as Administrative Agent, Swingline Lender and a L/C Issuer. The Credit Agreement is comprised of a 5-year $500 million revolving credit facility (the Revolving Credit Facility) and a 5-year $150 million term loan facility (the Term Loan Facility), both with a maturity date of July 20, 2023. The Term Loan Facility proceeds were used to (i) refinance a portion of existing indebtedness and terminate all commitments under the Company’s prior $430 million credit agreement and (ii) pay the fees, costs and expenses associated with the foregoing and the negotiation, execution and delivery of the Credit Agreement.
The Revolving Credit Facility is available for general corporate purposes. The Credit Agreement includes an accordion feature pursuant to which the Company is permitted to add one or more incremental term loan and/or increase commitments under the Revolving Credit Facility in an aggregate amount not exceeding $275 million, subject to the satisfaction of certain conditions.
The Term Loan Facility is payable in quarterly principal installments of $1.9 million with the balance payable on July 20, 2023.
Interest on outstanding borrowings under the Credit Agreement (other than swingline loans) accrues, at the Company’s option, at (a) the London Interbank Offered Rate (LIBOR) plus 1.0% to 2.0% or (b) the base rate plus 0.0% to 1.0%.
As of September 30, 2020, $138.8 million of the outstanding debt under the Credit Agreement is effectively at a fixed interest rate of 2.928% (plus the applicable margin) as a result of a $138.8 million notional interest rate swap contract discussed in Note 16. A commitment fee of 0.20% to 0.30% per annum (based on the debt to EBITDA ratio) on the unused portion of the revolving credit line is payable quarterly in arrears.
The Credit Agreement is generally secured by a pledge of (a) all the capital stock of the Company’s domestic subsidiaries and 65% of the capital stock of its directly owned foreign subsidiaries, (b) all or substantially all other personal property of Benchmark and its domestic subsidiaries (including, but not limited to, accounts receivable, contract assets, inventory, intellectual property and fixed assets of Benchmark and its domestic subsidiaries), in each case, subject to customary exceptions and limitations, and (c) all proceeds and products of the property and assets described in (a) and (b) above.
The Credit Agreement contains certain financial covenants as to interest coverage and debt leverage, and certain customary affirmative and negative covenants, including restrictions on the Company’s ability to incur additional debt and liens, pay dividends, repurchase shares, sell assets and merge or consolidate with other persons. Amounts due under the Credit Agreement could be accelerated upon specified events of default, including a failure to pay amounts due, breach of a covenant, material inaccuracy of a representation, or occurrence of bankruptcy or insolvency, subject, in some cases, to cure periods.
As of September 30, 2020, the Company had $138.8 million in borrowings outstanding under the Term Loan Facility and $15.0 million in borrowings and $3.7 million in letters of credit outstanding under the Revolving Credit Facility, respectively. The Company had $481.3 million available for future borrowings under the Revolving Credit Facility subject to compliance with financial covenants as to interest coverage and debt leverage, in addition to other debt covenant restrictions.
Note 7 – Leases
The Company determines if a contract is or contains a lease at inception. The Company has entered into leases for certain facilities, vehicles and other equipment. The Company’s leases consist mainly of operating leases which expire at various dates through 2036. Variable lease payments are generally expensed as incurred and include certain index-based changes in rent, certain nonlease components, such as maintenance and other services provided by the lessor, and other charges included in the lease.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This quarterly report (this Report) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act). These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts and may include words such as “anticipate,” “believe,” “intend,” “plan,” “projection,” “forecast,” “strategy,” “position,” “continue,” “estimate,” “expect,” “may,” “will,” or the negative or other variations thereof. In particular, statements, express or implied, concerning future operating results, including guidance for fourth quarter 2020 results and beyond, our ability to generate sales, income or cash flow, the anticipated impact of the COVID-19 pandemic, our anticipated plans and responses to the COVID-19 pandemic, our expected revenue mix, our business strategy and strategic initiatives, our repurchases of shares of our common stock and our intentions concerning the payment of dividends, among others, are forward-looking statements. Although we believe these statements are based upon reasonable assumptions, they involve risks, uncertainties and assumptions that are beyond our ability to control or predict, relating to operations, markets and the business environment generally, including those discussed in Part I, Item 1A of the 2019 10-K, in Part II, Item 1A of this Report and in any of our subsequent reports filed with the SEC. In particular, these statements also depend on the duration, severity and evolution of the COVID-19 pandemic and related risks, including government and other third-party responses to it and the consequences for the global economy, our business and the businesses of our suppliers and customers, as well as our ability (or inability) to execute on its plans to respond to the COVID-19 pandemic. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes, including the future results of our operations, may vary materially from those indicated. Undue reliance should not be placed on any forward-looking statements. Forward-looking statements are not guarantees of performance. The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying notes, and the 2019 10-K. All forward-looking statements included in this document are based upon information available to the company as of the date of this document, and it assumes no obligation to update them.
OVERVIEW
We are a worldwide provider of innovative product design, engineering services, technology solutions and advanced manufacturing services (both electronic manufacturing services (EMS) and precision technology machining services). In this Report, references to Benchmark, the Company or use of the words “we”, “our” and “us” include Benchmark’s subsidiaries unless otherwise noted.
From initial product concept to volume production, including direct order fulfillment and aftermarket services, Benchmark has been providing integrated services and solutions to original equipment manufacturers (OEMs) since 1979. Today, Benchmark proudly serves the following industries: aerospace and defense (A&D), medical technologies, complex industrials, semiconductor capital equipment (Semi-Cap), next-generation telecommunications and advanced computing.
Our customer engagement focuses on three principal areas:
•Engineering Services, which includes turnkey product design, design for manufacturability, manufacturing process and test development, concurrent and sustaining engineering and regulatory services. Our engineering services may be for systems, sub-systems, printed circuit boards and assemblies, and components. We provide these services across all the industries we serve, but focus primarily in regulated industries such as medical, complex industrials, aerospace and defense, and next-generation telecommunications.
•Technology Solutions, which involve developing a library of building blocks or reference designs primarily in defense solutions, surveillance systems, radio frequency and high-speed design, and front-end managed connectivity data collection systems. We often merge these technology solutions with engineering services in order to support manufacturing services. Our reference designs can be utilized across a variety of industries, but we have significant capabilities in the aerospace and defense and next-generation telecommunications markets. We have also developed stronger capabilities in radio frequency (RF) and high-speed design for both components and substrates. The need to reduce Size, Weight, and Power (SWaP) to accommodate embedding high frequency electronic communications into specific designs is important to customers in the aerospace and defense, medical, and next-generation telecommunications markets.
•Manufacturing Services, which include producing printed circuit board assemblies (PCBAs) using both traditional surface mount technologies (SMT) and microelectronics are then often integrated into a subsystem assembly, or a box build as part of systems integration. Systems integration often involves building a finished assembly that includes PCBAs, complex subsystem assemblies, mechatronics, displays, optics, and other components. These final products may be configured to order and delivered directly to the end-customer across all the industries we serve. Manufacturing services also includes precision technology manufacturing comprised of precision machining, advanced metal joining, assembly and functional testing primarily for customers in the semiconductor capital equipment as well as the medical and aerospace and defense markets.
Our core strength lies in our ability to provide concept-to-production solutions in support of our customers. Our global manufacturing presence increases our ability to respond to our customers’ needs by providing accelerated time-to-market and time-to-volume production of high-quality products – especially for complex products with lower volume and higher mix in regulated markets. These capabilities enable us to build strong strategic relationships with our customers and to become an integral part of their business.
We believe our primary competitive advantages are our engineering services (including product design), technology solutions, and manufacturing services (including electronics and precision technology capabilities) provided by highly skilled personnel. We continue to invest in our business to expand our skills and service offerings from direct customer inputs. We have a closed-loop feedback system in place to respond to customer ideas to enhance our future designs and manufacturing solutions in support of the full life cycle of their products. These solutions offload the electronics design work from our customers so they can focus on product areas where they can provide more value add and, in the process, accelerate their time-to-market and reduce their product development costs. Working closely with our customers and responding promptly to their needs, we become an integral part of their development process helping them bring products to market faster and more economically.
In addition, we believe that a strong focus on human capital through the talent we hire and retain is critical to maintaining our competitiveness. We are driving a customer-centric organization with a high degree of accountability and ownership to develop processes necessary to exceed customer expectations and deliver financial performance aligned to our goals. Through our employee feedback process, we solicit and act upon information to improve our company and better support our customers and business processes in the future. We have taken steps to attract the best leaders into our business and we are accelerating our efforts to mentor and develop key leaders for the future.
Our customers often face challenges in designing supply chains, demand planning, procuring materials and managing their inventories efficiently due to fluctuations in their customer demand, product design changes, short product life cycles and component price fluctuations.
We employ enterprise resource planning (ERP) systems and lean manufacturing principles to manage procurement and manufacturing processes in an efficient and cost-effective manner so that, where possible, components arrive on a just-in-time, as-and-when-needed basis. Because we are a significant purchaser of electronic components and other raw materials, we are able to capitalize on the economies of scale associated with our relationships with suppliers to negotiate price discounts, obtain components and other raw materials that are in short supply, and return excess components. Our agility and expertise in supply chain management and our relationships with suppliers across the supply chain enable us to help reduce our customers’ cost of goods sold and inventory exposure.
We recognize revenue as the customer takes control of the manufactured products built to customer specifications. We also generate revenue from our design, development and engineering services, in addition to the sale of other inventory.
Revenue is measured based on the consideration specified in a contract with a customer. Under the majority of our manufacturing contracts with customers, the customer controls all the work-in-progress as products are being built. Revenues under these contracts are recognized over time based on the cost-to-cost method. Under other manufacturing contracts, the customer does not take control of the product until it is completed. Under these contracts, we recognize revenue upon transfer of control of product to the customer, which is generally when the goods are shipped. Revenue from engineering services that include design and development elements also continues to be recognized over time as the services are performed. We assume no significant obligations after shipment as we typically warrant workmanship only. Therefore, the warranty provisions are generally not significant.
COVID-19 Pandemic Update
In late 2019, there was an outbreak of a new strain of coronavirus (COVID-19) first identified in Wuhan, Hubei Province, China, which has since spread globally. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. Further, the COVID-19 outbreak has resulted in government authorities around the world implementing numerous measures to try to reduce the spread of COVID-19, such as travel bans and restrictions, quarantines, “shelter-in-place,” “stay-at-home,” total lock-down orders, business limitations or shutdowns and similar orders. As a result, the COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and workforce participation, and created significant volatility and disruption of financial markets. In an effort to first and foremost protect the health and safety of our employees, we also took proactive action to adopt social distancing policies at our locations globally, including working from home for certain employees, limiting the number of employees attending meetings, reducing the number of people in our locations at any one time, and suspending employee travel.
Benchmark provides critical infrastructure products and essential services in each of our locations. However, as a result of the COVID-19 pandemic, including the related responses from government authorities, the Company’s operations were impacted worldwide starting in the first quarter of 2020. These impacts began with a shut-down of the Company’s manufacturing facilities in Suzhou, China early in the first quarter of 2020 (which ramped back to full capacity by mid-March). However, the disruptive impacts caused by the COVID-19 pandemic have since affected our operations in all other regions. For example, starting in mid-March, our Penang, Malaysia operation, which includes our largest precision machining facility, was significantly disrupted. As a result, our Penang, Malaysia operation had been operating at approximately 30% of capacity through the end of the first quarter of 2020, at approximately 50% of capacity through April of 2020 and subsequently ramped to full production capacity within a couple of weeks thereafter. Our California operations experienced significant disruptions through April 2020 due to “shelter-in-place” and “stay-at-home” orders and ordinances. Also, our operations in Tijuana and Guadalajara, Mexico have experienced significant disruptions due to similar “shelter-in-place” and
“stay-at-home” orders and ordinances. We resumed operations in Tijuana and Guadalajara during the middle of May of 2020 and returned to full production in phases.
As a result of the COVID-19 pandemic, our revenue for the first nine months of 2020 was negatively impacted primarily as a result of operational inefficiencies relating to reduced productivity levels throughout our facilities and supply chain constraints, which affected our ability to support customer demand. Additionally, the COVID-19 pandemic negatively impacted our first, second and third quarter results due to increased direct costs associated with labor expenses and personal protective equipment for our employees, as well as under absorption of fixed costs.
While our manufacturing and engineering services operations have essentially returned to pre-COVID-19 productivity levels, the COVID-19 pandemic continues to affect the Company’s operations into the fourth quarter of 2020. As a result, we expect our revenue will be in line with third quarter of 2020 levels and we do not expect a seasonal up trend in fourth quarter of 2020 revenues this year as customers are more cautious on increasing their demand signals given the economic and geopolitical environment. As we enter the fall and winter months, we may experience worsening impacts of the COVID-19 pandemic in many regions in the United States and worldwide which could further impact customer demand fluctuation.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in the United States in response to the COVID-19 pandemic. The CARES Act among other things, permits NOL carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021, and contains modifications on the limitation of business interest for tax years beginning in 2019 and 2020. The Company has evaluated the impact of these provisions and has determined these provisions did not have any impact on the nine months ended September 30, 2020. In addition, the CARES Act allows for employee retention tax credits to be taken in U.S. payroll tax filings and allows for the deferral of the employer portion of social security taxes with 50% to be paid at the end of calendar years 2021 and 2022, respectively. Accordingly, the Company has deferred the payment of the employer portion of social security taxes for the nine months ended September 30, 2020 until the end of 2021 and 2022, respectively. The Company has also determined it is entitled to employee retention credits and has filed for the credits in the second quarter payroll tax reports pursuant to the guidance provided by the Internal Revenue Service. The amount of credits has been recorded in operating expenses for the nine months ended September 30, 2020.
International authorities in various jurisdictions have also allowed for cash grants, delay of tax filings, and delay of tax payments for future quarters. We have taken advantage of these benefits by delaying our tax filings and respective tax payments in various jurisdictions.
In response to uncertainties related to the impact of the COVID-19 virus, we have taken a series of actions to lower our cost structure and reduce capital expenditures. On April 29, 2020, the Company announced a temporary 10% salary reduction for all executive officers (including our named executive officers) effective April 27, 2020 through December 31, 2020 and the Company Board of Directors approved a temporary 10% reduction in their quarterly cash compensation effective April 27, 2020 through December 31, 2020. Other senior leaders in the Company took a 7% salary reduction through September 29, 2020. Additional cost reduction actions in our U.S. factories consisted of employees taking rotating time off depending on the factory loading levels. Cost reduction actions in our non-U.S. locations depend on local law requirements. Additionally, we have reduced other discretionary expenses, such as travel. We have also implemented actions to conserve our cash and cash equivalents such as reducing planned capital expenditures, deferring certain planned investments, suspending our share repurchase activity, and deferring payroll and income tax payments in accordance with the CARES Act. Finally, we have implemented certain other procedures to manage potential risks related to working capital such as closely
monitoring the financial stability, payment terms and credit limits of our customers.
We continue to monitor the rapidly evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities, and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, the exact extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations, is currently unknown and will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted. This includes, but is not limited to, the duration and spread of the COVID-19 pandemic, its severity, the actions to contain the virus or treat its impact and how quickly and to what extent normal economic and operating conditions can resume.
Accordingly, our current results and financial condition discussed herein may not be indicative of future operating results and trends. See “Risk Factors” in Part II, Item 1A of this Report for additional risks we face due to the COVID-19 pandemic.
Third Quarter 2020 Highlights
Sales for the three months ended September 30, 2020 decreased 5% to $526.0 million compared to $555.2 million during the comparable 2019 period. During the third quarter of 2020, sales to customers in our various industry sectors fluctuated from the comparable 2019 period as follows:
Higher-Value Markets
Industrials decreased by 25%,
A&D decreased by 9%,
Medical increased by 5%, and
Semi-Cap increased by 45%.
Traditional Markets
Computing decreased by 26%, and
Telecommunications decreased by 17%.
Overall, higher-value market revenues during the third quarter were flat year-over-year. Demand strength in Medical supporting COVID-19 solutions and new product ramps and the continued Semi-Cap recovery were offset by weakness in commercial Aerospace within A&D and certain Industrials markets. Traditional market revenues were down 21% year-over-year primarily from our exit of the legacy Computing contract as discussed below.
Our sales depend on the success of our customers, some of which operate in businesses associated with rapid technological change and consequent product obsolescence. Developments adverse to our major customers or their products, or the failure of a major customer to pay for components or services, including in each case as a result of the COVID-19 pandemic, can adversely affect us. A substantial percentage of our sales are made to a small number of customers, and the loss of a major customer, if not replaced, would adversely affect us. Sales to our ten largest customers represented 42% and 41% of our sales in the nine months ended September 30, 2020 and 2019, respectively.
During 2018, as part of our ongoing process to review contracts that are marginal and dilutive to our gross margin, we made the decision not to renew a legacy contract with a large Computing customer that was to expire at the end of 2019. During the second quarter of 2019, we completed the final build out of this legacy contract and in the third quarter of 2019 had an immaterial amount of revenue from this contract as the transition was completed.
We experience fluctuations in gross profit from period to period. Different programs contribute different gross margins depending on the type of services involved, location of production, size of the program, complexity of the product and level of material costs associated with the various products. Moreover, new programs can contribute relatively less to our gross profit in their early stages when manufacturing volumes
are usually lower, resulting in inefficiencies and unabsorbed manufacturing overhead costs. In addition, several of our new and higher-volume programs remain subject to competitive constraints that can exert downward pressure on our margins. During periods of low production volume and slow new program ramps, we generally have idle capacity and reduced gross margin. Gross profit can also be impacted by other situations, such as the current COVID-19 global pandemic discussed above and the ransomware incident experienced in 2019.
We have undertaken initiatives to restructure our business operations with the intention of improving utilization and reducing costs. During the first nine months of 2020, we recognized $8.7 million of restructuring charges and other costs due in part to expenses associated with various site closures and restructuring activities. In addition, during the first nine months of 2020, we incurred $5.7 million and $1.0 million in costs related to asset impairments in the Americas and Asia, respectively.
RESULTS OF OPERATIONS
The following table presents the percentage relationship that certain items in our Condensed Consolidated Statements of Income bear to sales for the periods indicated. The financial information and the discussion below should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto in Part I, Item 1 of this Report.
|
|
|
Three Months Ended
|
Nine Months Ended
|
|
|
|
|
September 30,
|
September 30,
|
|
|
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|
Cost of sales
|
|
91.2
|
|
91.2
|
|
91.9
|
|
91.6
|
|
|
|
Gross profit
|
|
8.8
|
|
8.8
|
|
8.1
|
|
8.4
|
|
|
Selling, general and administrative expenses
|
|
5.7
|
|
5.6
|
|
5.9
|
|
5.3
|
|
|
Amortization of intangible assets
|
|
0.5
|
|
0.4
|
|
0.5
|
|
0.4
|
|
|
Restructuring charges and other costs
|
|
1.4
|
|
1.1
|
|
1.0
|
|
0.6
|
|
|
Ransomware incident related costs (recovery), net
|
|
(0.3)
|
|
-
|
|
(0.1)
|
|
-
|
|
|
|
Income from operations
|
|
1.6
|
|
1.8
|
|
0.9
|
|
2.1
|
|
|
Other income (expenses), net
|
|
(0.3)
|
|
(0.2)
|
|
(0.3)
|
|
-
|
|
|
|
Income before income taxes
|
|
1.4
|
|
1.6
|
|
0.5
|
|
2.2
|
|
|
Income tax expense
|
|
0.2
|
|
0.3
|
|
0.1
|
|
0.4
|
|
|
|
Net income
|
|
1.1
|
%
|
1.3
|
%
|
0.4
|
%
|
1.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
Sales for the third quarter of 2020 were $526.0 million, a 5% decrease from sales of $555.2 million for the same quarter in 2019. Sales for the first nine months of 2020 were $1.5 billion, a 13% decrease from sales of $1.8 billion for the same period in 2019. Sales by industry sector were as follows:
|
|
|
Three Months Ended
|
Nine Months Ended
|
|
|
|
|
September 30,
|
September 30,
|
|
|
(in thousands)
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
|
|
|
Higher-Value Markets
|
|
|
|
|
|
|
Industrials
|
$
|
86,184
|
$
|
114,973
|
$
|
276,140
|
$
|
346,010
|
|
|
A&D
|
|
104,899
|
|
115,354
|
|
312,623
|
|
326,208
|
|
|
Medical
|
|
134,142
|
|
127,773
|
|
386,869
|
|
345,438
|
|
|
Semi-Cap
|
|
98,721
|
|
68,051
|
|
268,292
|
|
196,522
|
|
|
|
|
|
423,946
|
|
426,151
|
|
1,243,924
|
|
1,214,178
|
|
|
|
Traditional Markets
|
|
|
|
|
|
|
|
|
|
|
Computing
|
|
44,339
|
|
59,522
|
|
124,793
|
|
316,522
|
|
|
Telecommunications
|
|
57,666
|
|
69,556
|
|
163,164
|
|
228,951
|
|
|
|
|
|
102,005
|
|
129,078
|
|
287,957
|
|
545,473
|
|
|
|
Total
|
$
|
525,951
|
$
|
555,229
|
$
|
1,531,881
|
$
|
1,759,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrials. Third quarter sales decreased 25% to $86.2 million from $115.0 million in 2019. Sales during the first nine months of 2020 decreased 20% to $276.1 million from $346.0 million in the same period of 2019. The decreases were primarily from softer demand from customers in the oil and gas industry and in both industrial commercial building and transportation markets.
Aerospace and Defense. Third quarter sales decreased 9% to $104.9 million from $115.3 million in 2019. Sales during the first nine months of 2020 were $312.6 million compared to $326.2 million in the same period of 2019. The decreases were due primarily to the general weakness in the commercial Aerospace market.
Medical. Third quarter sales increased 5% to $134.2 million from $127.8 million in 2019. Sales increased 12% to $386.9 million during the first nine months of 2020 from $345.5 million in the same period of 2019. These increases were primarily due to new program ramps and strength throughout our medical customers and increasing demand for critical devices supporting COVID-19 solution.
Semiconductor Capital Equipment. Third quarter sales increased 45% to $98.7 million from $68.0 million in 2019. Sales during the first nine months of 2020 increased 37% to $268.3 million from $196.5 million in the same period of 2019. These increases were due to continued Semi-Cap market recovery.
Computing. Third quarter sales decreased 26% to $44.3 million from $59.5 million in 2019 and decreased 61% to $124.8 million during the first nine months of 2020 from $316.5 million in the same period of 2019. These decreases were primarily related to our exit from a legacy contract as discussed above.
Telecommunications. Third quarter sales decreased 17% to $57.7 million from $69.6 million in 2019 and decreased 29% to $163.2 million during the first nine months of 2020 from $229.0 million in the same period of 2019. The decreases were primarily due to softer demand from broadband products and commercial satellite applications.
Our international operations are subject to the risks of doing business abroad. See Part I, Item 1A of our 2019 10-K for factors pertaining to our international sales and fluctuations in the exchange rates of foreign currency and for further discussion of potential adverse effects in operating results associated with the risks
of doing business abroad. During the first nine months of 2020 and 2019, 51% and 46%, respectively of our sales were from our international operations.
Gross Profit
Gross profit decreased 5% to $46.4 million for the three months ended September 30, 2020 from $49.0 million in the same quarter of 2019 and decreased 16% to $124.4 million for the nine months ended September 30, 2020 from $148.2 million in the same period of 2019. For the three and nine months ended September 30, 2020, gross profit included a $0.8 million and a $1.1 million recovery, respectively, associated with customer insolvencies in 2020. For the nine months ended September 30, 2019, gross profit included a $1.0 million recovery associated with customer insolvencies in 2019. In addition, gross profit for the three and nine months ended September 30, 2019 included a $0.8 million settlement accrual with a customer. Gross margin including these charges and recoveries was 8.8% and 8.1%, respectively, for the three and nine months ended September 30, 2020 and 8.8% and 8.4%, respectively, for the three and nine months ended September 30, 2019. Excluding these items, gross margin was 8.7% and 8.0%, respectively, for the three and nine months ended September 30, 2020 compared to 8.8% and 8.4%, respectively, in the same periods of 2019. The deterioration in gross margin when comparing the periods is primarily attributable to lower revenues and the disruptive impacts caused by the COVID-19 driven by reduced productivity levels throughout our facilities, increased direct costs associated with labor expenses and personal protective equipment for our employees and under absorption of fixed costs.
Selling, General and Administrative Expenses
SG&A decreased by 4% to $29.7 million in the third quarter of 2020 compared to $30.9 million in 2019 and decreased by 3% to $89.8 million in the first nine months of 2020 compared to $92.5 million in 2019. During the nine months ended September 30, 2019, we had a $1.7 million recovery of a provision for accounts receivable associated with the insolvency of a customer. Including this adjustment to the provision to accounts receivable, SG&A increased to 5.7% of sales for the third quarter of 2020 from 5.6% in 2019, and increased to 5.9% of sales for the first nine months of 2020 from 5.3% in 2019. Excluding this adjustment to the provision to accounts receivable, SG&A increased to 5.7% of sales for the third quarter of 2020 from 5.6% in 2019 and increased to 5.9% of sales for the first nine months of 2020 from 5.4% in 2019. The increases were primarily due to lower sales and a $2.2 million provision for bad debts recorded in 2020.
Amortization of Intangible Assets
Amortization of intangible assets was $7.1 million in the first nine months of 2020 and 2019.
Restructuring Charges and Other Costs
During the first nine months of 2020, we recognized $8.7 million of restructuring charges, primarily related to site closures and restructuring activities in certain facilities in the Americas and Asia. In addition, during the first nine months of 2020, we incurred $5.7 million and $1.0 million in costs related to asset impairments in the Americas and Asia, respectively. In the first nine months of 2019, we recognized $7.4 million of restructuring charges, primarily related to reductions in workforce in certain facilities in the Americas and Asia. In addition, during the first nine months of 2019, we incurred $3.4 million in costs primarily related to fees and costs incurred in reaching the cooperation agreement with Engaged Capital and other proxy related activities as well as our CEO transition. See Note 13 to the Condensed Consolidated Financial Statements in Part I, Item 1 of this Report.
Ransomware Incident Related Costs (Recovery), Net
During the fourth quarter ended December 31, 2019, ransomware incident related costs incurred totaled $7.7 million, net of estimated insurance recoveries of $5.0 million. These costs were primarily comprised of certain employee related expenses and various third-party consulting services including forensic experts, legal counsel and other IT professional expenses. During the nine months ended September 30, 2020, the Company collected $6.6 million of insurance recoveries. Further insurance recoveries will be recorded when considered probable.
Interest Expense
Interest expense increased to $6.2 million during the first nine months of 2020 from $5.0 million during the comparable 2019 period due to the outstanding amounts on the Revolving Credit facility in 2020 and increased interest rates based on our higher debt leverage ratio.
Interest Income
Interest income decreased to $1.0 million during the first nine months of 2020 from $3.1 million during the comparable 2019 period due primarily to lower invested cash equivalents and the lower interest rate environment.
Income Tax Expense
Income tax expense of $1.6 million represented an effective tax rate of 19.9% for the first nine months of 2020, compared with $7.8 million for the comparable 2019 period, which represented an effective tax rate of 20.5%. The decrease in the effective tax rate was primarily due to the mix of profits and losses in our worldwide operations.
We have been granted certain tax incentives, including tax holidays, for our subsidiaries in Malaysia and Thailand that will expire at various dates, unless extended or otherwise renegotiated, through 2021 in Malaysia and 2028 in Thailand. See Note 9 to the Condensed Consolidated Financial Statements in Part I, Item 1 of this Report.
Net Income
We reported net income of $6.4 million, or $0.17 per diluted share, for the first nine months of 2020, compared with a net income of $30.4 million, or $0.77 per diluted share, for the same period in 2019. The net decrease of $24.0 million from 2019 was primarily the result of lower gross profit as well as higher restructuring charges and other costs in 2020.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our organic growth and operations through funds generated from operations and occasional borrowings under our revolving credit facility. Cash and cash equivalents and restricted cash totaled $334.8 million at September 30, 2020 and $364.0 million at December 31, 2019, of which $174.1 million and $197.8 million, respectively, were held outside the U.S. in various foreign subsidiaries.
Cash provided by operating activities during the first nine months of 2020 was $25.6 million and consisted primarily of $6.4 million of net income adjusted for $36.9 million of depreciation and amortization, a $16.4 million decrease in accounts receivable, and a $21.1 million increase in customer deposits, partially offset by a $37.1 million increase in inventories and a $18.3 million decrease in accounts payable and a $13.5 million decrease in accrued liabilities. The decrease in accounts receivable was attributable to lower sales. The increase in customer deposits was primarily a result of deposits received from customers to cover higher inventory balances. The increase in inventories is primarily related to mix changes from customers and inventory to support long productions cycles for products in our Semi-Cap and Medical sectors. The decrease in accounts payable and accrued liabilities was primarily a result of the timing of payments. Working capital was $0.7 billion at September 30, 2020 and at December 31, 2019.
We purchase components only after customer orders or forecasts are received, which mitigates, but does not eliminate, the risk of loss on inventories. Supplies of electronic components and other materials used in operations are subject to industry-wide shortages. In certain instances, suppliers may allocate available quantities to us. If shortages of these components and other material supplies used in operations occur, vendors may not ship the quantities we need for production, and we may be forced to delay shipments, which can increase backorders and impact cash flows. We have also experienced, and continue to experience, labor constraints due to the COVID-19 virus.
Cash used in investing activities during the first nine months was $26.5 million for 2020, primarily due to purchases of additional property, plant and equipment totaling $26.1 million. The purchases of property, plant and equipment were primarily for machinery and equipment in the Americas and Asia.
Cash used in financing activities during the first nine months of 2020 was $29.7 million. Share repurchases totaled $19.3 million, net borrowing activities on long-term debt totaled $8.4 million, dividends totaled $17.2 million, and we received $0.4 million from the exercise of stock options.
Under the terms of our $650.0 million Credit Agreement, in addition to the Term Loan facility, we have a $500.0 million five-year revolving credit facility to be used for general corporate purposes (subject to compliance with financial covenants as to interest coverage and debt leverage, in addition to other debt covenant restrictions), both with a maturity date of July 20, 2023. The Credit Agreement includes an accordion feature pursuant to which total commitments under the facility may be increased by an additional $275.0 million, subject to satisfaction of certain conditions. As of September 30, 2020, we had $138.8 million in borrowings outstanding under the Term Loan Facility and $15.0 million in borrowings and $3.7 million in letters of credit outstanding under the Revolving Credit Facility, respectively. See Note 6 to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Report for more information regarding the terms of the Credit Agreement.
The Credit Agreement contains certain financial covenants as to interest coverage and debt leverage, and certain customary affirmative and negative covenants, including restrictions on our ability to incur additional debt and liens, pay dividends, repurchase shares, sell assets and merge or consolidate with other persons. Amounts due under the Credit Agreement could be accelerated upon specified events of default, including a failure to pay amounts due, breach of a covenant, material inaccuracy of a representation, or occurrence of bankruptcy or insolvency, subject, in some cases, to cure periods. As of September 30, 2020, we were in compliance with all these covenants and restrictions.
Our operations, and the operations of businesses we acquire, are subject to certain foreign, federal, state and local regulatory requirements relating to environmental, waste management, health and safety matters. We believe we operate in substantial compliance with all applicable requirements and we seek to ensure that newly acquired businesses comply or will comply substantially with applicable requirements. To date, the costs of compliance and workplace and environmental remediation have not been material to us. However, material costs and liabilities may arise from these requirements or from new, modified or more stringent requirements in the future. In addition, our past, current and future operations, and the operations of businesses we have or may acquire, may give rise to claims of exposure by employees or the public, or to other claims or liabilities relating to environmental, waste management or health and safety concerns.
As of September 30, 2020, we had cash and cash equivalents and restricted cash totaling $334.8 million and $481.3 million available for borrowings under the Revolving Credit Facility, subject to compliance with financial covenants as to interest coverage and debt leverage, in addition to other debt covenant restrictions as described above. During the next 12 months, we believe our capital expenditures will approximate $45 million to $50 million, principally for machinery and equipment to support our ongoing business around the globe, in addition to expenditures for information technology infrastructure items and software.
On October 26, 2018, our Board of Directors approved an expanded stock repurchase program granting us the authority to repurchase up to $100 million in common stock in addition to the $250 million approved on March 6, 2018. On February 19, 2020, the Board of Directors authorized the repurchase of an additional $150 million of the Company’s common stock. During the nine months ended September 30, 2020, the
Company repurchased a total of 0.7 million common shares for an aggregate of $19.3 million at an average price of $26.69 per share. As of September 30, 2020, we had $210.1 million remaining under the share repurchase authorization to purchase additional shares. We are under no commitment or obligation to repurchase any amount of common stock.
Management believes that our existing cash balances and funds generated from operations will be enough to permit us to meet our liquidity requirements over the next 12 months. Management further believes that our ongoing cash flows from operations and any borrowings we may incur under our Revolving Credit Facility will enable us to meet operating cash requirements in future years. If we consummated significant acquisitions in the future, our capital needs would increase and could possibly result in our need to increase available borrowings under our Credit Agreement or access public or private debt and equity markets. There can be no assurance, however, that we would be successful in raising additional debt or equity on acceptable terms.
CONTRACTUAL OBLIGATIONS
We have certain contractual obligations for operating and capital leases that were summarized in a table of Contractual Obligations in our 2019 10-K. There have been no material changes to our contractual obligations, outside of the ordinary course of our business, since December 31, 2019.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2020, we did not have any significant off-balance sheet arrangements. See Note 16 to the Condensed Consolidated Financial Statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES AND RECENTLY ENACTED ACCOUNTING PRINCIPLES
Management’s discussion and analysis is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. See Note 2 to the Condensed Consolidated Financial Statements in Part 1, Item 1 of this Report for a discussion of recently enacted accounting principles. Also, our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements included in our 2019 10-K.
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
Our international sales comprise a significant portion of our net sales. We are exposed to risks associated with operating internationally, including:
•Foreign currency exchange risk;
•Import and export duties, taxes and regulatory changes;
•Inflationary economies or currencies; and
•Economic and political instability.
Additionally, some of our operations are in developing countries. Certain events, including natural disasters, can impact the infrastructure of a developing country more severely than they would impact the infrastructure of a developed country. A developing country can also take longer to recover from such events, which could lead to delays in our ability to resume full operations.
We transact business in various foreign countries and are subject to foreign currency fluctuation risks. We use natural hedging and forward contracts to economically hedge transactional exposure primarily
associated with trade accounts receivable, other receivables and trade accounts payable that are denominated in a currency other than the functional currency of the respective operating entity. We do not use derivative financial instruments for speculative purposes. The forward contract in place as of September 30, 2020 has not been designated as an accounting hedge and, therefore, changes in fair value are recorded within our Condensed Consolidated Statements of Income.
Our sales are substantially denominated in U.S. dollars. Our foreign currency cash flows are generated in certain European and Asian countries and Mexico.
We are also exposed to market risk for changes in interest rates on our financial instruments, a portion of which relates to our invested cash balances. We do not use derivative financial instruments in our investing activities. We place cash and cash equivalents and investments with various major financial institutions. We protect our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by generally investing in investment-grade securities.
We are also exposed to interest rate risk on borrowings under our Credit Agreement. As of September 30, 2020, we had $15.0 million outstanding on the floating rate revolving credit facility. In addition, we had $138.8 million outstanding on the floating rate term loan facility, and we have an interest rate swap agreement with a notional amount of $138.8 million. Under this swap agreement, we receive variable rate interest rate payments and pay fixed rate interest payments. The effect of this swap is to convert a portion our floating rate interest expense to fixed interest rate expense. The interest rate swap is designated as a cash flow hedge. For additional information, see Note 16 to the Condensed Consolidated Financial Statements in Item 1 of this Report.
Item 4 – Controls and Procedures
As of the end of the period covered by this Report, the Company’s management (with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO)) conducted an evaluation pursuant to Rule 13a-15 under the Exchange Act, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) of the Exchange Act). Based on this evaluation, the CEO and CFO concluded that as of the end of the period covered by this Report such disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Additionally, the controls and procedures were designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
There has been no change in our internal control over financial reporting (as defined in Rule13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the last fiscal quarter covered by this Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by individuals’ acts, by collusion of two or more people, or by management overriding the control. The design of any system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.