SUBSCRIBE TO TMCnet
TMCnet - World's Largest Communications and Technology Community

TMCNet:  SMTC CORP - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations

[April 14, 2014]

SMTC CORP - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) You should read this Management's Discussion and Analysis of Financial Condition and Results of Operation ("MD&A") in combination with the accompanying audited consolidated financial statements and the accompanying notes to the consolidated financial statements prepared in accordance with U.S. GAAP included within this annual report.


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

Overview 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 has facilities in the United States, Mexico, and China, with approximately 1,800 full-time employees. SMTC's services extend over the entire electronic product life cycle from the design, early supplier involvement, new product integration ("NPI") through to growth, maturity and end-of-life phases. SMTC offers fully integrated contract manufacturing services to global original equipment manufacturers, or OEMs, and technology companies primarily within the industrial, computing and networking, communications, and medical market sectors.

In connection with the preparation of its financial statements for the fiscal year ended December 29, 2013, SMTC conducted a full physical count of its inventory. As a result of this full physical count, the Company identified an overstatement of inventory at its Chihuahua, Mexico operations with a total cumulative value of $3.2 million which was recorded in the fourth quarter of 2013. However, $0.9 million of this overstatement represented accumulated differences relating to adjustments on spare machine parts, adjustments due to purchasing errors made in excess of customer demand or forecast, inventory identified to be scrapped but that was combined as a part of the count variances and capitalized labor and overhead that required expensing with the reduced WIP levels which were previously capitalized to inventory. Therefore, the true count variance from book to physical inventory count was a $2.3 million reduction of inventory recorded.

Management promptly attempted to determine the root cause(s) of the book to physical loss and the periods in which the losses should have been recorded.

Management determined that the primary reason for the inventory overstatement was a result of the improper shop floor practice and management of aged open work orders. It was determined that aged partial work orders remained open for extended periods of time in the Chihuahua, Mexico plant due to new employees hired in late 2012 and early 2013 who were not properly trained. Initially, management believed it possible to allocate the loss to specific prior quarters beginning with the fiscal 2012 fourth quarter based on the dates on the aged open work orders. However, based on additional analysis, management subsequently concluded that the loss could not be specifically allocated to prior periods as it was determined that the work order dates were not a reliable measure to determine the timing of the loss due to the lack of integrity of the work orders and as a result the entire adjustment was recorded in the fourth quarter of 2013 as it was quantified during the physical inventory count.

23 --------------------------------------------------------------------------------Developments in the year ended December 29, 2013 For the year ended December 29, 2013 ("fiscal 2013") revenue decreased $25.6 million, or 8.6%, from $296.3 million for the year ended December 30, 2012 ("fiscal 2012") to $270.7 million. The majority of the decrease in revenue was due to decreased volumes with three long standing customers of approximately $15.6 million in addition to two customer disengagements as a result of the Markham production facility closure at the end of the second quarter of 2013 resulting in additional reduced revenues of $10.6 million.

In fiscal 2013 a $7.7 million loss before income taxes was incurred compared to earnings before income taxes of $5.7 million in fiscal 2012. The decrease was mainly due to a number of charges incurred during 2013 that were not incurred in prior years related to inventory provisions and write downs in addition to decreased revenue levels and the resulting impact on the ability to cover fixed costs. Gross margin percentage declined mainly due to a physical inventory count adjustment recorded in the fourth quarter of 2013 in addition to inefficiency of labor, and an unrealized foreign exchange loss in the current year compared to a gain in prior year.

In fiscal 2013, the Company recorded restructuring charges of $2.0 million, consisting of severance costs of $1.7 million and facility exit costs of $0.3 million. The severance charges related to the remaining Markham employees and reductions in full-time equivalents (FTEs) in Mexico and San Jose. The additional facility exit costs related to the final settlement on the ZF lease facility.

The Company violated one of its bank covenants with PNC as of December 29, 2013.

Subsequent to December 29, 2013, the Company secured a waiver to the lending agreement covering the event of default. In addition, the Company and its lender have amended the lending agreement and management believes that the Company will be in compliance with these covenants for the foreseeable future. Continued compliance with its covenants, however, is dependent on the Company achieving certain forecasts. While management is confident in its plans, market conditions have been difficult to predict and there is no assurance that the Company will achieve its forecasts.

The Company generated cash from operations of $2.9 million. The PNC facility provided additional cash of $7.3 million, which was offset by the pay down of the EDC term facility of $4.6 million which was paid off in full in the fourth quarter of 2013, principal payments of capital leases of $2.2 million and contingent consideration payments of $1.1 million.

24-------------------------------------------------------------------------------- Results of Operations The following table sets forth certain operating data expressed as a percentage of revenue for the fiscal periods ended: December 29, December 30, 2013 2012 January 1, 2012 Revenue 100.0 % 100.0 % 100.0 % Cost of sales 94.3 % 91.1 % 90.3 % Gross profit 5.7 % 8.9 % 9.7 % Selling, general and administrative expenses 7.1 % 5.9 % 6.7 % Restructuring charges 0.7 % 0.7 % 1.2 % Loss (gain) on contingent consideration 0.1 % (0.2 )% - Loss on extinguishment of debt - - 0.1 % Gain on disposal of capital assets (0.1 )% - - Other charges - - 0.1 % Operating earnings (loss) (2.2 )% 2.5 % 1.6 % Interest expense 0.6 % 0.7 % 0.7 % Earnings (loss) before income taxes (2.8 )% 1.8 % 0.9 % Income tax (recovery) expense Current 0.4 % 0.1 % 0.3 % Deferred 1.2 % (0.8 )% 0.1 % 1.6 % (0.7 )% 0.4 % Net earnings (loss) (4.4 )% 2.5 % 0.5 % Fiscal period ended December 29, 2013 compared to the fiscal period ended December 30, 2012 Revenue Our contractual arrangements with our key customers generally provide a framework for our overall relationship with our customers. Revenue from the sale of products is recognized when goods are shipped to customers and title has passed to the customer, persuasive evidence of an arrangement exists, performance has occurred, all customer-specified test criteria have been met and the earnings process is complete. Actual production volumes are based on purchase orders for the delivery of products. Typically, these orders do not commit to firm production schedules for more than 30 to 90 days in advance. To minimize inventory risk, we generally order materials and components only to the extent necessary to satisfy existing customer forecasts or purchase orders.

Fluctuations in material costs typically are passed through to customers. We may agree, upon request from our customers, to temporarily delay shipments, which causes a corresponding delay in our revenue recognition. The Company also derives revenue from engineering and design services. Service revenue is recognized as services are performed.

For the year ended December 29, 2013 ("fiscal 2013") revenue decreased $25.6 million, or 8.6%, from $296.3 million for the year ended December 30, 2012 ("fiscal 2012") to $270.7 million. The majority of the decrease in revenue was due to decreased volumes with three long standing customers totalling approximately $15.6 million in addition to two customer disengagements as a result of the Markham production facility closure at the end of the second quarter of 2013 resulting in additional reduced revenues of $10.6 million.

During fiscal 2013, revenue from the industrial sector represented 77.6% of revenue compared to 80.0% of revenue in fiscal 2012. Revenue from the industrial sector decreased by $27.0 million or 11.4% mainly due to the reduced volumes with four customers in addition to one of the customer disengagements related to the Markham production facility closure. Revenue from the networking and enterprise computing sector in fiscal 2013 increased compared to fiscal 2012 by $3.0 million mainly due to increase in revenue of two customers partially offset by a decrease in revenue with one customer. The percentage of revenue attributable to the network and enterprise sector increased $2.9 million or 12.0% during fiscal 2013 from 8.4% during fiscal 2012. Revenue from the communications sector decreased by $2.8 million or 13.8% in fiscal 2013 mainly due to decreased revenue of one customer and one customer disengagement as a result of the Markham production facility closure, slightly offset by a increases in revenue from other customers in this sector. The percentage of revenue attributable to the communications sector decreased to 6.5% during fiscal 2013 from 6.9% in fiscal 2012. Revenue for the medical sector increased by $1.2 million in fiscal 2013 to $15.1 million, compared to $13.9 million in fiscal 2012 mainly due to an increase in revenue from one customer. The percentage of revenue attributable to the medical sector increased to 5.6% during fiscal 2013 from 4.7% during fiscal 2012 due to the increased revenue and reduction in the industrial sector.

During fiscal 2013, the Company recorded approximately $6.0 million of sales of raw materials inventory to customers, which carried no margin, compared to $6.7 million in fiscal 2012. The Company purchases raw materials based on customer purchase orders. To the extent 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.

25-------------------------------------------------------------------------------- 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 vary from year to year. The Company's ten largest customers represented 89.4% of revenue during fiscal 2013, compared to 88.4% in fiscal 2012. Revenue from our two largest customers during fiscal 2013 was $102.6 million and $31.2 million, representing 37.9% and 11.5% of revenue for fiscal 2013, respectively. This compares with revenue from the same two customers during fiscal 2012 of $106.0 million $36.9 million, representing 35.8%, and 12.4% of revenue for fiscal 2012, respectively. No other customer represented more than 10% of revenue in either year.

During fiscal 2013, 66.9% of our revenue was attributable to our operations in Mexico, 19.2% in Asia, 10.0% in the US and 3.9% in Canada. During fiscal 2012, 61.8% of our revenue was attributable to our operations in Mexico, 14.4% in Asia, 13.7% in the US and 10.1% in Canada.

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 a decline in revenue 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, or lose customers, we could experience declines in revenue.

Gross Profit Gross profit decreased to $15.4 million in fiscal 2013 from $26.5 million in fiscal 2012 due to the decrease of revenue levels and the resulting impact on the ability to cover fixed costs and unfavorable foreign exchange rates on outstanding Canadian dollar and Mexican peso forward exchange contracts compared to the same period in 2012. This was partially offset by the closure of the Markham production facility in June 2013 which had incurred losses, as well as improved margins earned in Asia which were offset by reduced margins in Mexico.

The reduced margins in Mexico in 2013 were primarily the result of higher direct and variable labor charges as a percentage of revenues compared to 2012. As a result, manufacturing operations in Mexico were not as efficient as in fiscal 2012. In addition, there were additional charges of $1.3 million relating to material adjustments based on inventory cycle count results performed during the year, an adjustment for scrap inventory and an increase to the inventory reserve due to changes in estimates of recoverable amounts. In addition there was a charge of $3.2 million in the fourth quarter of 2013 made up of $2.3 million based on the full physical inventory count results at the Mexico facility and a remaining charge of $0.9 million related to write down of spare parts inventory, capitalized labor and overhead charged due to lower WIP levels as a result of the count variance and write downs of inventory due to purchasing errors with two customers, whereby inventory was purchased in excess of customer demand. As a percentage of revenue gross profit decreased by 36.5% to 5.7% in fiscal 2013 compared to 8.9% in fiscal 2012 as a result of the above noted items.

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.

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 in earnings in the consolidated statement of operations and comprehensive income. Included in cost of sales in fiscal 2013 was an unrealized loss recognized as a result of revaluing the instruments to fair value of $1.0 million, and a realized gain of $0.5 million. During fiscal 2012, an unrealized gain was recognized as a result of revaluing the instruments to fair value of $0.6 million, and a realized gain of $0.7 million.

Selling, General & Administrative Expenses Selling, general and administrative expenses increased from $17.3 million in fiscal 2012 to $19.2 million in fiscal 2013, and increased as a percentage of revenue from 5.8% for fiscal 2012 to 7.1% of revenue for fiscal 2013. The increase in fiscal 2013 was mainly due to charges of $1.2 million incurred during 2013 including executive severance and executive recruiting charges totaling $0.6 million and lease exit costs of $0.4 million. Other increases were attributed to interim executive management services not incurred in the prior year, and increased information technology charges.

Sale of Property, Plant and Equipment In fiscal 2013, certain equipment was sold for proceeds which generated a gain on the sale of $0.1 million. This was due in part to closure of the Markham production facility which resulted in a gain on the sale of select pieces of equipment as well as a gain on the sale of equipment in Mexico. There were no sales of property, plant and equipment during 2012.

26 -------------------------------------------------------------------------------- Restructuring Charges Total restructuring charges of $2.0 million were incurred in 2013 compared to $2.2 million in 2012. Included in the charges was $1.4 million of additional severance charges related to the Markham production facility closure in Q2 2013.

In addition, $0.3 million of additional facility exit costs was incurred related to the ZF lease facility whereby a settlement was reached during fiscal 2013. A 2013 plan was approved that impacted approximately 89 FTEs in the Mexico and San Jose facilities which resulted in additional severance charges of $0.3 million recorded during the fourth quarter of 2013.

Contingent consideration Upon the acquisition of ZF Array on August 31, 2011, the Company paid $4 million in cash, less cash acquired of $0.9 million and accrued $2.4 million for contingent consideration. Contingent consideration is based on financial performance of the acquired company's operations for a 24-month period following the acquisition date, to a maximum of $2.4 million. Based on the results to date in fiscal 2013, the final year of the contingent consideration period, the fair value of the contingent consideration liability was increased during fiscal 2013 resulting in recognition of a loss of $0.3 million ($0.7 million gain in 2012).

The final payment was made in the fourth quarter of 2013.

Interest Expense Interest expense decreased by $0.3 million, from $2.0 million in fiscal 2012 to $1.7 million in fiscal 2013. Included in interest expense is amortization of deferred financing fees of $0.4 million for fiscal 2013, compared to $0.4 million in fiscal 2012.

Although interest rates on the Company's outstanding indebtedness were higher in 2013 compared to 2012, interest expense decreased in fiscal 2013 due to lower average debt levels. The weighted average interest rates with respect to the debt were 3.7% and 3.3%, for the periods ended December 29, 2013 and December 30, 2012, respectively.

Income Tax Expense The net tax expense for fiscal 2013 of $4.2 million is due to $0.9 million of taxes in Mexico and China. In addition a $4.0 million valuation allowance was recorded against the deferred tax asset. These charges were partially offset by $0.7 million of deferred tax recovery primarily related to revised tax legislation in Mexico. 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, ("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. The Canadian jurisdiction continues to have a full valuation allowance recorded against the deferred tax assets.

At December 29, 2013, the Company had total net operating loss carry forwards of $88.2 million, of which $10.2 million will expire in 2014, $4.1 million will expire in 2015, $1.1 million will expire in 2018, $20.6 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, and the remainder will expire between 2029 and 2033.

27--------------------------------------------------------------------------------Fiscal period ended December 30, 2012 compared to the fiscal period ended January 1, 2012 Revenue Revenue increased by $75.9 million, or 34.5%, from $220.4 million for fiscal 2011 to $296.3 million for fiscal 2012. The majority of the increase in revenue was due to increased orders from two of the Company's long standing customers, combined with having a full year of revenue from the customers acquired in the ZF Array acquisition on August 31, 2011, compared to 4 months in 2011.

During fiscal 2012, revenue from the industrial sector represented 80.0% of revenue compared to 73.1% of revenue in fiscal 2012. Revenue from the industrial sector increased by $75.8 million or 47.1% mainly due to the two long standing customers described above. Revenue from the networking and enterprise computing sector in fiscal 2012 decreased compared to fiscal 2011 by $6.2 million mainly due to decreases in revenue of three customers. The percentage of revenue attributable to the network and enterprise sector decreased to 8.4% during fiscal 2012 from 14.2% during fiscal 2011. Revenue from the communications sector increased by $4.4 million or 27.3% in fiscal 2013 mainly due to an increase in revenue of one customer, slightly offset by a decrease in revenue from one customer in this sector. The percentage of revenue attributable to the communications sector decreased to 6.9% during fiscal 2012 from 7.3% during fiscal 2011 due to the greater percentage increase in the industrial sector.

Revenue for the medical sector increased by $1.9 million in fiscal 2012 to $13.9 million, compared to $12.0 million in fiscal 2011 due to an increase in revenue from one customer. However, the percentage of revenue attributable to the medical sector decreased to 4.7% during fiscal 2012 from 5.4% during fiscal 2011 due to the greater percentage increase in the industrial sector.

During fiscal 2012, the Company recorded approximately $6.7 million of sales of raw materials inventory to customers, which carried no margin, compared to $4.7 million in fiscal 2011. The Company purchases raw materials based on customer purchase orders. To the extent 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.

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 vary from year to year. The Company's ten largest customers represented 88.4% of revenue during fiscal 2012, compared to 79.4% in fiscal 2011. Revenue from our two largest customers during fiscal 2012 was $106.0 million and $36.9 million, representing 35.8% and 12.4% of revenue for fiscal 2012, respectively. This compares with revenue from our three largest customers during fiscal 2011 was $48.1 million, $23.3 million and $22.5 million, representing 21.8%, 10.6% and 10.2% of revenue for fiscal 20121, respectively.

No other customer represented more than 10% of revenue in either year.

During fiscal 2012, 61.8% of our revenue was attributable to our operations in Mexico, 14.4% in Asia, 13.7% in the US and 10.1% in Canada. During fiscal 2011, 57.5% of our revenue was attributable to our operations in Mexico, 17.2% in Asia, 14.3% in Canada and 11.0% 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 a decline in revenue 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, or lose customers we could experience declines in revenue.

Gross Profit Gross profit increased to $26.5 million in fiscal 2012 from $21.3 million in fiscal 2011 due to the increase in revenue levels. However as a percentage of revenue gross profit decreased by 0.8% to 8.9% in fiscal 2012 compared to 9.7% in fiscal 2011. The decrease in gross margin percentage was due to an increase in cost of materials and an inefficiency of labor, slightly offset by realized and unrealized foreign exchange gains.

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 in net income in the consolidated statement of operations and comprehensive income. Included in cost of sales in fiscal 2012 was an unrealized gain recognized as a result of revaluing the instruments to fair value of $0.6 million, and a realized gain of $0.7 million. During fiscal 2011, an unrealized loss was recognized as a result of revaluing the instruments to fair value of $0.1 million, and a realized gain of $0.1 million.

28 --------------------------------------------------------------------------------Selling, General & Administrative Expenses Selling, general and administrative expenses increased from $14.8 million in fiscal 2011 to $17.3 million in fiscal 2012, however decreased as a percentage of revenue from 6.7% for fiscal 2011 to 5.8% of revenue for fiscal 2012. The increase in fiscal 2012 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 for a full year, the increase in headcount to support the new Dongguan site and increased travel expenses to generate additional revenue.

The Company determines the allowance for doubtful accounts for estimated credit losses based on the length of time the accounts receivable have been outstanding, customer and industry concentrations, the current business environment and historical experience.

Restructuring Charges During the first quarter 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 $0.5 million, consisting of severance costs of $0.2 million and facility exit costs of $0.3 million.

Staff levels were reduced by approximately 16 full-time equivalents. During the fourth quarter of 2012, the Company announced that the closure of the Markham facility will occur in the second quarter of 2013 and recorded severance restructuring charges of $1.8 million, impacting approximately 197 full-time equivalents.

During fiscal 2011, the Company recorded restructuring charges of $2.7 million, consisting largely of severance charges of $0.6 million in the Mexican segment, $2.0 million in the Canadian segment, and $0.1 million in the U.S. segment and reduced staff levels by 241, 150 and 1 in each segment respectively, in response to expected lower revenues in the year.

Acquisition Costs There were no acquisition charges in fiscal 2012.

In fiscal 2011 the Company acquired 100% of the outstanding common shares of ZF Array, a privately held electronics manufacturing services provider based in San Jose, California. The purchase price was $6.4 million, of which $2.4 million was composed of a 2-year performance based earn out. Acquisition costs related to this purchase were $0.1 million.

Contingent consideration Upon the acquisition of ZF Array on August 31, 2011, the Company paid $4 million in cash; less cash acquired of $967 and accrued $2.4 million for contingent consideration. Contingent consideration is based on financial performance of the acquired company's operations for a 24-month period following the acquisition date, to a maximum of $2.4 million. Based on the results to date and anticipated future performance it is evident that the maximum amount will not be earned; fair value of the contingent consideration liability was reduced during fiscal 2012 resulting in recognition of a gain of $650.

Interest Expense Interest expense increased by $0.5 million, from $1.5 million in fiscal 2011 to $2.0 million in fiscal 2012. Included in interest expense is amortization of deferred financing fees of $0.4 million for fiscal 2012, compared to $0.3 million in fiscal 2011.

Interest expense increased in fiscal 2013 due to higher average debt levels to support the increase in working capital required for the increased revenue compared to fiscal 2012. The weighted average interest rates with respect to the debt were 3.3% and 3.6%, for the periods ended December 30, 2012 and January 1, 2012, respectively.

Income Tax Expense The net tax recovery for fiscal 2012 of $1.8 million is due to a $2.4 million deferred tax recovery primarily related to a release of valuation allowance associated with deferred tax assets in the U.S., offset by minimum taxes in Mexico.

29 -------------------------------------------------------------------------------- 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 Accounting Standards Codification ("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. 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 and 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 no valuation allowance has been recorded against these deferred tax assets. The Canadian jurisdiction continues to have a full valuation allowance recorded against the deferred tax assets.

At December 30, 2012, the Company had total net operating loss carry forwards of $79.9 million, of which $2.8 million will expire in 2013, $10.3 million will expire in 2014, $4.2 million will expire in 2015, $1.1 million will expire in 2018, $0.1 million will expire in 2019, $0.1 million will expire in 2020, $18.3 million will expire in 2023, and the remainder will expire between 2026 and 2031.

Liquidity and Capital Resources Our principal sources of liquidity are cash provided from operations and borrowings under the PNC facility which expires in January 2, 2015. The Company violated a covenant as of December 29, 2013. Subsequent to December 29, 2013, the Company secured a waiver covering this violation. Our principal uses of cash have been to meet debt service requirements, pay down debt and invest in capital expenditures and to finance working capital requirements. In the future, cash may also be used for acquisitions.

The following table summarizes cash flow changes for the following periods: Period ended Period ended Period ended December 29, 2013 December 30, 2012 January 1, 2012Cash provided by (used in): Operating activities $ 2.9 $ 9.9 $ 2.0 Financing activities 0.4 (4.0 ) 3.6 Investing activities (2.2 ) (6.3 ) (3.9 ) Increase (decrease) in cash and cash equivalents 1.1 (0.4 ) 1.7 Cash, beginning of year 2.2 2.6 0.9 Cash, end of the year $ 3.3 $ 2.2 $ 2.6 Fiscal 2013 Net cash provided by operating activities for fiscal 2013 was $2.9 million. The source of cash mainly resulted from decreases in inventory and accounts receivable offset by reductions in accounts payable and accrued liabilities.

Accounts receivable days sales outstanding for fiscal 2013 decreased to 41 days compared to 44 days for fiscal 2012 due to quicker collection in fiscal 2013.

Inventory turnover on an annualized basis increased to seven times in fiscal 2013 compared to five times in fiscal 2012. This was due to better inventory management in fiscal 2013 over 2012. Accounts payable days outstanding for fiscal 2013 dropped to 47 days versus 66 days for fiscal 2012. The reduction is a function of reduced inventory levels, which in turn reduced vendor payables and required quicker pay down of outstanding payables.

Net cash provided from financing activities during fiscal 2013 was $0.4 million, consisting of the repayment of the EDC term facility of $4.6 million, principal payments of capital lease obligations of $2.2 million and payment of contingent consideration of $1.1 million. These were offset by an increase in revolving debt of $7.3 million, proceeds from issuance of common stock of $0.1 million and proceeds from a sale and leaseback of $1.0 million.

Cash used in investing activities for fiscal 2013 of $2.2 million was for purchases of machinery and equipment of $2.6 million which was partially offset by proceeds from the sale of capital assets of $0.4 million.

30 -------------------------------------------------------------------------------- Fiscal 2012 Net cash provided by operating activities for fiscal 2012 was $9.9 million. The source of cash mainly resulted from income from operations, decreases in accounts receivable and increases in accounts payable offset by an increases in inventory. Accounts receivable days sales outstanding for fiscal 2012 decreased to 44 days compared to 49 days for fiscal 2011 due to quicker collection in fiscal 2012. Inventory turnover on an annualized basis remained consistent at 5 times for both fiscal 2012 and fiscal 2011. Accounts payable days outstanding for fiscal 2012 remained consistent with fiscal 2011 at 66 days compared to 67 days in fiscal 2011.

Net cash used in financing activities during fiscal 2012 was $4.0 million, consisting of repayment of long term debt of $2.2 million, principal payments of capital lease obligations of $1.7 million, and payment of contingent consideration for the ZF Array purchase of $1.0 million. These were partially offset by an increase in revolving debt of $0.4 million, proceeds from issuance of common stock of $0.2 million and proceeds from a sale and leaseback of $0.2 million.

Net cash used in investing activities for fiscal 2012 of $6.3 million was for purchases of machinery and equipment.

Capital Resources The Company borrows money under a Revolving Credit and Security Agreement with PNC Bank, National Association and its Canadian branch (collectively, "PNC").

This revolving credit facility (the "PNC Facility") has a term of three years, but subsequent to December 29, 2013 the term of the PNC facility was extended to January 2, 2015. The term debt facility with Export Development Canada ("EDC", and the "EDC Facility") was fully paid on October 1, 2013. Advances made under the U.S. revolving PNC Facility bear interest at the U.S. base rate plus 1.75%.

Advances made under the Canadian revolving PNC Facility denominated in Canadian dollars bear interest at the Canadian base rate plus 1.75%. For advances made under the Canadian facility denominated in U.S. dollars, interest will be charged at the U.S. base rate plus 1.75%. The base commercial lending rate of each respective country of borrowing should approximate prime rate. The Company violated certain of its bank covenants under the PNC facility as of December 29, 2013. Subsequent to December 29, 2013, the Company secured a waiver covering the event of default. In addition, the Company and PNC have amended the lending agreement, however continued compliance with its covenants is dependent on the Company achieving certain forecasts. While management is confident in its plans, market conditions have been difficult to predict and there is no assurance that the Company will achieve its forecasts.

We believe that cash generated from operations, available cash and amounts available under our PNC Facility and additional financing sources such as leasing companies and other lenders will be adequate to meet our debt service requirements, capital expenditures and working capital needs at our current level of operations for at least the next 12 months, although no assurance can be given in this regard, particularly with respect to amounts available from lenders. 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, there can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available to enable us to service our indebtedness. Our future operating performance and ability to service indebtedness will be subject to future economic conditions and to financial, business and other factors, certain of which are beyond our control.

During 2013, there were $1.4 million of additions of property, plant and equipment acquired via capital leases.

31 --------------------------------------------------------------------------------As at December 29, 2013, contractual repayments due within each of the next five years and thereafter are as follows: (in US$ millions) 2014 2015 2016 2017 2018 Thereafter Total Revolving credit facility(1) $ 20.2 $ - $ - $ - $ - $ - $ 20.2 Capital lease obligations 1.6 0.5 - - - - 2.1 Operating lease obligations 2.1 1.9 1.9 0.6 0.6 0.2 7.3 Purchase obligations - - - - - - - Total $ 23.9 $ 2.4 $ 1.9 $ 0.6 $ 0.6 $ 0.2 $ 29.6 In the normal course of business, we may be subject to litigation and claims from customers, suppliers and former employees. We believe that adequate provisions have been recorded in the accounts, where required. We do not believe that it is reasonably possible that a loss exceeding the amounts already recognized may have been incurred that would be material. Although it is not possible to estimate the extent of potential costs, if any, management believes that ultimate resolution of such contingencies would not have an adverse effect on our financial position, results of operations or cash flows.

(1) The revolving credit facility matures in January 2, 2015, and is classified as a current liability in the consolidated balance sheet.

Accounting changes and recent accounting pronouncements Please refer to Note 2 of the accompanying consolidated financial statements.

Critical Accounting Estimates The preparation of financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Note 2 to the consolidated financial statements describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. The following critical accounting policies are affected significantly by judgments, assumptions and estimates used in the preparation of financial statements. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Allowance for Doubtful Accounts We evaluate the collectability of accounts receivable and record an allowance for doubtful accounts, which reduces the accounts receivable to the amount we reasonably believe will be collected. A specific allowance is recorded against customer accounts receivable that are considered to be impaired based on our knowledge of the financial condition of our customers. In determining the amount of the allowance, we consider factors such as the length of time the accounts receivable have been outstanding, customer and industry concentrations, the current business environment and historical experience.

Inventory Valuation Inventories are valued, on a first-in, first-out basis, at the lower of cost and replacement cost for raw materials and at the lower of cost and net realizable value for work in progress and finished goods. Inventories include an application of relevant overhead. We write down estimated obsolete or excess inventory for the difference between the cost of inventory and estimated net 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 inventory to customers or return to suppliers. Customers are liable for inventory orders in compliance with the backlog and forecasts with SMTC, plus additional material to provision for minimum order quantity or fixed lot multiples. If these assumptions change, additional write-downs may be required.

Long-lived Assets We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with subtopic 10 of ASC 360, "Property, Plant and Equipment". Under ASC 360-10 assets must be classified as either held-for-use or held-for-sale. An impairment loss is recognized when the carrying amount of an asset that is held and used exceeds the projected undiscounted future net cash flows expected from its use and disposal, and is measured as the amount by which the carrying amount of the asset exceeds its fair value, which is measured by discounted cash flows when quoted market prices are not available. For assets held-for-sale, an impairment loss is recognized when the carrying amount exceeds fair value less costs to sell.

Income Tax Valuation Allowance In assessing the realization of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Guidance under 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. Based upon consideration of these factors, management believes the recorded valuation allowance related to all of its deferred tax assets arising in Canada and a portion of its deferred tax assets arising in the United States and Mexico is appropriate.

32--------------------------------------------------------------------------------

[ Back To Technology News's Homepage ]

OTHER NEWS PROVIDERS







Technology Marketing Corporation

800 Connecticut Ave, 1st Floor East, Norwalk, CT 06854 USA
Ph: 800-243-6002, 203-852-6800
Fx: 203-866-3326

General comments: tmc@tmcnet.com.
Comments about this site: webmaster@tmcnet.com.

STAY CURRENT YOUR WAY

© 2014 Technology Marketing Corporation. All rights reserved | Privacy Policy