Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated condensed financial statements and the related notes and the other financial information included in this Quarterly Report on Form 10-Q. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of specified factors, including those set forth in Item 1A “Risk Factors” of Part II below and elsewhere in this Quarterly Report on Form 10-Q. This discussion and analysis should also be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in our Annual Report on Form 10-K for the fiscal year ended December 30, 2019, filed with the SEC.
COMPANY OVERVIEW
We are a leading global printed circuit board (PCB) manufacturer, focusing on quick-turn and volume production of technologically advanced PCBs and backplane assemblies as well as a global designer and manufacturer of high-frequency radio frequency (RF) and microwave components and assemblies. We focus on providing time-to-market and volume production of advanced technology products and offer a one-stop design, engineering and manufacturing solution to our customers. This one-stop design, engineering and manufacturing solution allows us to align technology development with the diverse needs of our customers and to enable them to reduce the time required to develop new products and bring them to market. We serve a diversified customer base consisting of approximately 1,200 customers in various markets throughout the world, including aerospace and defense, computing, automotive components, medical, industrial and instrumentation related products, as well as networking/communications infrastructure products. Our customers include both original equipment manufacturers (OEMs) and electronic manufacturing services (EMS) providers.
RECENT DEVELOPMENTS
The recent coronavirus (COVID-19) pandemic first caused some business disruption in our operations in China beginning in January 2020. By March 2020, the situation escalated as the scope of the COVID-19 pandemic worsened outside of the Asia-Pacific region, with Europe and North America being affected by the pandemic. There is significant uncertainty relating to the potential impacts of the COVID-19 pandemic, and we cannot reasonably estimate its duration or severity. The COVID-19 pandemic creates various global macroeconomic, customer demand, operational and supply chain risks any one of which could have a material and adverse impact on our business going forward. See Item 1A, Risk Factors , of Part II below for further information related to the COVID-19 pandemic. We have taken measures to protect our employees, suppliers and customers by implementing our pandemic recovery protocols, establishing situational leadership teams in Asia-Pacific and North America along with regularly scheduled executive review and planning calls, implementing global travel restrictions, and conforming to the guidance and direction of local governments and global health organizations. We are monitoring the impacts the COVID-19 pandemic has had, and continues to have, on our supply chain and are collaborating with our third-party partners with the goal of mitigating, to the extent reasonably practicable, significant delays in delivery of our products.
FINANCIAL OVERVIEW
On April 17, 2020, we completed the sale of our Mobility business unit for a final purchase price of $569.2 million, received proceeds from the sale, net of cash disposed of $507.5 million, and recorded a gain on sale before income taxes of $237.3 million. Results related to our Mobility business unit are reported as discontinued operations for all periods presented. See Part I, Item 1, Note 2, Discontinued Operations , of the Notes to Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q for further information. Unless otherwise noted, amounts and disclosures throughout our Management’s Discussion and Analysis of Financial Condition and Results of Operations relate to our continuing operations.
While our customers include both OEMs and EMS providers, we measure customers based on OEM companies, as they are the ultimate end customers. Sales to our ten largest customers accounted for 40% and 38% of our net sales for the quarter and three quarters ended September 28, 2020, respectively. Sales to our ten largest customers accounted for 39% and 41% of our net sales for the quarter and three quarters ended September 30, 2019, respectively. We sell to OEMs both directly and indirectly through EMS providers.
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The following table shows the percentage of our net sales attributable to each of the principal end markets we served for the periods indicated:
Quarter Ended
Three Quarters Ended
End Markets (1)
September 28, 2020
September 30, 2019
September 28, 2020
September 30, 2019
Aerospace and Defense
36
%
32
%
35
%
32
%
Automotive
14
21
14
19
Cellular Phone
—
—
—
—
Computing/Storage/Peripherals
12
11
12
11
Medical/Industrial/Instrumentation
19
17
19
17
Networking/Communications
17
17
18
19
Other (2)
2
2
2
2
Total
100
%
100
%
100
%
100
%
(1)
Sales to EMS companies are classified by the end markets of their OEM customers.
(2)
Other consumer devices that include wearables, portable video devices and personal headphones are included in the Other end market.
We derive revenues primarily from the sale of PCBs, custom electronic assemblies using customer-supplied engineering and design plans as well as our long-term contracts related to the design and manufacture of RF and microwave components, assemblies and subsystems. Orders for products generally correspond to the production schedules of our customers and are supported with firm purchase orders. Our customers have continuous control of the work in progress and finished goods throughout the PCB and custom electronic assemblies manufacturing process, as these are built to customer specifications with no alternative use, and there is an enforceable right of payment for work performed to date. As a result, we recognize revenue progressively over time based on the extent of progress towards completion of the performance obligation. We recognize revenue based on the cost-to-cost method as it best depicts the transfer of control to the customer which takes place as we incur costs. Under the cost-to-cost measure of progress, the extent of progress toward completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues are recorded proportionally as costs are incurred.
We also manufacture certain components, assemblies, and subsystems which service our RF and Specialty Components (RF&S Components) customers. We recognize revenue at a point in time upon transfer of control of the products to our customer. Point in time recognition was determined as our customers do not simultaneously receive or consume the benefits provided by our performance and the asset being manufactured has alternative uses to us.
Net sales consist of gross sales less an allowance for returns, which typically have been approximately 2% of gross sales. We provide our customers a limited right of return for defective PCBs including components, subsystems and assemblies. We record an estimate for sales returns and allowances at the time of sale based on historical results and anticipated returns.
Cost of goods sold consists of materials, labor, outside services, and overhead expenses incurred in the manufacture and testing of our products. Shipping and handling fees and related freight costs and supplies associated with shipping products are also included as a component of cost of goods sold. Many factors affect our gross margin, including capacity utilization, product mix, production volume, and yield. While we have entered into supply assurance agreements with some of our key suppliers to maintain the continuity of supply of some of the key materials we use, we generally do not participate in any significant long-term contracts with suppliers, and we believe there are a number of potential suppliers for most of the raw materials we use.
Selling and marketing expenses consist primarily of salaries, labor related benefits, and commissions paid to our internal sales force, independent sales representatives, and our sales support staff, as well as costs associated with marketing materials and trade shows.
General and administrative costs primarily include the salaries for executive, finance, accounting, information technology, facilities, and human resources personnel, as well as expenses for restructuring, accounting, legal assistance and incentive compensation expense, and gains or losses on the sale or disposal of property, plant and equipment.
Research and development expenses consist primarily of salaries and labor related benefits paid to our research and development staff, as well as material costs.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated condensed financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales and expenses, and related disclosure of contingent assets and liabilities.
See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , in our Annual Report on Form 10-K for the fiscal year ended December 30, 2019 for further discussion of critical accounting policies and estimates. There were no material changes to our critical accounting policies and estimates since December 30, 2019, except for the estimates used in
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the quantitative goodwill impairment analysis performed as of September 28, 2020 . See Part I, Item 1, Note 6, Goodwill , of the Notes to Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q for further information .
RESULTS OF OPERATIONS
The following table sets forth the relationship of various items to net sales in our consolidated condensed statements of operations:
Quarter Ended
Three Quarters Ended
September 28, 2020
September 30, 2019
September 28, 2020
September 30, 2019
Net sales
100.0
%
100.0
%
100.0
%
100.0
%
Cost of goods sold
82.6
84.0
82.9
82.7
Gross profit
17.4
16.0
17.1
17.3
Operating expenses:
Selling and marketing
3.1
3.2
3.0
3.2
General and administrative
5.7
6.2
7.0
6.0
Research and development
1.0
0.8
0.9
0.8
Amortization of definite-lived intangibles
2.0
1.8
1.8
2.3
Impairment of goodwill
13.4
—
4.4
—
Total operating expenses
25.2
12.0
17.1
12.3
Operating (loss) income
(7.8
)
4.0
—
5.0
Other (expense) income:
Interest expense
(3.9
)
(3.8
)
(3.7
)
(3.9
)
Other, net
(0.5
)
1.0
—
0.5
Total other expense, net
(4.4
)
(2.8
)
(3.7
)
(3.4
)
(Loss) income from continuing operations before income taxes
(12.2
)
1.2
(3.7
)
1.6
Income tax benefit (provision)
0.3
(0.8
)
0.2
(0.3
)
Net (loss) income from continuing operations
(11.9
)
%
0.4
%
(3.5
)
%
1.3
%
During the quarter ended September 28, 2020, our RF&S Components operating segment met the quantitative threshold for separate presentation of a reportable segment. In prior periods, we had two reportable segments: PCB and E-M Solutions. The RF&S Components reportable segment was previously aggregated with the PCB reportable segment. The PCB reportable segment is comprised of multiple operating segments. Factors considered in determining whether operating segments can be aggregated into reportable segments included similarity regarding economic characteristics, products, production process, type or class of customers, distribution methods and regulatory environments.
Net Sales
Total net sales decreased $20.6 million, or 3.9%, to $513.6 million for the third quarter of 2020 from $534.2 million for the third quarter of 2019. This decrease primarily resulted from a decrease in net sales for the E-M Solutions reportable segment of $29.5 million, or 43.6%, to $38.2 million for the third quarter of 2020 from $67.7 million for the third quarter of 2019 primarily due to winding down of this reportable segment and lower demand in our Automotive end market. Also contributing to this decrease in total net sales was a decrease in net sales for the RF&S Components reportable segment of $1.9 million, or 13.9%, to $11.7 million for the third quarter of 2020 from $13.6 million for the third quarter of 2019 primarily due to lower demand in our Networking/Communications end market. The decrease in total net sales was partially offset by an increase in net sales for the PCB reportable segment of $10.8 million, or 2.4%, to $463.7 million for the third quarter of 2020 from $452.8 million for the third quarter of 2019. The increase was primarily due to increased demand in our Aerospace and Defense, Medical/Industrial/Instrumentation, and Computing/Storage/Peripherals end markets, partially offset by lower demand in our Automotive end market. In addition, these changes in the PCB reportable segment resulted in an increase in the average price per square foot of 13.3%, driven mainly by product mix shift. The resulting increase in net sales, however, was partially offset by a 4.4% decrease in the volume of PCB shipments as compared to the third quarter of 2019.
Total net sales decreased $16.0 million, or 1.0%, to $1,581.5 million for the first three quarters of 2020 from $1,597.5 million for the first three quarters of 2019. This decrease primarily resulted from a decrease in net sales for the E-M Solutions reportable segment of $60.4 million, or 33.7%, to $118.6 million for the first three quarters of 2020 from $179.0 million for the first three quarters of 2019 primarily due to winding down of this reportable segment and lower demand in our Automotive end market. Also contributing to this decrease in total net sales was a decrease in net sales for the RF&S Components reportable segment of $18.5 million, or 35.7%, to $33.3 million for the first three quarters of 2020 from $51.7 million for the first three quarters of 2019 primarily due to a loss of a key customer in this reportable segment and coupled with the impact of COVID-19, resulted in lower demand in our Networking/Communications end market. The decrease in total net sales was partially offset by an increase in net sales for the
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PCB reportable segment of $ 62 . 9 million, or 4 . 6 %, to $ 1,4 29 . 6 million for the first three quarters of 2020 from $ 1, 366 . 8 million for the first t hree quarters of 2019. The increase was primarily due to increased demand in our Aerospace and Defense, Medical/Industrial/Instrumentation, and Computing/Storage/Peripherals end markets, partially offset by lower demand in our Automotive and Networking/Communications end market s . In addition, these changes in the PCB reportable segment resulted in an increase in the average price per square foot of 20 . 7 %, driven mainly by product mix shift . The resulting increase in net sales , however, was partially offset by a 14 . 2 % decrease in the volume of PCB shipments as compared to the first t hree quarters of 2019.
Gross Margin
Overall gross margin increased to 17.4% for the third quarter of 2020 from 16.0% for the third quarter of 2019. This increase was primarily driven by an increase in gross margin for the PCB reportable segment increased to 18.7% for the third quarter of 2020 from 16.7% for the third quarter of 2019, primarily due to higher volumes. Gross margin for the RF&S Components and E-M Solutions reportable segments decreased to 48.1% and 5.3%, respectively, for the third quarter of 2020 from 60.7% and 7.9%, respectively, for the third quarter of 2019, in each case primarily due to lower sales.
Overall gross margin decreased to 17.1% for the first three quarters of 2020 from 17.3% for the first three quarters of 2019. Gross margin for the PCB reportable segment increased to 18.8% for the first three quarters of 2020 from 17.6% for the first three quarters of 2019. However, the decrease in overall gross margin was primarily driven by the gross margin for the RF&S Components reportable segment, which decreased to 50.8% for the first three quarters of 2020 from 64.3% for the first three quarters of 2019, primarily due to lower sales. Furthermore, gross margin for the E-M Solutions reportable segment decreased to (0.2%) for the first three quarters of 2020 from 7.2% for the first three quarters of 2019, primarily due to lower sales and an additional provision for excess and obsolete inventories.
Capacity utilization is a key driver for us, which is measured by the actual production as a percentage of maximum capacity. This measure is particularly important in our high volume facilities in Asia, as a significant portion of our operating costs are fixed in nature. Capacity utilization for the third quarter of 2020 in our Asia and North America PCB facilities was 63% and 61%, respectively, compared to 60% and 58%, respectively, for the third quarter of 2019. Capacity utilization for the first three quarters of 2020 in our Asia and North America PCB facilities was 62% and 63%, respectively, compared to 61% and 60%, respectively for the first three quarters of 2019. The increase in capacity utilization in our Asia and North America PCB facilities was due to an increase in production related to increased sales in our Aerospace and Defense, Medical/Industrial/Instrumentation, and Computing/Storage/Peripherals end markets.
Selling and Marketing Expenses
Selling and marketing expenses decreased $1.3 million, to $15.9 million for the third quarter of 2020 from $17.2 million for the third quarter of 2019. As a percentage of net sales, selling and marketing expenses was 3.1% for the third quarter of 2020, as compared to 3.2% for the third quarter of 2019. The decrease in selling and marketing expense for the third quarter of 2020 was primarily due to reduced travel expense due to the COVID-19 pandemic, which has decreased travel on a temporary basis.
Selling and marketing expenses decreased $3.6 million, to $48.0 million for the first three quarters of 2020 from $51.6 million for the first three quarters of 2019. As a percentage of net sales, selling and marketing expenses was 3.0% for the first three quarters of 2020, as compared to 3.2% for the first three quarters of 2019. The decrease in selling and marketing expense for the first three quarters of 2020 was primarily due to reduced travel and commission expense.
General and Administrative Expenses
General and administrative expenses decreased $4.0 million to $29.1 million, or 5.7% of net sales, for the third quarter of 2020 from $33.1 million, or 6.2% of net sales, for the third quarter of 2019. This decrease was primarily due to a decrease in acquisition costs and supplies expense.
General and administrative expenses increased $15.2 million to $110.5 million, or 7.0% of net sales, for the first three quarters of 2020 from $95.3 million, or 6.0% of net sales, for the first three quarters of 2019. This increase was primarily due to the $14.7 million restructuring charges associated with the E-M Solutions business unit.
Impairment of Goodwill
During the third quarter of 2020, we performed an interim evaluation of goodwill as we believed there were impairment triggering events and circumstances that warranted an evaluation. These circumstances included a permanent loss of a key customer in the RF&S Components reporting unit that coupled with the impact of COVID-19, resulted in lower than anticipated results and continued decline in sales. As a result, we recorded a charge for the impairment of goodwill in the amount of $69.2 million in the third quarter of 2020.
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Other Expense
Other expense, net increased $7.8 million to $22.5 million for the third quarter of 2020 from $14.5 million for the third quarter of 2019. This increase was primarily the result of foreign currency losses in the current quarter due to the strengthening of the Chinese Renminbi (RMB) in the third quarter of 2020 compared to the third quarter of 2019. We utilize the RMB at our China facilities for employee-related expenses, RMB denominated purchases, and other costs of running our operations in China.
Other expense, net increased $4.3 million to $57.9 million for the first three quarters of 2020 from $53.6 million for the first three quarters of 2019. This increase was primarily the result of foreign currency losses due to the strengthening of the RMB in the first three quarters of 2020 compared to the first three quarters of 2019. The foreign currency loss was partially offset by a decrease in interest expense of $3.6 million mainly as a result of the $400.0 million debt principal prepayment for the Term Loan made during the third quarter of 2020.
Income Taxes
Income tax benefit increased by $5.5 million to $1.3 million of tax benefit for the third quarter of 2020 from $4.2 million of tax expense for the third quarter of 2019. The increase in income tax benefit for the third quarter of 2020 was primarily due to a decrease in continuing operating income, a change in the estimated tax benefit related to Global Intangible Low Taxed Income (GILTI) in the United States and unrealized foreign exchange gain and loss in Hong Kong.
The income tax benefit increased by $9.1 million to $3.6 million of tax benefit for the first three quarters of 2020 from $5.5 million of tax expense for the first three quarters of 2019. The increase in income tax benefit for the first three quarters of 2020 was primarily due to (i) a decrease in continuing operating income, (ii) an increase in the release of uncertain tax positions due to the expiration of the statute of limitation in foreign jurisdictions, netted against (iii) an increase related to the retroactive approval of the Company’s renewal application for High and New Tax Enterprise status in China, and (iv) an increase in the valuation allowance and withholding tax deferred tax liability related to the announced closure of two of the E-M Solutions plants.
Our effective tax rate is primarily impacted by tax rates in China and Hong Kong, the U.S. federal income tax rate, apportioned state income tax rates, the generation of credits and deductions available to us, as well as changes in valuation allowances and certain non-deductible items.
On March 27, 2020, the President of the United States signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) providing economic relief to disruptions caused by the Coronavirus pandemic. Accounting Standard Codification (ASC) 740, Accounting for Income Taxes , requires companies to recognize the effect of tax law changes in the period of enactment regardless of the effective date of those tax law changes. We considered the impact to our financial statements of the corporate income tax aspects of the CARES Act and determined the impact is not material to our financial statements. The CARES Act includes a number of provisions, including the increase of IRC Section 163(j) interest expense deduction limitation of Adjusted Tax Income (ATI) from 30% to 50%. This is applicable to the 2019 and 2020 tax years. The Company accounted for such change in the Q1 2020 provision calculation. There are also provisions that allow for a 100% refund of Alternative Minimum Tax Credit carryforwards and which postpone tax compliance deadlines and payments ordinarily due April 15, 2020.
Liquidity and Capital Resources
Our principal sources of liquidity have been cash provided by operations, the issuance of debt, and borrowings under our Revolving Credit Facility. Our principal uses of cash have been to finance capital expenditures, finance acquisitions, fund working capital requirements, and to repay existing debt. We anticipate that servicing debt, financing capital expenditures, financing acquisitions, and funding working capital requirements will continue to be the principal demands on our cash in the future.
Cash flow provided by operating activities for continuing operations during the first three quarters of 2020 was $192.2 million as compared to cash flow provided by operating activities for continuing operations of $169.6 million in the same period in 2019. The increase in cash flow was primarily due to less investment in working capital.
Net cash used in investing activities for continuing operations was approximately $75.0 million for the first three quarters of 2020, comprised primarily of $74.5 million for purchases of property, plant and equipment and other assets. Net cash used in investing activities for continuing operations was approximately $68.6 million for the first three quarters of 2019, reflecting $74.6 million for purchases of property, plant and equipment and other assets less proceeds from sale of property, plant and equipment and other assets of $6.0 million.
Net cash used in financing activities for continuing operations during the first three quarters of 2020 was $392.5 million, reflecting repayment of long-term debt of $400.0 million, offset by $7.3 million for capital equipment financing. Net cash used in financing activities was approximately $31.6 million for the first three quarters of 2019, reflecting repayment of long-term debt of $30.0 million and payment of debt issuance costs of $1.6 million.
We received proceeds from the sale of the Mobility business unit, net of cash disposed of $507.5 million during the first three quarters of 2020, which have been presented in the consolidated condensed statements of cash flows within net cash provided by investing activities from discontinued operations.
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As of September 2 8 , 2020, we had cash , cash equivalents , and restricted cash of approximately $6 63 . 3 million, of which approximately $ 233.8 million was held by our foreign subsidiaries, primarily in Hong Kong and China. As of September 28, 2020, o ur restricted cash balance of $250.0 million consisted of a specifi c deposit account to be used for principal payment on the Convertible Senior Notes due December 2020.
Our 2020 capital expenditures are expected to be approximately $100.0 million.
We believe our existing cash resources and sources of liquidity, together with cash generated from operations, will be sufficient to meet our working capital requirements for at least the next twelve months. However, should demand for our products change significantly over the next twelve months or should we experience significant increases in delinquent or uncollectible accounts receivable for any reason, including in particular continued or worsening economic conditions caused by the COVID-19 global pandemic, our cash provided by operations could decrease significantly and we could be required to seek additional sources of liquidity to continue our operations at their current level.
Long-term Debt and Letters of Credit
As of September 28, 2020, we had $1,090.0 million of outstanding debt, net of discount and debt issuance costs, composed of $402.2 million of Term Loan debt due September 2024, $370.3 million of Senior Notes due October 2025, $247.6 million of Convertible Senior Notes due December 2020, $40.0 million under the U.S. ABL, and $30.0 million under the Asia ABL.
Borrowings under the Term Loan Facility and Senior Notes Facility are subject to certain affirmative and negative covenants, including limitations on indebtedness, corporate transactions, investments, dispositions, and share payments. Under the occurrence of certain events, the ABL Revolving Loans are subject to various financial and operational covenants, including maintaining minimum fixed charge coverage ratios. As of September 28, 2020, we were in compliance with the covenants under the Term Loan Facility, Senior Notes Facility and ABL Revolving Loans.
Additional information regarding our indebtedness, including information about availability under our credit facilities, interest rates and other key terms of our outstanding indebtedness, is included in Part I, Item 1, Note 8, Long-term Debt and Letters of Credit , of the Notes to Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q.
Contractual Obligations and Commitments
As of the date of this report, there were no material changes to our contractual obligations and commitments outside the ordinary course of business since December 30, 2019 as reported in our Annual Report on Form 10-K for the fiscal year ended December 30, 2019.
Off Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As a result, we are not materially exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in these relationships.
Seasonality
Orders for our products generally correspond to the production schedules of our customers. We historically experience seasonal fluctuations in the first quarter due to the Chinese New Year holidays, which typically results in lower net sales for that quarter. We attribute this decline to shutdowns of our customers’ and our own China based manufacturing facilities surrounding the Chinese New Year public holidays, which normally occur in January or February of each year.
Recently Issued Accounting Standards
For a description of recently adopted and issued accounting standards, including the respective dates of adoption and expected effects on our results of operations and financial condition, see Part I, Item 1, Note 1, Nature of Operations and Basis of Presentation , of the Notes to Consolidated Condensed Financial Statements included in this Quarterly Report on Form 10-Q.
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