Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
References in this report to “the Company,” “Benchmark,” “we,” or “us” mean Benchmark Electronics, Inc. together with its subsidiaries. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains certain 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. These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. They use words such as “anticipate,” “believe,” “intend,” “plan,” “projection,” “forecast,” “strategy,” “position,” “continue,” “estimate,” “expect,” “may,” “will,” or the negative of those terms or other variations of them or comparable terminology. In particular, statements, express or implied, concerning future operating results or the ability to generate sales, income or cash flow are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions, including those discussed under Part II, Item 1A of this report. The future results of our operations may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results are beyond our ability to control or predict, including but not limited to uncertainties concerning the recent flooding in Thailand, the extent of damage to our facilities and equipment, the timeframe for the flood waters in Thailand receding, the restoration of operations and associated costs with such restoration, our ability to effectively shift production from our Ayudhaya facilities to other facilities in order to maintain supply continuity for our customers and the recovery of insurance proceeds associated with our business interruption coverage. Undue reliance should not be placed on any forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.
The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.
OVERVIEW
We are a worldwide provider of integrated electronic manufacturing services. We provide our services to original equipment manufacturers (OEMs) of computers and related products for business enterprises, medical devices, industrial control equipment, which includes equipment for the aerospace and defense industry, testing and instrumentation products, and telecommunication equipment. The services that we provide are commonly referred to as electronics manufacturing services (EMS). We offer our customers comprehensive and integrated design and manufacturing services from initial product design to volume production, including direct order fulfillment and post deployment services. Our manufacturing and assembly operations include printed circuit boards and subsystem assembly, box build and systems integration, the process of integrating subsystems and, often, downloading and integrating software, to produce a fully configured product. As part of our design service offerings, we also provide a broad range of custom assembly equipment. The assembly solutions are designed to meet our customers’ specific requirements and include mechanized stations, automated cells, and full automated assembly lines. Our recently added precision technology manufacturing capabilities complement our proven electronic manufacturing expertise by providing further vertical integration of critical mechanical components. These capabilities include precision machining, advanced metal joining, and functional testing for multiple industries including medical, instrumentation, aerospace and semiconductor capital equipment. We are also able to provide specialized engineering services, including product design, printed circuit board layout, prototyping and test development. We believe that we have developed strengths in the manufacturing process for large, complex, high-density printed circuit boards as well as the ability to manufacture high and low volume products in lower cost regions such as Brazil, China, Malaysia, Mexico, Romania and Thailand.
We believe that our global manufacturing presence increases our ability to be responsive to our customers’ needs by providing accelerated time-to-market and time-to-volume production of high quality products. These capabilities enable us to build stronger strategic relationships with our customers and to become a more integral part of their operations. Our customers face challenges in planning, procuring and managing their inventories efficiently due to customer demand fluctuations, product design changes, short product life cycles and component price fluctuations. We employ production management systems to manage their 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. We are a significant purchaser of electronic components and other raw materials, and can 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 expertise in supply chain management and our relationships with suppliers across the supply chain enables us to reduce our customers’ cost of goods sold and inventory exposure.
We recognize revenue from the sale of manufactured products built to customer specifications and excess inventory when title and risk of ownership have passed, the price to the buyer is fixed and determinable and collectibility is reasonably assured, which generally is when the goods are shipped. Revenue from design, development and engineering services is recognized when the services are performed and collectibility is reasonably certain. Such services provided under fixed price contracts are accounted for using the percentage of completion method. We assume no significant obligations after product shipment as we typically warrant workmanship only. Therefore, our warranty provisions are not significant.
Our cost of sales includes the cost of materials, electronic components and other materials that comprise the products we manufacture, the cost of labor and manufacturing overhead, and adjustments for excess and obsolete inventory. Our procurement of materials for production requires us to commit significant working capital to our operations and to manage the purchasing, receiving, inspection and stocking of materials. Although we bear the risk of fluctuations in the cost of materials and excess scrap, we periodically negotiate cost of materials adjustments with our customers. Our gross margin for any product depends on the sales price, the proportionate mix of the cost of materials in the product and the cost of labor and manufacturing overhead allocated to the product. We typically have the potential to realize higher gross margins on products where the proportionate level of labor and manufacturing overhead is greater than that of materials. As we gain experience in manufacturing a product, we usually achieve increased efficiencies, which result in lower labor and manufacturing overhead costs for that product and higher gross margins. Our operating results are impacted by the level of capacity utilization of manufacturing facilities. Operating income margins have generally improved during periods of high production volume and high capacity utilization. During periods of low production volume, we generally have idle capacity and reduced operating income margins.
Severe Flooding in Thailand and Suspension of Thailand Operations
As a result of the flooding in Thailand, our previously announced suspension of operations in Ayudhaya continues to be in effect. Local officials have estimated that the flooding will continue through the middle of November 2011, at which time they will begin to pump water from the industrial park.
The Ayudhaya, Thailand facilities are among our largest, generating 20-25% of our revenue in 2011. As a result, the impact on revenue and operations will be significant for the next several fiscal quarters. We are evaluating the situation on an on-going basis and are working to mitigate the impact to us and our customers. We carry property and business interruption insurance that we believe is appropriate and adequate in this situation. Our combined limit for real and personal property as well as business interruption insurance is approximately $300 million.
We and our customers are developing contingency and recovery plans that aim to enable us to meet customer needs. As part of those plans, we restarted production at our Korat, Thailand facility in November 2011 and we are shifting production from the Ayudhaya facility to our various other sites around the globe. As a result of the capital purchases associated with our contingency plans, we anticipate higher than normal capital expenditures in the fourth quarter of 2011, in an amount in the range of $20 to $25 million.
Summary of Results
Sales for the three months ended September 30, 2011 decreased 7% to $570.1 million compared to $613.9 million for the same period of 2010. During the three months ended September 30, 2011, sales to customers in the testing and instrumentation industry, computers and related products for business enterprises industry, and medical devices industry decreased 40%, 17% and 10%, respectively, from 2010. These decreases were partially offset by a 10% and 5% increase in sales to customers in the telecommunication equipment industry and industrial control equipment industry, respectively, during the same period.
Our future sales are dependent 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, could have an adverse effect on us. A substantial percentage of our sales have been 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 50% and 45% of our sales in the three months ended September 30, 2011 and 2010, respectively. Our largest customer, International Business Machines Corporation, represented 11% of our sales during the three months ended September 30, 2011.
Our gross profit as a percentage of sales decreased to 6.1% for the three months ended September 30, 2011 from 7.7% in the same period of 2010 primarily due to lower sales volumes, product mix, new program ramp costs and capacity expansion costs primarily in Asia. We experience fluctuations in gross profit from period to period. Different programs contribute different gross profits depending on factors such as the types 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, a number of our new and higher volume programs remain subject to competitive constraints that could exert downward pressure on our margins. During periods of low production volume, we generally have idle capacity and reduced gross profit.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2010. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to accounts receivable, inventories, income taxes, long-lived assets, stock-based compensation and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Accounts Receivable
Our accounts receivable balance is recorded net of allowances for amounts not expected to be collected from our customers. Because our accounts receivable are typically unsecured, we periodically evaluate the collectibility of our accounts based on a combination of factors, including a particular customer’s ability to pay as well as the age of the receivables. To evaluate a specific customer’s ability to pay, we analyze financial statements, payment history, third-party credit analysis reports and various information or disclosures by the customer or other publicly available information. In cases where the evidence suggests a customer may not be able to satisfy its obligation to us, we set up a specific allowance in an amount we determine appropriate for the perceived risk. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories
We purchase inventory based on forecasted demand and record inventory at the lower of cost or market. We reserve for estimated obsolescence as necessary in an amount equal to the difference between the cost of inventory and estimated market value based on assumptions of future demands and market conditions. We evaluate our inventory valuation on a quarterly basis based on current and forecasted usage and the latest forecasts of product demand and production requirements from our customers. Customers frequently make changes to their forecasts, requiring us to make changes to our inventory purchases, commitments, and production scheduling and may require us to cancel open purchase commitments with our vendors. This process may lead to on-hand inventory quantities and on-order purchase commitments that are in excess of our customers’ revised needs, or parts that become obsolete before use in production. In addition, the shifting of production from Ayudhaya, Thailand to Korat, Thailand and various other sites around the globe may lead to on-hand inventory quantities in excess of our customers’ needs. We record inventory reserves on excess and obsolete inventory. These reserves are established on inventory which we have determined our customers are not responsible for or on inventory which we believe our customers will be unable to fulfill their obligation to ultimately purchase. If actual market conditions are less favorable than those we projected, additional inventory write-downs may be required.
Income Taxes
We estimate our income tax provision in each of the jurisdictions in which we operate, including estimating exposures related to uncertain tax positions. We must also make judgments regarding the ability to realize the deferred tax assets. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to subsequently determine that we would be able to realize our deferred tax assets in excess of our net recorded amount, an adjustment to the valuation allowance would increase income in the period such determination was made. Similarly, should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance would reduce income in the period such determination was made. We may be able to realize all or a portion of our deferred tax assets in the U.S. in the foreseeable future. Upon such determination, an adjustment to the valuation allowance related to our deferred tax assets could cause a material increase to net income in the period such determination is made.
As of September 30, 2011, we evaluated the recoverability of our deferred tax assets using the criteria described above and concluded that our projected future taxable income in the U.S. is sufficient to utilize additional net operating loss carryforwards and other deferred tax assets. As a result, we reduced our valuation allowance by $17.5 million in the U.S. and, at the same time, increased our valuation allowance by $1.2 million in foreign jurisdictions. This net decrease was a discrete event and $16.3 million was recorded as a tax benefit in our consolidated statement of income during the third quarter of 2011.
We are subject to examination by tax authorities for varying periods in various U.S. and foreign tax jurisdictions. During the course of such examinations, disputes may occur as to matters of fact and/or law. In most tax jurisdictions the passage of time without examination will result in the expiration of applicable statutes of limitations, thereby precluding the taxing authority from conducting an examination of the tax period(s) for which such statute of limitations has expired. We believe that we have adequately provided for our tax liabilities.
Our subsidiary in Thailand has filed for a refund of $8.3 million of previously paid income taxes, which is included in other assets. The Thailand tax authorities are currently conducting an examination of the applicable filings. During the three months ended September 30, 2011, we recorded a reserve for uncertain tax benefits of $7.1 million against this receivable.
Long-Lived Assets
Long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized by the amount that the carrying amount of the asset exceeds the fair value of the asset.
Goodwill is tested annually for impairment and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss would be recognized to the extent that the carrying amount exceeds the asset’s fair value. Goodwill is measured at the reporting unit level, which we have determined to be consistent with our operating segments as defined in Note 8 to the Condensed Consolidated Financial Statements in Item 1 of this report by determining the fair values of the reporting units and comparing those fair values to the carrying values, including goodwill, of the reporting units. We completed the annual impairment test during the fourth quarter of 2010 and determined that no impairment existed as of December 31, 2010. We estimated that the fair value of our Asia business segment exceeded its carrying amount by approximately 117% at the time our 2010 impairment test was performed. Because the situation in Thailand is still evolving, significant uncertainty remains regarding the ultimate financial impact the flooding will have on our Asia business segment and its fair value. As of September 30, 2011, we had goodwill associated with our Asia business segment of approximately $37.9 million. Circumstances that may lead to future impairment of goodwill include unforeseen decreases in future performance or industry demand, the restructuring of our operations as a result of a change in our business strategy or other factors.
Stock-Based Compensation
We recognize stock-based compensation expense in our consolidated statements of income. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. Option-pricing models require the input of subjective assumptions, including the expected life of the option and the expected stock price volatility. Judgment is also required in estimating the number of stock-based awards that are expected to vest as a result of satisfaction of time-based vesting schedules. If actual results or future changes in estimates differ significantly from our current estimates, stock-based compensation could increase or decrease. For restricted stock unit awards with performance conditions, compensation expense is initially based on the target number of shares that would vest if 100% of the target performance goal is achieved, which was considered the probable outcome on the grant date. Throughout the service period, management monitors the probability of achievement of the performance condition. If it becomes probable, based on our expectation of performance during the measurement period, that more or less than the current estimate of the awarded shares will vest, an adjustment to stock-based compensation expense will be recognized as a change in accounting estimate. See Note 2 to the Condensed Consolidated Financial Statements in Item 1 of this report.
Recently Enacted Accounting Principles
See Note 11 to the Condensed Consolidated Financial Statements in Item 1 of this report for a discussion of recently enacted accounting principles.
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 Item 1 of this report.
| |
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
| |
|
September 30,
|
|
|
September 30,
|
|
| |
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
Cost of sales
|
|
|
93.9 |
|
|
|
92.3 |
|
|
|
93.5 |
|
|
|
92.2 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
6.1 |
|
|
|
7.7 |
|
|
|
6.5 |
|
|
|
7.8 |
|
|
Selling, general and administrative expenses
|
|
|
4.0 |
|
|
|
3.8 |
|
|
|
4.0 |
|
|
|
3.9 |
|
|
Restructuring charges
|
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.1 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
2.0 |
|
|
|
3.8 |
|
|
|
2.5 |
|
|
|
3.8 |
|
|
Other income (expense), net
|
|
|
(0.0 |
) |
|
|
0.2 |
|
|
|
0.0 |
|
|
|
0.0 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
2.0 |
|
|
|
4.0 |
|
|
|
2.5 |
|
|
|
3.8 |
|
|
Income tax expense (benefit)
|
|
|
(1.5 |
) |
|
|
0.3 |
|
|
|
(0.4 |
) |
|
|
0.4 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
3.5 |
% |
|
|
3.7 |
% |
|
|
2.9 |
% |
|
|
3.4 |
% |
Sales
Sales for the third quarter of 2011 were $570.1 million, a 7% decrease from sales of $613.9 million for the same quarter in 2010. Sales for the nine months ended September 30, 2011 were $1.7 billion, a 5% decrease from sales of $1.8 billion for the same period in 2010. The following table sets forth, for the periods indicated, the percentages of our sales by industry sector.
| |
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
| |
|
September 30,
|
|
|
September 30,
|
|
| |
|
2011
|
|
|
2010
|
|
|
2011
|
|
|
2010
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrial control equipment
|
|
|
29 |
% |
|
|
26 |
% |
|
|
28 |
% |
|
|
25 |
% |
|
Computers and related products for business enterprises
|
|
|
28 |
|
|
|
31 |
|
|
|
28 |
|
|
|
31 |
|
|
Telecommunication equipment
|
|
|
27 |
|
|
|
22 |
|
|
|
25 |
|
|
|
23 |
|
|
Medical devices
|
|
|
9 |
|
|
|
10 |
|
|
|
9 |
|
|
|
11 |
|
|
Testing and instrumentation products
|
|
|
7 |
|
|
|
11 |
|
|
|
10 |
|
|
|
10 |
|
| |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
During the nine months ended September 30, 2011, sales to customers in the computers and related products for business enterprises industry, medical devices industry, and testing and instrumentation industry decreased 16%, 14% and 8%, respectively, from 2010. These decreases were partially offset by a 9% and 2% increase in sales to customers in the industrial control equipment industry and telecommunication equipment industry, respectively.
Our future sales are dependent 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, could have an adverse effect on us. A substantial percentage of our sales have been 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 52% and 47% of our sales in the first nine months ended September 30, 2011 and 2010, respectively. Our largest customer represented 12% of our sales during the nine months ended September 30, 2011.
Our international operations are subject to the risks of doing business abroad. These risks have not had a material adverse effect on our results of operations through September 30, 2011. However, we can make no assurances that there will not be an adverse impact in the future. See Part II, Item 1A 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 2011 and 2010, 53% and 48%, respectively, of our sales were derived from our international operations.
Gross Profit
Gross profit decreased 27% to $34.6 million for the three months ended September 30, 2011 from $47.2 million in the same period of 2010 and decreased 21% to $110.0 million for the nine months ended September 30, 2011 from $138.7 million in the same period of 2010, due primarily to $3.5 million of settlement costs associated with the transfer of a major program, new program ramp costs and capacity expansion costs primarily in Asia incurred in 2011. Gross profit as a percentage of sales decreased to 6.1% during the third quarter of 2011 from 7.7% in 2010 and decreased to 6.5% during the first nine months of 2011 from 7.8% in 2010, primarily due to lower sales volumes, product mix, new program ramp costs and capacity expansion costs primarily in Asia, which resulted in underabsorbed manufacturing overhead costs. We experience fluctuations in gross profit from period to period. Different programs contribute different gross profits depending on factors such as the types 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, a number of our new and higher volume programs remain subject to competitive constraints that could exert downward pressure on our margins. During periods of low production volume, we generally have idle capacity and reduced gross profit.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased 2% to $22.9 million in the third quarter of 2011 from $23.4 million in the third quarter of 2010. Selling, general and administrative expenses decreased 2% to $67.8 million in the first nine months of 2011 from $68.9 million in the same period of 2010 primarily due to reduced stock-based compensation expenses, overhead resulting from cost controls and lower variable compensation expenses offset by higher employee related costs. Selling, general and administrative expenses, as a percentage of sales, were 4.0% and 3.8%, respectively, for the third quarter of 2011 and 2010, and 4.0% and 3.9%, respectively, for the first nine months of 2011 and 2010. The increase in selling, general and administrative expenses as a percentage of sales is due to the impact of lower sales volumes during 2011.
Restructuring Charges
We recognized $0.6 million in restructuring charges during the first nine months of 2011 primarily related to the decision to close our Dublin facility by the end of 2011. We expect to incur approximately $3.4 million in additional restructuring charges primarily related to the closure of this facility during the fourth quarter of 2011. The recognition of the restructuring charges requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with planned exit activities. To the extent our actual results in exiting these facilities differ from our estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the recognition of additional restructuring charges or the reduction of liabilities already recognized. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans. See Note 12 to the Condensed Consolidated Financial Statements in Item 1 of this report.
Income Tax Expense (Benefit)
Income tax expense (benefit) of $(7.1) million represented an effective tax benefit of 17.0% for the nine months ended September 30, 2011, compared with $7.2 million representing an effective tax rate of 10.6% for the same period in 2010. In the first nine months of 2011, we recorded a $0.6 million discrete tax benefit as a result of a 2010 tax rate incentive received by one of our China subsidiaries during the first quarter of 2011 and a $17.5 million discrete tax benefit as a result of a decrease in valuation allowances on deferred tax assets in the U.S., offset by a discrete tax expense of $7.1 million of additional reserves for uncertain tax benefits and $1.2 million in additional deferred tax valuation allowances for foreign net operating loss carryforwards. In the third quarter of 2010, we recorded a $1.4 million tax benefit as a result of the expiration of the statute of limitations primarily related to an intercompany transaction between two of our subsidiaries. Excluding these one-time net tax benefits, the effective tax rate would have been 6.4% in 2011 compared to 12.7% in 2010. This decrease in the effective tax rate is primarily due to the impact from tax incentives and the reduced tax rate in China for one of our subsidiaries during 2011. See Note 7 to the Condensed Consolidated Financial Statements in Item 1 of this report.
Net Income
We reported net income of $49.1 million, or diluted earnings per share of $0.81 for the first nine months of 2011, compared with net income of $60.7 million, or diluted earnings per share of $0.96 for the same period of 2010. The net decrease of $11.7 million from 2010 was primarily due to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our growth and operations through funds generated from operations, proceeds from the sale and maturity of our investments and funds borrowed under our credit facilities. Cash and cash equivalents totaled $253.8 million at September 30, 2011 and $346.3 million at December 31, 2010, of which $202.0 million at September 30, 2011 and $241.6 million at December 31, 2010 was held outside the U.S. in various foreign subsidiaries. Substantially all of the amounts held outside of the U.S. are intended to be indefinitely reinvested in foreign operations. Under current tax laws and regulations, if cash and cash equivalents held outside the U.S. were to be distributed to the U.S. in the form of dividends or otherwise, we would be subject to additional U.S. income taxes and foreign withholding taxes.
Cash provided by operating activities was $0.2 million for the nine months ended September 30, 2011. The cash provided by operations during 2011 consisted primarily of $49.1 million of net income adjusted for $26.2 million of depreciation and amortization, and a $19.4 million increase in accounts payable, offset by a $69.5 million increase in inventories, an $11.5 million increase in deferred income taxes, a $7.0 million increase in accounts receivable and a $9.8 million decrease in accrued liabilities. Working capital was $865.5 million at September 30, 2011 and $895.9 million at December 31, 2010.
We are continuing the practice of purchasing 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 would increase backorders and therefore impact cash flows.
Cash used in investing activities was $39.0 million for the nine months ended September 30, 2011 primarily due to the purchases of additional property, plant and equipment totaling $49.8 million, offset by redemptions of investments totaling $11.1 million. Purchases of additional property, plant and equipment consisted primarily of facilities and certain other assets to expand our precision technologies capabilities in Penang, Malaysia.
Cash used in financing activities was $51.8 million for the nine months ended September 30, 2011. Share repurchases totaled $53.2 million and we received $1.6 million from the exercise of stock options.
Under the terms of a credit agreement (the Credit Agreement), we have a $100.0 million five-year revolving credit facility to be used for general corporate purposes with a maturity date of December 21, 2012. The Credit Agreement includes an accordion feature under which total commitments under the facility may be increased by an additional $100 million, subject to satisfaction of certain conditions and lender approval. Interest on outstanding borrowings under the Credit Agreement is payable quarterly, at our option, at LIBOR plus 0.75% to 1.75% or a prime rate plus 0.00% to 0.25%, based upon our debt ratio as specified in the Credit Agreement. A commitment fee of 0.15% to 0.35% per annum (based upon our debt ratio) on the unused portion of the revolving credit line is payable quarterly in arrears. As of September 30, 2011 and December 31, 2010, we had no borrowings outstanding under the Credit Agreement and $100.0 million was available for future borrowings.
The Credit Agreement is secured by our domestic inventory and accounts receivable, 100% of the stock of our domestic subsidiaries, and 65% of the voting capital stock of each direct foreign subsidiary and substantially all of our and our domestic subsidiaries’ other tangible and intangible assets. The Credit Agreement contains customary financial covenants as to working capital, debt leverage, fixed charges and consolidated net worth, and restricts our ability to incur additional debt, pay dividends, repurchase shares, sell assets and merge or consolidate with other persons. As of September 30, 2011, we were in compliance with all such covenants and restrictions.
Our Thailand subsidiary has a multi-purpose credit facility with Kasikornbank Public Company Limited (the Thai Credit Facility) that provides for approximately $11.2 million (350 million Thai baht) in working capital availability. The Thai Credit Facility is secured by land and buildings in Thailand. The availability of funds under the Thai Credit Facility is reviewed annually and is currently accessible through October 2012. As of September 30, 2011, our Thailand subsidiary had no working capital borrowings outstanding.
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, 2011, we had cash and cash equivalents totaling $253.8 million and $100.0 million available for borrowings under the Credit Agreement. We expect that our cash position will be adversely impacted by the suspension of our operations in Ayudhaya, Thailand and expenditures related to recovery from the flooding of our facilities in Ayudhaya. Specifically, we anticipate our cash flow for the quarter ended December 31, 2011, and possibly beyond, to be negative. As a result of the capital purchases associated with our Thailand contingency plans, we anticipate higher than normal capital expenditures in the fourth quarter of 2011, in an amount in the range of $20 to $25 million. We also expect to incur unusual charges and expenses related to the flooding, some of which will be cash charges and expenses. During the next twelve months, we believe our capital expenditures will be approximately $40 to $50 million, principally for machinery and equipment to support our ongoing business around the globe.
On March 3, 2010, our Board of Directors approved the repurchase of up to $100 million of our outstanding common shares (the 2010 Repurchase Program). As of September 30, 2011, we have $38.2 million remaining under the 2010 Repurchase Program to repurchase additional shares. We are under no commitment or obligation to repurchase any particular amount of common shares. We have suspended the repurchase of our common shares due to the significant uncertainty regarding the ultimate financial impact of the flooding in Thailand on our cash flows.
Notwithstanding the foregoing, management believes that our existing cash balances and funds generated from operations will be sufficient to permit us to meet our liquidity requirements over the next twelve months. Management further believes that our ongoing cash flows from operations and any borrowings we may incur under our credit facilities will enable us to meet operating cash requirements in future years. Should we decide to consummate significant acquisition opportunities, our capital needs would increase and could possibly result in our need to increase available borrowings under our revolving credit facility 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 terms that we would consider acceptable.
CONTRACTUAL OBLIGATIONS
We have certain contractual obligations for operating leases that were summarized in a table of Contractual Obligations in our Annual Report on Form 10-K for the year ended December 31, 2010. There have been no material changes to our contractual obligations, outside of the ordinary course of our business, since December 31, 2010.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2011, we did not have any significant off-balance sheet arrangements.
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
Our international sales are a significant portion of our net sales. We are exposed to risks associated with operating internationally, including the following:
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•
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Foreign currency exchange risk;
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•
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Import and export duties, taxes and regulatory changes;
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•
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Inflationary economies or currencies; and
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•
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Economic and political instability.
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We do not use derivative financial instruments for speculative purposes. As of September 30, 2011, we did not have any foreign currency hedges. In the future, significant transactions involving our international operations may cause us to consider engaging in hedging transactions to attempt to mitigate our exposure to fluctuations in foreign exchange rates. These exposures are primarily, but not limited to, vendor payments and intercompany balances in currencies other than the currency in which our foreign operations primarily generate and expend cash. Our international operations in some instances operate in a natural hedge because both operating expenses and a portion of sales are denominated in local currency. Our sales are substantially denominated in U.S. dollars. Our foreign currency cash flows are generated in certain Asian and European countries, Mexico and Brazil.
We are also exposed to market risk in connection with changes in interest rates, 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. As of September 30, 2011, the outstanding amount in the long-term investment portfolio included $28.1 million (par value) of auction rate securities with an average annual return of approximately 0.35%.
Item 4 – Controls and Procedures
Our management has evaluated, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon such evaluation, our CEO and CFO have concluded that, as of such date, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in our internal control over financial reporting that occurred during the fiscal period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management, including our CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. 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 our 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 the individual acts of some persons, by collusion of two or more people, or by management override of 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. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Exhibits 31.1 and 31.2 are the Certifications of the CEO and the CFO, respectively. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). This Item is the information concerning the Evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
On June 3, 2007, Power Paper, Ltd. (Power Paper), a limited liability company from Israel filed suit against Pemstar Inc. (Pemstar) in U.S. District Court in Minnesota. Pemstar was a Minnesota public company that was acquired by us in January 2007. Power Paper’s claim sought damages of up to $22.8 million based on an alleged breach of contract. The trial, which began on September 12, 2011, resulted in a jury verdict in favor of Pemstar.
In addition to the matter described above, we are involved in various legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these other matters will not have a material adverse effect on our consolidated financial position or results of operations.
Item 1A. Risk Factors.
The risk factor set forth below is in addition to the risk factors previously set forth in Part I, Item 1A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
Recent severe flooding in Thailand, which has inundated our Ayudhaya, Thailand manufacturing facilities, resulted in the suspension of all production in those facilities, has adversely affected the near-term availability of components from some of our suppliers located in Thailand and will adversely affect our near-term business, results of operations and financial condition.
The recent severe flooding in Thailand, and the suspension of production in our Ayudhaya, Thailand manufacturing facilities, which generated 20-25% of our revenue in 2011, will adversely affect our near-term business, results of operations and financial condition. Material risks and uncertainties we face as a result of flooding in Thailand include the following:
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Recommencement of Operations. Our ability and the time required to recommence operations following the flooding of our Ayudhaya, Thailand facilities will be affected by the time necessary for the flood waters to recede, the extent of damage to our facilities and equipment caused by the floods, the time required to repair or replace damaged equipment and our ability to access freight lanes and transportation routes. At this time, we anticipate recommencing full operations during the first quarter of 2012. While we are ramping capacity at our other facilities around the world, including our recently restarted facility in Korat, Thailand, the extent of additional capacity we can achieve may be limited by the space available and our ability to extract and transfer equipment to other facilities. Until we are able to recommence production at normal capacity, our costs will be impacted negatively by significant underabsorption of our assets and infrastructure, our production levels will be constrained and our business and results of operations will be adversely affected.
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Availability of Components. We are also experiencing component shortages from vendors located in several Thailand industrial parks that have already been inundated by the flooding or have been affected by protective plant shut downs. We are working with our suppliers to understand the extent of their capacity constraints, if any, and to find alternative sources for our component materials if required. Additionally, due to supply constraints, the cost of certain component materials may increase, which may adversely affect our results of operations.
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Recovery and Related Charges and Expenses. We expect to incur charges and expenses related to recovering from the flooding of our Ayudhaya, Thailand facilities and its impact on our operations, including items such as fixed asset impairments, inventory write-downs and charges for restoration and recovery work. The amount of these charges and expenses cannot currently be estimated and is dependent on several factors, including our ability to extract water from our facilities, the extent of damage to our facilities, existing inventories and equipment caused by the flooding, and the time and effort required to restore or replace damaged equipment. The ultimate timing of the incurrence of these charges and expenses is dependent on the time required to complete our recovery efforts and recommence production in Thailand at normal capacity.
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Insurance. We maintain insurance coverage that provides for reimbursement from losses resulting from flood damage. The magnitude of the flood damage we will incur is dependent on a number of factors, including those described above, and cannot currently be estimated. We also maintain insurance for business interruption losses, and we are currently working with our insurance carrier to determine the amounts we may recover under this policy. We cannot estimate the timing of the receipt of proceeds we will ultimately obtain under our insurance policies, and there may be a substantial delay between our incurrence of losses and our recovery under our insurance policies.
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Because the situation in Thailand is still evolving, significant uncertainty remains regarding the ultimate financial impact the flooding will have on our company. Furthermore, if the flooding in Thailand continues, worsens or occurs with greater frequency in the future, disruptions to our facilities could continue over an extended period of time, restrict our ability to obtain required components from our Thailand suppliers, impair our ability to meet our customers’ production requirements, cause cancellations of customer orders and reduce demand for our products, which could have a materially adverse affect on our business, results of operations and financial condition.
Item 2. Unregistered Sales Of Equity Securities And Use Of Proceeds.
(c) The following table provides information about the Company repurchases of its equity securities that are registered pursuant to Section 12 of the Exchange Act during the quarter ended September 30, 2011, at a total cost of $53.2 million:
ISSUER PURCHASES OF EQUITY SECURITIES
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(d) Maximum
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(c) Total
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Number (or
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Number of
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Approximate
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Shares (or
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Dollar Value)
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Units)
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of Shares (or
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Purchased as
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Units) that
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(a) Total
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Part of
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May Yet Be
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Number of
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(b) Average
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Publicly
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Purchased
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Shares (or
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Price Paid per
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Announced
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Under the
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Units)
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Share (or
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Plans or
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Plans or
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Period
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Purchased (1)
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Unit) (2)
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Programs
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Programs (3)
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July 1 to 31, 2011
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357,500 |
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$ |
16.38 |
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357,500 |
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$ |
60.9 |
million |
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August 1 to 31, 2011
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1,222,744 |
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$ |
13.61 |
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1,222,744 |
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$ |
44.2 |
million |
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September 1 to 30, 2011
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455,000 |
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$ |
13.13 |
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455,000 |
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$ |
38.2 |
million |
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Total
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2,035,244 |
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$ |
13.99 |
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2,035,244 |
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(1) All share repurchases were made on the open market.
(2) Average price paid per share is calculated on a settlement basis and excludes commission.
(3) On March 3, 2010, the Board of Directors of the Company approved the repurchase of up to $100 million of the Company’s outstanding common shares. Share purchases may be made in the open market, in privately negotiated transactions or block transactions, at the discretion of the Company’s management and as market conditions warrant. Purchases will be funded from available cash and may be commenced, suspended or discontinued at any time without prior notice. All shares repurchased through September 30, 2011 were retired. The Company has suspended the repurchase of our common shares due to the significant uncertainty regarding the ultimate financial impact of the flooding in Thailand on its cash flows.
Item 6. Exhibits.
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10.1
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Form of Performance-Based Restricted Stock Unit Award Agreement for use under the 2010 Omnibus Incentive Compensation Plan (incorporated by reference to exhibit 10.1 to the Company’s Form 8-K dated March 2, 2011 filed on March 4, 2011 (Commission file number 1-10560)).
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31.1
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Section 302 Certification of Chief Executive Officer
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31.2
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Section 302 Certification of Chief Financial Officer
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32.1
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Section 1350 Certification of Chief Executive Officer
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32.2
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Section 1350 Certification of Chief Financial Officer
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101.INS*
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XBRL Instance Document
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101.SCH*
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XBRL Taxonomy Extension Schema Document
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101.CAL*
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XBRL Taxonomy Extension Calculation Linkbase Document
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101.LAB*
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XBRL Taxonomy Extension Label Linkbase Document
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101.PRE*
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XBRL Taxonomy Extension Presentation Linkbase Document
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101.DEF*
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XBRL Taxonomy Extension Definition Linkbase Document
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* XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934 and otherwise is not subject to liability under these sections.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on November 8, 2011.
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BENCHMARK ELECTRONICS, INC.
(Registrant)
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By:
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/s/ Cary T. Fu |
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Cary T. Fu
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Chief Executive Officer
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(Principal Executive Officer) |
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By:
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/s/ Donald F. Adam |
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(Principal Financial Officer)
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Exhibit
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Number
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Description of Exhibit
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10.1
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Form of Performance-Based Restricted Stock Unit Award Agreement for use under the 2010 Omnibus Incentive Compensation Plan (incorporated by reference to exhibit 10.1 to the Company’s Form 8-K dated March 2, 2011 filed on March 4, 2011 (Commission file number 1-10560)).
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31.1
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Section 302 Certification of Chief Executive Officer
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31.2
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Section 302 Certification of Chief Financial Officer
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32.1
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Section 1350 Certification of Chief Executive Officer
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32.2
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Section 1350 Certification of Chief Financial Officer
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101.INS*
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XBRL Instance Document
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101.SCH*
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XBRL Taxonomy Extension Schema Document
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101.CAL*
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XBRL Taxonomy Extension Calculation Linkbase Document
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101.LAB*
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XBRL Taxonomy Extension Label Linkbase Document
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101.PRE*
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XBRL Taxonomy Extension Presentation Linkbase Document
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101.DEF*
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XBRL Taxonomy Extension Definition Linkbase Document
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* XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934 and otherwise is not subject to liability under these sections.