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SMTX > SEC Filings for SMTX > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for SMTC CORP


9-Nov-2012

Quarterly Report


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 it may apply. 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 8, 2012. 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 That May Affect Future Results" section in the Annual Report on Form 10-K filed on March 8, 2012, 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. Although we believe expectations reflected in such forward-looking statements are reasonable based upon the assumptions in this MD&A, they may prove to be inaccurate and consequently our actual results could differ materially from our expectations set out in this MD&A. 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, Canada, Mexico, and China, with approximately 1,875 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.

Developments in 2012

In the third quarter of 2012, revenue was $75.6 million compared to $44.1 million for the third quarter of 2011. Revenue has increased for the fourth consecutive quarter.

Year to date revenue increased $73.9 million, or 49.5%, from $149.2 million for the first nine months of 2011 to $223.1 million for the first nine months of 2012 mainly due to an increase in revenue for two of the Company's long standing customers, combined with revenue generated from new customers. New customers have contributed $25.4 million in increased revenue, more than offsetting the loss of customers and existing programs.

For the nine months ended September 30, 2012, the Company recorded net income of $6.6 million compared to a net loss of $1.7 million for the comparative period in the prior year. This was mainly due to an increase in revenue levels and the resulting impact on the ability to cover fixed costs, improved selling, general and administration expenses and as a percentage of revenue, a reduction in restructuring costs, a gain on contingent consideration and realized and unrealized foreign exchange gains on forward foreign exchange contracts.


Results of Operations

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

Quarter ended September 30, 2012 compared with the quarter ended October 2, 2011:

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

                            Three months ended              Three months ended                  Change
                            September 30, 2012               October 2, 2011                 2012 to 2011
                             $                %             $                $              $             %
Revenue                 $     75.6           100.0 %    $     44.1           100.0 %    $    31.5          71.4 %
Cost of sales                 69.6            92.1 %          40.4            91.6 %         29.2          72.3 %

Gross profit                   6.0             7.9 %           3.7             8.4 %          2.3          62.2 %
Selling, general and
administrative
expenses                       4.2             5.5 %           3.7             8.4 %          0.5          13.5 %
Loss on
extinguishment of
debt                             -               -             0.3             0.7 %         (0.3 )           -
Restructuring charges            -               -             0.7             1.6 %         (0.7 )           -
Operating (loss)
earnings                       1.8             2.4 %          (1.0 )          (2.3 )%         2.8           280 %
Interest expense               0.5             0.7 %           0.3             0.7 %          0.2          66.7 %
Earnings before
income taxes                   1.3             1.7 %          (1.3 )          (2.9 )%         2.6           200 %
Income tax
(recoverable) expense
Current                       (0.1 )          (0.1 %)          0.1             0.2 %         (0.2 )        (200 )%
Deferred                         -               -             0.1             0.2 %         (0.1 )        (100 )%
                              (0.1 )           0.4 %           0.2             0.4 %         (0.3 )        (150 )%
Net earnings            $      1.4             1.9 %    $     (1.5 )          (3.4 )%   $     2.9           193 %

Revenue

Revenue increased $31.5 million, or 71.4%, from $44.1 million for the third quarter of 2011 to $75.6 million for the third quarter of 2012 mainly due to an increase in revenue for three of the Company's long-standing customers, combined with revenue for a full quarter from the customers acquired in the ZF Array acquisition compared to one month in the third quarter of 2011 and revenue generated from new customers. New customers have contributed $4.3 million in increased revenue, more than offsetting attrition.

During the third quarter of 2012, revenue from the industrial sector increased to $59.1 million compared with $32.6 million for the same period in 2011, mainly due to the increase from the customers described above. Revenue from the industrial sector as a percentage of total revenue increased to 78.1% in the third quarter of 2012 compared with 73.9% in the third quarter of 2011.

Revenue from the communications sector increased in the third quarter of 2012 to $5.6 million compared to $2.5 million for the third quarter of 2011, which represented 7.4% of revenue in the third quarter of 2012, up from 5.7% of revenue in the third quarter of 2011. The increase was due to one new customer.

Revenue from the networking and enterprise computing sector increased to $7.4 million for the third quarter of 2012 compared with $6.6 million in 2011. The increase was due to one customer with increased demand. However, due to a larger increase in the industrial sector in the third quarter in 2012, as a percentage of total revenue this sector decreased to 9.9% of revenue compared to 15.0% in the third quarter in 2011.

Revenue for the medical sector increased by $1.1 million to $3.5 million in the third quarter of 2012, compared to $2.4 million in the third quarter of 2011 due to the increase in demand from one customer. However, revenue from the medical sector as a percentage of total revenue decreased to 4.6% in the third quarter of 2012 compared with 5.5% in the third quarter of 2011 due to the large increase in the industrial sector in the third quarter of 2012.

During the third quarter of 2012, the Company recorded approximately $1.9 million of sales of raw materials inventory to customers, which carried no margin, compared with $1.1 million in the third quarter of 2011. 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.


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 89.5% of revenue from continuing operations during the third quarter of 2012, compared with 83.1% in the third quarter of 2011. Revenue from the two largest customers during the third quarter of 2012 was $27.7 million and $8.4 million representing 36.6%, and 11.1% of total revenue for the third quarter of 2012, respectively. This compares with revenue from our four largest customers of $9.9 million, $5.1 million, $4.9 million, and $4.6 million representing 22.5%, 11.6%, 11.0%, and 10.4% of total revenue for the third quarter of 2011, respectively. No other customers represented more than 10% of revenue in either period.

During the third quarter of 2012, 65.0% of our revenue was attributable to production from our operations in Mexico, 13.6% in Asia, 10.7% in Canada and 10.7% in the U.S. During the third quarter of 2011, 58.0% of our revenue was attributable to production from our operations in Mexico, 20.7% in Asia, 10.4% in Canada and 10.8% in the U.S.

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 third quarter of 2012 increased by $2.3 million to $6.0 million, However gross profit as a percentage of revenue decreased from 8.4% of revenue in the third quarter of 2011 to 7.9% in the third quarter of 2012. The main reason for the decrease in gross margin percentage was due to the increase in the cost of materials, inefficiency in labor, and severance cost at the Markham facility, slightly offset by an unrealized foreign exchange gain.

The Company adjusts for estimated obsolete or excess inventory for the difference between the cost of inventory and estimated realizable value based upon customer forecasts, shrinkage, the aging and future demand of the inventory, past experience with specific customers and the ability to sell back inventory to customers or suppliers. If these estimates change, additional write-downs may be required.

Starting in the third quarter of 2011, 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. Included in cost of sales for the third quarter of 2012 was an unrealized gain recognized as a result of revaluing the instruments to fair value of $1.1 million, and a realized loss of $0.1 million. During the third quarter of 2011 an unrealized loss was recognized as a result of revaluing the instruments to fair value of $0.1 million. There was no realized gain or loss related to forward foreign exchange contracts recorded in the third quarter of 2011.

Selling, General & Administrative Expenses

Selling, general and administrative expenses increased by $0.5 million during the third quarter of 2012 to $4.2 million, however, as a percentage of sales has decreased to 5.5% from 8.4% in the third quarter of 2011. The increase was mainly due to increased labor costs as headcount was increased to correspond with the increase in revenue, and the assumption of headcount from ZF Array.

Loss on Extinguishment of Debt

Upon the repayment of the Company's previous credit facility with Wells Fargo during the third quarter of 2011, the Company recorded a non-cash charge to write off the remaining unamortized deferred financing costs related to the extinguished revolving credit facility of $0.3 million. There was no loss on extinguishment of debt in the third quarter of 2012.

Restructuring Charges

During the third quarter of 2011, the Company continued its 2011 Restructuring Plan. The Company recorded restructuring charges of $0.7 million, consisting of severance costs of $0.2 million in the United States, $0.2 million in the Markham facilities, and $0.3 in the corporate office. There were no restructuring charges recorded in the third quarter of 2012.

Interest Expense

Interest expense increased from $0.3 million in the third quarter of 2011 to $0.5 million in the third quarter of 2012, primarily resulting from an increased average debt level to support the increase in working capital required for the increased revenue level. Interest expense in the third quarter of both 2011 and 2010 included amortization of deferred financing fees of $0.1 million. The weighted average interest rates with respect to the debt were 3.3% and 4.6% for each of the third quarters of 2012 and 2011, respectively.


Income Tax Expense

During the three months ended September 30, 2012 the Company recorded a net income tax recoverable of $0.1 million related to a recovery of $0.4 million due to a revision of prior period estimates for US alternative minimum taxes offset by taxes on profits and foreign exchange in certain jurisdictions of $0.3 million. During the three months ended October 2, 2011, the Company recorded a net income tax expense of $0.2 million, primarily related 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 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" 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. At the end of the second quarter of 2003, the Company concluded that given the weakness and uncertainly in the economic environment at that time, it was appropriate to establish a full valuation allowance for the deferred tax assets. Commencing in 2004, it was determined by management that it was more likely than not that the deferred tax assets associated with the Mexican jurisdiction would be realized and no valuation allowance has been recorded against these deferred tax assets since 2004. In 2010, 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 no valuation allowance has been recorded against these deferred tax assets. The same determination was made by management in 2011. The Canadian jurisdiction continues to have a full valuation allowance recorded against the deferred tax assets.

At September 30, 2012, the Company had total net operating loss carry forwards of $107,833, of which $1,260 will expire in 2012, $10,278 will expire in 2014, $4,154 will expire in 2015, $1,078 will expire in 2018, $60 will expire in 2019, $30 will expire in 2020, $11,365 will expire in 2021, $16,207 will expire in 2022, $27,270 will expire in 2023, and the remainder will expire between 2025 and 2031.


Nine months ended September 30, 2012 compared with nine months ended October 2, 2011:

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

                            Nine months ended             Nine months ended                  Change
                           September 30, 2012              October 2, 2011                2012 to 2011
                            $               %              $              %              $             %
Revenue                 $    223.1          100.0 %    $    149.2         100.0 %    $    73.9          49.5 %
Cost of sales                202.3           90.7 %         135.7          90.9 %         66.6          49.1 %
Gross profit                  20.8            9.3 %          13.5           9.1 %          7.3          54.1 %
Selling, general and
administrative
expenses                      12.6            5.6 %          10.6           7.1 %          2.0          18.9 %
Contingent
Consideration                 (0.7 )         (0.3 )%            -             -           (0.7 )           -
Loss on
extinguishment of
debt                             -              -             0.3           0.2 %         (0.3 )           -
Restructuring charges          0.5            0.2 %           2.8           1.9 %         (2.3 )           -
Operating earnings             8.4            3.8 %          (0.2 )         0.1 %          8.6         430.0 %
Interest expense               1.5            0.7 %           1.0           0.7 %          0.5          50.0 %
Earnings before
income taxes                   6.9            3.1 %          (1.2 )        (0.8 )%         8.1         675.0 %
Income tax expense
Current                        0.3            0.1 %           0.5           0.3 %         (0.2 )       (40.0 )%
Deferred                         -            0.0 %             -           0.0 %            -             -
                               0.3            0.1 %           0.5           0.3 %         (0.2 )       (40.0 )%
Net earnings            $      6.6            3.0 %    $     (1.7 )        (1.1 )%   $     8.3         488.2 %

Revenue

Revenue increased $73.9 million, or 49.5%, from $149.2 million for the first nine months of 2011 to $223.1 million for the first nine months of 2012 mainly due to an increase in revenue for two of the Company's long standing customers, combined with revenue generated from new customers. New customers have contributed $25.4 million in increased revenue, more than more than offsetting the loss of customers and existing programs.

During the first nine months of 2012, revenue from the industrial sector increased to $177.7 million compared with $106.4 million for the same period in 2011, mainly due to the increase from two customers described above and revenue generated from new customers. Revenue from the industrial sector as a percentage of total revenue increased to 79.6% in the first nine months of 2012 compared with 71.3% in the first nine months of 2011.

Revenue from the communications sector increased to $17.2 million for the first three quarters of 2012 compared to $10.2 million in 2011, which represented 7.7% of revenue in the first nine months of 2012, compared with 6.8% of revenue in the first nine months of 2011. The increase was due to two new customers in 2012 slightly offset by a decrease in one existing customer.

Revenue from the networking and enterprise computing sector decreased to $17.6 million for the first three quarters of 2012 compared to $25.3 million in 2011, which represented 7.9% of revenue in the first nine months of 2012, down from 17.0% of revenue in the first nine months of 2011. The decrease was due to two customers with lower demand.

Revenue for the medical sector increased by $3.3 million to $10.6 million for the first nine months of 2012, compared to $7.3 million in the first nine months of 2011 due to the increase in demand from one customer. Revenue from the medical sector as a percentage of total revenue remained consistent year over year with a slight decrease in the first nine months of 2012 to 4.8% of revenue compared to 4.9% in 2011.

During the first nine months of 2012, the Company recorded approximately $4.2 million of sales of raw materials inventory to customers, which carried no margin, compared with $3.7 million in the first nine months of 2011. 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.

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 88.7% of revenue from continuing operations during the first nine months of 2012, compared with 81.8% in the first nine months of 2011. Revenue from our two largest customers during the first nine months of 2012 was $76.4 million, and $29.9 million, representing 34.3%, and 13.4% of total revenue for the first nine months of 2012, respectively. Revenue from our four largest customers during the first nine months of 2011 was $26.4 million, $18.3 million, $17.8 million and $15.4 million, representing 17.7%, 12.2%, 11.9 % and 10.3% of total revenue for the first nine months of 2011, respectively. No other customers represented more than 10% of revenue in either period.


During the first nine months of 2012, 59.0% of our revenue was attributable to production from our operations in Mexico, 16.0% in Asia, 14.1% in the US and 10.9% in Canada. During the first nine months of 2011, 58.2% of our revenue was attributable to production from our operations in Mexico, 18.7% in Asia, 15.4% in Canada and 7.8% in the U.S.

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 nine months of 2012 increased by $7.2 million to $20.8 million or 9.3% of revenue compared with 9.1% of revenue for the same period in 2011. The main reason for the increase in gross margin percentage was due an unrealized foreign exchange gain, slightly offset by the increase in the cost of materials and inefficiency in labor.

The Company adjusts for estimated obsolete or excess inventory for the difference between the cost of inventory and estimated realizable value based upon customer forecasts, shrinkage, the aging and future demand of the inventory, past experience with specific customers and the ability to sell back inventory to customers or suppliers. If these estimates change, additional write-downs may be required.

Starting in the third quarter of 2011, 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. Included in cost of sales for the first nine months of 2012 was an unrealized gain recognized as a result of revaluing the instruments to fair value of $1.1 million, and a realized gain of $0.4 million. During the first nine months of 2011 an unrealized loss was recognized as a result of revaluing the instruments to fair value of $0.1 million. There was no realized gain or loss related to forward foreign exchange contracts recorded in the first nine months of 2011.

Selling, General & Administrative Expenses

Selling, general and administrative expenses increased by $2.0 million during the first nine months of 2012 to $12.6 million, however, as a percentage of sales has decreased to 5.6% from 7.1% in the first nine months of 2011. The increase was mainly due to increased labor costs as headcount was increased to correspond with the increase in revenue, the assumption of headcount from ZF Array, and increased business trip expense to generate additional revenue.

Restructuring Charges

During the first nine months of 2012, the Company executed its 2012 Plan to combine the operations of the San Jose and ZF Array Technologies facilities into one facility. The Company recorded restructuring charges of $451, consisting of severance costs of $196 and facility exit costs of $255. Staff levels were reduced by approximated 16 full-time equivalents.

During the first nine months of 2011 the Company executed its 2011 Plan to streamline operations in response to reductions in revenues. The Company recorded restructuring charges of $2.8 million, consisting of severance costs of $0.2 million in the United States, $0.6 million in Mexico, and $2.0 million in Canada. The Company reduced staff levels by approximately 13 in the United States, 241 in Mexico and 150 in Canada.

Loss on Extinguishment of Debt

Upon the repayment of the Company's previous credit facility with Wells Fargo during the first nine months of 2011, the Company recorded a non-cash charge to write off the remaining unamortized deferred financing costs related to the extinguished revolving credit facility of $0.3 million. There was no loss on extinguishment of debt in the first nine months of 2012. . . .

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