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DDI CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following is a discussion of the financial condition and results of operations for our three and six months ended June 30, 2011. As used herein, the "Company," "we," "us," or "our" means DDi Corp. and its wholly-owned subsidiaries. This discussion and analysis should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in DDi Corp.'s Annual Report on Form 10-K for the year ended December 31, 2010 (the "Form 10-K"). Some of the statements in this section contain forward-looking statements regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events, which involve risks and uncertainties. All statements other than statements of historical facts included in this section relating to expectation of future financial performance, continued growth, changes in economic conditions or capital markets and changes in customer usage patterns and preferences, are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, intend, forecast, anticipate, believe, estimate, predict, potential, continue or the negative of these terms or other comparable terminology. The forward-looking statements contained in this section involve known and unknown risks, uncertainties and situations that may cause our or our industry's actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. Factors that might cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters listed under "Risk Factors" in Item 1A in our Form 10-K including, but not limited to, changes in general economic conditions in the markets in which we may compete and fluctuations in demand in the electronics industry; increased competition; increased costs; our ability to retain key members of management; our ability to address changes to environmental laws and regulations; potential impacts of natural disasters on the electronics industry and the company's supply chain; risks associated with acquisitions; adverse state, federal or foreign legislation or regulation or adverse determinations by regulators; and other factors identified from time to time in our filings with the U. S. Securities and Exchange Commission ("SEC"). Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all such factors. 10-------------------------------------------------------------------------------- Table of Contents Our Company We are a leading provider of time-critical, technologically-advanced printed circuit board ("PCB") engineering and manufacturing services. We specialize in engineering and fabricating complex multi-layer PCBs on a quick-turn basis, with lead times as short as 24 hours, and in manufacturing products with high levels of complexity and reliability with low-to-moderate production volumes. We have over 1,000 PCB customers in various market segments including communications, computing, military/aerospace, industrial electronics, instrumentation, medical and high-durability commercial markets. Our customers include both original equipment manufacturers ("OEMs") and electronic manufacturing services ("EMS") providers. With such a broad customer base and approximately 60 new PCB designs tooled per day, we have accumulated significant process and engineering expertise. Our core strength is developing innovative, high-performance solutions for customers during the engineering, test and launch phases of new electronic product development and supporting long-term requirements for low-to-moderate production volumes, such as those required by the military/aerospace market. Our entire organization is focused on rapidly and reliably filling complex customer orders and building long-term customer relationships. Our engineering capabilities and seven manufacturing facilities located in the United States and Canada, together with our suppliers in Asia, enable us to respond to time-critical orders and technology challenges for our customers. Industry Overview PCBs are a fundamental component of virtually all electronic equipment. A PCB is comprised of layers of laminate and copper and contains patterns of electrical circuitry to connect electronic components. The level of PCB complexity is determined by several characteristics, including interconnect and circuit density, size, layer count, material type and functionality. High-end commercial and military/aerospace equipment manufacturers require complex PCBs fabricated with higher layer counts, greater interconnect and circuit density and advanced materials, and demand highly complex and sophisticated manufacturing capabilities. By contrast, other PCBs, such as those used in non-wireless consumer electronic products, are generally less complex and have less sophisticated manufacturing requirements. Critical Accounting Policies and Use of Estimates The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. Information with respect to our critical accounting policies which we believe could have the most significant effect on our reported results and require subjective or complex judgments by management is contained on pages 24 to 26 in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of the Company's Annual Report on Form 10-K. We believe that at June 30, 2011 there had been no material changes to this information. Results of Operations - Summary During the second quarter of 2011, we experienced a reduced level of demand as customer orders fell sequentially by 8% to $66.2 million reflecting a 1.00 book to bill ratio. This sequential decrease during the second quarter of 2011 follows an 18% sequential increase in customer orders to a record level of $72.2 million during the first quarter of 2011. During the fourth quarter of 2010 we experienced a 15% sequential decrease in customer orders. These three consecutive quarters of inconsistent trends in customer demand follows five consecutive quarters of increasing customer orders starting in the third quarter of 2009. For the six months ended June 30, 2011, total customer orders were $138.4 which reflects a slight decrease of 2% from the same period of the prior year. This slight decrease is primarily comprised of lower demand in the communications and consumer electronics segments partially offset by increases in the government, military and aerospace segment, industrial electronics segment, and the instrumentation and medical segment. Likewise, the net sales were $132.7 million for the six months ended June 30, 2011 which are basically flat with the $133.0 million recorded in the same period of the prior year. Looking ahead to the balance of 2011, we are cautious regarding the overall economic environment in North America and the impact on the demand for printed circuit boards. In particular, we have seen spots of softer demand being forecasted in the military/aerospace market sector with the budget pressures anticipated on the U.S. Department of Defense and our customers in this market segment. With the economic recovery uncertain, we remain intensely focused on operational and financial discipline, gaining market share in our core markets, and technological innovation to continue to improve DDi's overall business platform. 11 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Three Months Ended June 30, 2011 Compared to the Three Months Ended June 30, 2010 The following tables set forth select data from our Unaudited Condensed Consolidated Statements of Income (in thousands): Three Months Ended June 30, 2011 2010 $ Change % Change Net sales $ 66,224 $ 68,382 $ (2,158 ) (3.2 %) Cost of goods sold 51,781 53,067 (1,286 ) (2.4 %) Gross profit $ 14,443 $ 15,315 $ (872 ) (5.7 %)Gross profit as a percentage of net sales 21.8 % 22.4 % Net Sales Net sales are derived from the engineering and manufacture of complex, technologically-advanced multi-layer PCBs. Net sales decreased $2.2 million or 3.2%, to $66.2 million for the first quarter of 2011, from $68.4 million for the same period in 2010. This slight decrease in net sales is primarily driven by decreased sales to the communications, consumer electronics, and the government, military and aerospace segments partially offset by higher sales to the computer, industrial electronics, and instrumentation and medical segments. Gross Profit Gross profit for the second quarter of 2011 was $14.4 million, or 21.8% of net sales as compared to $15.3 million, or 22.4% of net sales for the same period in 2010. The decrease in gross profit from the same period in the prior year was primarily due to slightly lower revenues and higher material costs driven by higher commodity prices, labor and depreciation partially off-set by lower overhead costs. Lower overhead costs during the second quarter of 2011 primarily represent the benefits realized from our Toronto facilities integration. Sales and Marketing Expenses Three Months Ended June 30, 2011 2010 $ Change % Change Sales and marketing expenses $ 4,284 $ 4,294 $ (10 ) (0.2 %) Percentage of net sales 6.5 % 6.3 % Sales and marketing expenses remained flat on an absolute dollar basis for the second quarter of 2011 compared to the same period of the prior year and increased slightly as a percent of sales due to lower sales in the second quarter of 2011 compared to the same period in the prior year. General and Administrative Expenses Three Months Ended June 30, 2011 2010 $ Change % Change General and administrative expenses $ 3,846 $ 3,790 $ 56 1.5 % Percentage of net sales 5.8 % 5.5 % General and administrative expenses remained flat for the three months ended June 30, 2011 at $3.8 million as compared to the same period of the prior year. Amortization of Intangibles Amortization of intangible assets relates to customer relationships identified in connection with the purchase of Sovereign Circuits Inc. in the fourth quarter of 2006. These intangible assets are being amortized using the straight-line method over an estimated useful life of five years resulting in $0.2 million of amortization expense per quarter for the remaining acquisition-related customer relationships through October 2011. 12-------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense consists of amortization of debt issuance costs, interest expense associated with long-term deferred leases, and interest on seven asset-backed term loans. Interest expense was $0.4 million for the second quarter of 2011 compared $0.3 million in the same period of the prior year. Net Other Expense (Income) Net other income consists of foreign exchange transaction gains or losses related to our Canadian operations and other miscellaneous non-operating items. For the second quarter of 2011, net other income was flat at $0.1 million compared to the same period of the prior year. Restructuring and Other Related Charges The acquisition of Coretec on December 31, 2009 prompted us to integrate the operations of DDi's legacy facility in Toronto (McNicoll) with Coretec's Toronto facility (Sheppard Avenue) during 2010, which reduced fixed overhead costs, rationalized capacity, and allowed for taking full advantage of the modern Sheppard Avenue manufacturing facility. During the second quarter of 2011, we incurred $0.6 million of severance costs related to the final phase of the Toronto integration plan. During the three and six months ended June 30, 2010, we incurred $0.3 million of integration costs which were composed of estimated site remediation, asset disposals, severance, and other typical integration expenses. Income Tax Expense We recorded an income tax expense for the second quarter of 2011 of $0.1 million or 2.0% of pre-tax income, compared to income tax expense of $0.3 million, or 4.9% of pre-tax income, for the same period in the prior year. The decrease in income tax expense during the second quarter of 2011 was primarily due to uncertain tax positions and state income taxes. Our effective income tax rate differs from the U.S. federal statutory tax rate of 35% primarily as a result of the mix of earnings between tax jurisdictions, research and development credits, state income taxes and our continuous evaluation of the realization of our deferred tax assets and uncertain tax positions, and the impact of the recognition of the tax benefit of net operating loss carry forwards to the extent of current earnings. Results of Operations for the Six Months Ended June 30, 2011 Compared to the Six months Ended June 30, 2010 The following tables set forth select data from our Unaudited Condensed Consolidated Statement of Operations (in thousands): Six Months Ended June 30, 2011 2010 $ Change % Change Net sales $ 132,683 $ 133,047 $ (364 ) (0.3 %) Cost of goods sold 104,088 103,746 342 0.3 % Gross profit $ 28,595 $ 29,301 $ (706 ) (2.4 %) Gross profit as a percentage of net sales 21.6 % 22.0 % Net Sales Net sales remained flat for the six months ended June 30, 2011 at $132.7 million as compared to $133.0 million in the same period of the prior year. Gross Profit Gross profit for the six months ending June 30, 2011 was $28.6 million, or 21.6% of net sales, compared to $29.3 million, or 22.0% of net sales, for the same period in the prior year. Gross profit for the six months ending June 30, 2010 was lower primarily due to higher material costs driven by higher commodity prices, labor and depreciation partially offset by lower overhead costs. Lower overhead costs during the six months ended June 30, 2011 primarily represent the benefits realized from our Toronto facilities integration. 13-------------------------------------------------------------------------------- Table of Contents Sales and Marketing Expenses Six Months Ended June 30, 2011 2010 $ Change % Change Sales and marketing expenses $ 8,922 $ 8,801 $ 121 1.4 % Percentage of net sales 6.7 % 6.6 % Sales and marketing expenses increased slightly on an absolute dollar basis by $0.1 million, to $8.9 million or 6.7% of net sales for the six months ended June 30, 2010, from $8.8 million, or 6.6% of net sales for the same period in the prior year. General and Administrative Expenses Six Months Ended June 30, 2011 2010 $ Change % Change General and administrative expenses $ 7,805 $ 8,213 $ (408 ) (5.0 %) Percentage of net sales 5.9 % 6.2 % General and administrative expenses decreased on an absolute dollar basis by $0.4 million to $7.8 million, or 5.9% of net sales for the six months ending June 30 2011, from $8.2 million, or 6.2% of net sales for the same period in the prior year. The decrease in general and administrative expenses was primarily due to $0.4 million of professional fees from the Coretec acquisition included in the six months ended June 30, 2010. Amortization of Intangible Assets Amortization of intangible assets relates to customer relationships identified in connection with the purchase of Sovereign Circuits in the fourth quarter of 2006. These intangible assets are being amortized using the straight-line method over an estimated useful life of five years resulting in $0.4 million of amortization expense for the six month period ending June 30, 2011 and 2010. Interest Expense Interest expense consists of amortization of debt issuance costs, interest expense associated with long-term deferred leases, and interest on our long-term debt. Interest expense was $0.8 million for the six months ended June 30, 2011 as compared to $0.8 million for the same period in the prior year. Other Expense (Income), Net Net other expense consists of foreign exchange transaction gains or losses related to our Canadian operations and other miscellaneous non-operating items. For the six months ending June 30, 2011 the balance was less than $0.1 million as compared $0.4 million for the same period in the prior year. Restructuring and Other Related Charges The acquisition of Coretec on December 31, 2009 prompted us to integrate the operations of DDi's legacy facility in Toronto (McNicoll) with Coretec's Toronto facility (Sheppard Avenue) during 2010, which reduced fixed overhead costs, rationalized capacity, and allowed for taking full advantage of the modern Sheppard Avenue manufacturing facility. During the six months ended of 2011, we incurred $0.6 million of severance costs related to the final phase of the Toronto integration plan. During the six months ended June 30, 2010, we incurred $0.3 million of integration costs which were composed of estimated site remediation, asset disposals, severance, and other typical integration expenses. Income Tax Expense The Company recorded an income tax expense for the six months ended June 30, 2011 of $0.2 million or 1.6% of pre-tax income as compared to an income tax expense of $0.7 million, or 6.9% of pre-tax income for the same period in the prior year. The decrease in income tax expense was primarily due to a higher than historical Canadian income tax expense during the six months ended June 30, 2010. Our effective income tax rate differs from the U.S. federal statutory tax rate of 35% primarily as a result of the mix of earnings between tax jurisdictions, research and development credits, state income taxes and our continuous evaluation of the realization of our deferred tax assets and uncertain tax positions, and the impact of the recognition of the tax benefit of net operating loss carry forwards to the extent of current earnings. 14-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources June 30, December 31, 2011 2010 (Dollars in thousands) Working capital $ 57,653 $ 51,026 Current ratio (current assets to current liabilities) 2.57 : 1.0 2.24 : 1.0 Cash and cash equivalents $ 25,646 $ 28,347 Long-term debt $ 9,269 $ 9,704 Our principal sources of liquidity to fund ongoing operations have been existing cash on hand and cash generated from operations. As of June 30, 2011, we had total cash and cash equivalents of $25.6 million. Management defines cash and cash equivalents as highly liquid deposits with original maturities of 90 days or less when purchased. We maintain cash and cash equivalents at certain financial institutions in excess of amounts insured by federal agencies. However, management does not believe this concentration subjects the Company to any unusual financial risk beyond the normal risk associated with commercial banking relationships. We frequently monitor the third-party depository institutions that hold our cash and cash equivalents. Our emphasis is primarily on safety of principal and secondarily on maximizing yield on those funds. The increase in our working capital and related improvement to our current ratio at June 30, 2011from December 31, 2010 was primarily due to an increase in our current assets and decrease to our current liabilities. This increase in current assets from December 31, 2010 was primarily due to higher accounts receivable and inventory balances offset by a decrease in cash and cash equivalents. The decrease in current liabilities from December 31, 2010 was primarily due to a decrease in accounts payable and accrued expenses. The decrease in our cash and cash equivalents of $2.7 million from December 31, 2010 was primarily due to our net income for the six months ended June 30, 2011 of $10.0 million, non-cash operating activities of $5.3 million, offset by working capital uses of cash totaling $8.6 million. Investing activities totaled $4.8 million and primarily consisted of property and equipment purchases at our manufacturing facilities. Financing activities totaled $4.5 million and primarily consisted of our cash dividend of $4.1 million, principal payments of long term debt of $0.4 million, offset by stock option exercise proceeds of $0.5 million. We believe that our current cash balance, in combination with net cash expected to be generated from operations and available borrowing under our revolving line of credit, will fund ongoing operations for at least the next twelve months. Revolving Credit Facilities JPMorgan Chase Credit Agreement. On September 23, 2010, the Company entered into a Credit Agreement (the "Credit Agreement") with JPMorgan Chase Bank, N.A., as Administrative Agent and U.S. Lender, and JPMorgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent and Canadian Lender (the "Lender"). The Credit Agreement provides for a revolving credit in an aggregate principal amount of $25.0 million, with a Canadian sub-limit of $10.0 million. The revolving credit agreement has an accordion provision that allows the Company to increase the size to $40.0 million under certain circumstances. As of June 30, 2011, we had no borrowings outstanding under the Credit Agreement. On March 14, 2011, The Company entered into an amendment (the "March 2011 Credit Amendment") to the Credit Agreement dated September 23, 2010. The March 2011 Credit Amendment amends the Credit Agreement to (i) reduce the margin from 3.25% to 2.50% that is added to published interest rates to determine the applicable interest rates for borrowing and (ii) increase the amount of dividends that the Company can pay without obtaining the consent of the Lender from $8 million in a rolling twelve-month period (and $25 million over the term of the Credit Agreement) to $12 million ($40.0 million over the term of the Credit Agreement). At June 30, 2011 there had been no material changes in the Company's significant contractual obligations and commitments as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2010. 15-------------------------------------------------------------------------------- Table of Contents Consolidated Cash Flows The following table summarizes our statements of cash flows for the six months ended June 30, 2011 and 2010 (in thousands): Six Months Ended June 30, 2011 2010 Net cash used in: Operating activities $ 6,639 $ 4,440 Investing activities (4,824 ) (3,623 ) Financing activities (4,495 ) (4,802 ) Effect of exchange rates on cash (21 ) 140 Net decrease in cash and cash equivalents $ (2,701 ) $ (3,845 ) Net cash used in operating activities represents net income adjusted for non-cash charges and working capital changes. The $2.2 million increase in net cash provided by operating activities for the six months ended June 30, 2011 compared to the same period in 2010 was primarily due to a lower increase in accounts receivable and a lower decrease in accrued expenses partially offset by a higher increase in inventories and a decrease in accounts payable. Net cash used in investing activities for the six months ended June 30, 2011 increased by $1.2 million compared to the same period in 2010 due to an increased investment in capital assets. The $0.3 million decrease in net cash used in financing activities for the six months ended June 30, 2011 compared to the same period in 2010 was primarily due to the $4.3 million payoff in the first quarter of 2010 of the borrowings from the credit facility assumed upon the acquisition of Coretec. This decrease was largely matched by the $4.1 million cash dividend payments to common shareholders in the six months ended June 30, 2011. |