|
1,627
|
|
Amortization of intangible assets
|
|
|
1,518
|
|
|
|
1,844
|
|
Interest
|
|
|
2,093
|
|
|
|
2,870
|
|
Income taxes
|
|
|
290
|
|
|
|
271
|
|
EBITDA
|
|
$
|
6,279
|
|
|
$
|
7,823
|
|
|
|
|
|
|
|
|
|
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring charges (recovery)
|
|
|
(221
|
)
|
|
|
624
|
|
Stock based compensation
|
|
|
162
|
|
|
|
88
|
|
Fair value adjustment of warrant liability
|
|
|
(517
|
)
|
|
|
(101
|
)
|
Fair value adjustment to contingent consideration
|
|
|
—
|
|
|
|
(3,050
|
)
|
Merger and acquisition related expenses
|
|
|
—
|
|
|
|
91
|
|
Unrealized foreign exchange loss on unsettled forward exchange contracts
|
|
|
512
|
|
|
|
—
|
|
Adjusted EBITDA
|
|
$
|
6,215
|
|
|
$
|
5,475
|
|
Adjusted EBITDA for three months ended March 29, 2020 increased by $0.8 million to $6.2 million compared with $5.5 million for the same period in 2019 due to the increase in gross profit, partially offset by increased selling, general and administrative expenses.
Liquidity
As at March 29, 2020, the Company’s liquidity was comprised of $1.4 million in cash on hand and $31.2 million of funds available to borrow under the PNC Facility, which mature on November 8, 2023. The Company funds its operations by regularly utilizing its PNC Facility (refer to Note 4). The Company manages it capital requirements through budgeting and forecasting processes while monitoring for compliance with bank covenants. Funds available under the PNC Facility are managed on a weekly basis based on the cash flow requirements of the various operating segments. Cash flows generated from operations are immediately applied towards paying down the PNC Facility.
Market conditions, including the implications of the COVID-19 pandemic, may negatively impact our ability to secure and source alternative methods of financing. We do not currently foresee a material impact in the short term based on our working capital needs, however if a number of our customers reduce or temporarily cease payments to us, this would present a risk and negatively impact our cash flow and ability to meet our working capital obligations to operate our business, which could require us to secure alternative methods of financing.
Net cash generated in operating activities during the three months ended March 29, 2020, was $2.9 million compared to $2.8 million for the same period in the prior year. Working capital changes related to $4.5 million reduction in inventory offset by the $2.5 million increase in the unbilled contract assets. Accounts payable had decreased $6.2 million due to timing of payments, improved payment terms and reduced inventory. Accounts payable days outstanding decreased to 68 days for the first quarter of 2020 compared to 73 days for the first quarter of 2019. Inventory turnover, on an annualized basis, decreased to 4.5 times for the first quarter of 2020 compared to 5 times for the first quarter of 2019. Accounts receivable days sales outstanding increased to 60 days in the first quarter of 2020 from 58 days for the first quarter of 2019.
Net cash used in financing activities during the first quarter of 2020 was $2.0 million compared to net cash used by $2.2 million for the first quarter of 2019. During the first quarter of 2020 and 2019, the Company made net repayments to the revolving debt of $1.4 million. The Company also paid down its long-term debt in the amount of $0.3 million in the first quarters of 2020 and 2019. Principal repayments on capital lease obligations were $0.4 million in the first quarter of 2020 compared to $0.5 million in the same period in the prior year.
Net cash used in investing activities during the first quarter of 2020 was $0.9 million compared to $0.7 million in the first quarter of 2019, related to capital asset purchases.
Capital Resources
The Company borrows money under the PNC Facility. The PNC Facility has a term ending on November 8, 2023. Advances made under the PNC Facility bear interest at the U.S. base rate plus an applicable margin ranging from 0.75% to 1.25%, or LIBOR plus an applicable margin ranging from 2.50% to 3.00%. The base commercial lending rate should approximate U.S. prime rate.
The Company also borrows money under the Financing Agreement which governs the Term A Loan Facility that matures on the Maturity Date. The Term Loan A Facility bears interest at LIBOR plus an applicable margin of 8.75% through June 30, 2020, and borrowings under the Financing Agreement will thereafter bear interest at LIBOR plus an applicable margin ranging from 7.25% to 8.75%. Payments made under the Term Loan A Facility at any time prior to the Maturity Date (other than scheduled amortization payments and mandatory prepayments) are subject to an applicable premium equal to the amount of such payment multiplied by (i) 3.00% in the event that such payment occurs before November 8, 2019, (ii) 2.00% in the event that such payment occurs after November 8, 2019, and on or before November 8, 2020, and (iii) 1.00% in the event that such payment occurs after November 8, 2020, and on or before November 8, 2021. No such applicable premium is payable for any payment of loans made under the Term Loan A Facility occurring after November 8, 2021.
The Credit Facilities are joint and several obligations of the Company and its subsidiaries that are borrowers under the facilities and are jointly and severally guaranteed by other subsidiaries of the Company. Repayment under the PNC Facility and Term A Loan Facility are collateralized by the assets of the Company and each of its subsidiaries. The Credit Facilities contain certain financial and non-financial covenants, including restrictions on dividend payments. The financial covenants under each Credit Facility require the Company to maintain a fixed charge coverage ratio and a total leverage ratio quarterly during the term of the Credit Facilities. The Company was in compliance with the financial covenants included in the Credit Facilities as at March 29, 2020.
We believe that our sources of liquidity and capital, including cash we expect to generate from operations, available cash and amounts available under our Credit Facilities, will be adequate to meet our debt service requirements, capital expenditures and working capital needs at our current level of operations for the next twelve months. However, we make no assurance that these sources of liquidity and capital, particularly with respect to amounts available from lenders, will be sufficient to meet our future needs. We have agreed to a borrowing base formula under which the amount we are permitted to borrow under the PNC Facility is based on our accounts receivable and inventory. Further, we make no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available to enable us to service our indebtedness. Our future operating performance and ability to service indebtedness will be subject to future economic conditions and to financial, business and other factors, certain of which are beyond our control.
Market conditions, including the implications of the COVID-19 pandemic, may negatively impact our ability to secure and source alternative methods of financing. We do not currently foresee a material impact in the short term based on our working capital needs, however if a number of our customers reduce or temporarily cease payments to us, this would present a risk and negatively impact our cash flow and ability to meet our working capital obligations to operate our business, which could require us to secure alternative methods of financing. In order to meet our customers’ delivery requirements, we have incurred and may continue to incur COVID-19 related expenses. These are primarily due to incremental logistics costs associated with expediting inventory purchases from existing and new sources, and labor and production inefficiencies and retention of temporary replacement labor to address workplace absenteeism due to illness, potential COVID-19 exposure or personal commitments. We are currently taking steps to limit our expenses, including putting a pause on all non-essential new hiring and new programs, and reducing our second quarter capital expenditures.
Item 3 Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
The Company borrows money under the PNC Facility. The PNC Facility has a term ending on November 8, 2023. Advances made under the PNC Facility bear interest at the U.S. base rate plus an applicable margin ranging from 0.75% to 1.25%, or LIBOR plus an applicable margin ranging from 2.50% to 3.00%. The base commercial lending rate should approximate U.S. prime rate.
The Company also borrows money pursuant to the Financing Agreement. The Term A Loan Facility matures on its Maturity Date. The Term Loan A Facility bears interest at LIBOR plus an applicable margin of 8.75% through June 30, 2020, and borrowings under the Financing Agreement will thereafter bear interest at LIBOR plus an applicable margin ranging from 7.25% to 8.75%. Payments made under the Term Loan A Facility at any time prior to the Maturity Date (other than scheduled amortization payments and mandatory prepayments) are subject to an applicable premium equal to the amount of such payment multiplied by (i) 3.00% in the event that such payment occurs before November 8, 2019, (ii) 2.00% in the event that such payment occurs after November 8, 2019, and on or before November 8, 2020, and (iii) 1.00% in the event that such payment occurs after November 8, 2020, and on or before November 8, 2021. No such applicable premium is payable for any payment of loans made under the Term Loan A Facility occurring after November 8, 2021.
The impact of a 10% change in interest rates would be estimated to have the following impact on our reported earnings.
10% increase in interest rate (million)
|
|
$
|
0.6
|
|
10% decrease in interest rate (million)
|
|
$
|
(0.6
|
)
|
Foreign Currency Exchange Risk
Given our global business operations, we are exposed to exchange rate fluctuations on expenditures denominated in foreign currencies. However, most of our sales and component purchases are denominated in U.S. dollars, which limits our foreign currency risk. Our foreign exchange risk relates primarily to our Canadian, Mexican and Asian payroll, Euro based component purchases and other operating expenses denominated in local currencies in our geographic locations. To mitigate this risk, the Company enters into forward foreign exchange contracts to reduce its exposure to foreign exchange currency rate fluctuations related to forecasted Canadian dollar and Mexican peso expenditures. The strengthening of the Canadian dollar and Mexican peso would result in an increase in costs to the organization and may lead to a reduction in reported earnings.
The impact of a 10% change in exchange rates would be estimated to have the following impact on cost of sales for the Company:
10% increase in both the CAD and PESO foreign exchange rates (million)
|
|
$
|
1.5
|
|
10% decrease in both the CAD and PESO foreign exchange rates (million)
|
|
$
|
(1.8
|
)
|
Credit Risk
In the normal course of operations, there is a risk that a counterparty may default on its contractual obligations to us which would result in a financial loss that could impact our reported earnings. In order to mitigate this risk, we complete credit approval procedures for new and existing customers and obtain credit insurance where it is financially viable to do so given anticipated revenue volumes, in addition to monitoring our customers’ financial performance. We believe our procedures in place to mitigate customer credit risk and the respective allowance for doubtful accounts are adequate. The Company takes measures to reduce credit risk, these charges can have a material impact on our financial performance.
While we continue to communicate with our customers and monitor cash collections, market conditions, including as a result of the COVID-19 pandemic, may negatively impact our customers’ ability to pay. We do not currently foresee a material impact in the short term based on our customers’ payment patterns, however if a number of our customers reduce or temporarily cease payments to us, this would present a risk and any charges could have a material impact on our financial performance.
There is limited risk of financial loss of defaults on our outstanding forward currency contracts as the counterparty to the transactions had a Standard and Poor’s rating of A- or above as at March 29, 2020.
Liquidity Risk
There is a risk that we may not have sufficient cash available to satisfy our financial obligations as they come due. The financial liabilities we have recorded in the form of accounts payable, accrued liabilities and other current liabilities are primarily due within 90 days with the exception of the current portion of capital lease obligations which could exceed 90 days and our PNC Facility which utilizes a lock-box to pay down the obligation effectively daily. As at March 29, 2020, the Company’s liquidity is comprised of $1.4 million in cash on hand and $31.2 million of funds available to borrow under the PNC Facility. We believe that cash flow from operations, together with cash on hand and our PNC Facility, which has a maximum credit limit of $65.0 million of which $31.2 million of funds were available as at March 29, 2020 is sufficient to fund our financial obligations. However, availability under the PNC Facility is subject to certain conditions, including borrowing base conditions based on eligible inventory and accounts receivable, as determined by the lender.
Market conditions, including as a result of the COVID-19 pandemic, may negatively impact our ability to secure and source alternative methods of financing. We do not currently foresee a material impact in the short term based on our working capital needs, however if a number of our customers reduce or temporarily cease payments to us, this would present a risk and negatively impact our cash flow and ability to meet our working capital obligations to operate our business, which could require us to seek alternative methods of financing, which may only be available to use on unfavorable terms, if at all.
Fair Value Measurement
The carrying values of the Company’s cash, accounts receivable, accounts payable and accrued liabilities due within one-year approximate fair values due to the short-term maturity of these instruments. The Company’s financial instruments at March 29, 2020, are comprised of the following:
|
|
As at March 29, 2020
|
|
|
As at December 29, 2019
|
|
|
|
Carrying
Amount
|
|
|
Estimated
Fair Value
|
|
|
Carrying
Amount
|
|
|
Estimated
Fair Value
|
|
Level 1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,354
|
|
|
$
|
1,354
|
|
|
$
|
1,368
|
|
|
$
|
1,368
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving credit facility
|
|
|
31,185
|
|
|
|
31,185
|
|
|
|
34,701
|
|
|
|
34,701
|
|
Current and long term debt
|
|
|
34,927
|
|
|
|
38,438
|
|
|
|
35,000
|
|
|
|
38,750
|
|
Warrant liability
|
|
|
1,213
|
|
|
|
1,213
|
|
|
|
1,730
|
|
|
|
1,730
|
|