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VIASYSTEMS GROUP INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with "Selected Financial Data" and our consolidated financial statements and related notes included elsewhere in this Report. The following discussion contains forward-looking statements based upon current expectations and related to future events, and our future financial performance involves risks and uncertainties. We based these statements on assumptions we consider reasonable. Actual results and the timing of events could differ materially from those discussed in the forward-looking statements; see "Cautionary Statements Concerning Forward-Looking Statements." Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this document, particularly in "Risk Factors." Recent Developments The DDi Acquisition On May 31, 2012, we acquired DDi Corp. ("DDi") in an all cash purchase transaction pursuant to which DDi became our wholly owned subsidiary (the "DDi Acquisition"). DDi was a leading manufacturer of technologically advanced, multi-layer printed circuit boards with operations in the United States and Canada. The DDi Acquisition increased our PCB manufacturing capacity by adding seven additional PCB production facilities, added flexible circuit manufacturing capabilities and enhanced our North American quick-turn services capability. The total consideration we paid in the merger was $282.0 million. We have recorded the assets acquired and liabilities assumed from DDi at their estimated fair values. Issuance of Senior Secured Notes due 2019 and Redemption of Senior Secured Notes due 2015 On April 30, 2012, our subsidiary, Viasystems, Inc., completed a private offering of $550.0 million of 7.875% Senior Secured Notes due 2019 (the "2019 Notes") and, on May 30, 2012, redeemed all of its outstanding $220.0 million aggregate principal amount of 12.0% senior secured notes due 2015 (the "2015 Notes") at a redemption price of 107.4% plus accrued interest. The net proceeds of the 2019 Notes were used to fund the redemption of our 2015 Notes and the DDi Acquisition. In connection with the redemption of the 2015 Notes, we incurred a loss on the early extinguishment of debt of $24.2 million, which included a call premium of $16.3 million, the write-off of unamortized original issue discount of $4.1 million and the write-off of unamortized deferred financing fees of $3.8 million. Guangzhou Fire On September 5, 2012, we experienced a fire contained to a part of one building on the campus of our PCB manufacturing facility in Guangzhou, China, which resulted in damage to inventory and fixed assets and temporarily reduced the facility's manufacturing capacity. As of December 31, 2012, we had restored a portion of the manufacturing capacity lost as a result of the fire damage, and completed our recovery in January 2013. 31-------------------------------------------------------------------------------- Table of Contents Company Overview We are a leading worldwide provider of complex multi-layer printed circuit boards ("PCBs") and electro-mechanical solutions ("E-M Solutions"). PCBs serve as the "electronic backbone" of almost all electronic equipment, and our E-M Solutions products and services integrate PCBs and other components into finished or semi-finished electronic equipment, which include custom and standard metal enclosures, metal cabinets, metal racks and sub-racks, backplanes, cable assemblies and busbars. We operate our business in two segments: Printed Circuit Boards, which includes our PCB products, and Assembly, which includes our E-M Solutions products and services. The components we manufacture include, or can be found in, a wide variety of commercial products, including automotive engine controls, hybrid converters, automotive electronics for navigation, safety and entertainment, telecommunications switching equipment, data networking equipment, computer storage equipment, semiconductor test equipment, wind and solar energy applications, off-shore drilling equipment, communications applications, flight control systems and complex industrial, medical and other technical instruments. We are a supplier to more than 1,000 original equipment manufacturers ("OEMs") and contract electronic manufacturers ("CEMs") in numerous end markets. Our OEM customers include industry leaders such as Agilent Technologies, Inc., Alcatel-Lucent SA, Apple Inc., Autoliv, Inc., BAE Systems, Inc., Robert Bosch GmbH, Broadcom Corporation, Ciena Corporation, Cisco Systems, Inc., Continental AG, Dell Inc., Danahar Corporation, Ericsson AB, General Electric Company, Goodrich Corporation, Harris Communications, Hitachi, Ltd., Huawei Technologies Co. Ltd., Intel Corporation, L-3 Communications Holdings, Inc., Motorola Inc., NetApp, Inc., Q-Logic Corporation, Qualcomm Incorporated, Raytheon Company, Rockwell Automation, Inc., Rockwell Collins, Tellabs, Inc., TRW Automotive Holdings Corp., and Xyratex Ltd. In addition, we have good working relationships with industry-leading CEMs such as Benchmark Electronics, Inc., Celestica, Inc., Flextronics International Ltd., Foxconn Technology Group, Jabil Circuit, Inc. and Plexus Corp., and we supply PCBs and E-M Solutions products to these customers as well. We have fifteen manufacturing facilities, including eight in the United States and seven located outside of the United States, which allows us to take advantage of low cost, high quality manufacturing environments, while serving a broad base of customers around the globe. Our PCB products are produced in our eight domestic facilities, three of our five facilities in China and our one facility in Canada. Our E-M Solutions products and services are provided from our other two facilities in China and our one facility in Mexico. In addition to our manufacturing facilities, in order to support our customers' local needs, we maintain engineering and customer service centers in Hong Kong, China, the Netherlands, England, Canada, Mexico and the United States. The locations of our engineering and customer service centers correspond directly to the primary areas where we ship our products. For the year ended December 31, 2012, on a pro forma basis, assuming the DDi Acquisition occurred on January 1, 2012, approximately 49.6%, 30.9% and 19.5% of our net sales were generated by shipments to destinations in North America, Asia and Europe, respectively. The Merix Acquisition On February 16, 2010, we acquired Merix Corporation ("Merix") in a transaction pursuant to which Merix became a wholly owned subsidiary of our company (the "Merix Acquisition"). Merix was a leading manufacturer of technologically advanced, multi-layer printed circuit boards with operations in the United States and China. The Merix Acquisition increased our PCB manufacturing capacity by adding four additional PCB production facilities, added North American PCB quick-turn services capability and added military and aerospace to our already diverse end-user markets. 2010 Recapitalization In connection with the Merix Acquisition, on February 11, 2010, our company was recapitalized pursuant to a recapitalization agreement (the "Recapitalization Agreement") such that (i) each outstanding share of common stock was exchanged for 0.083647 shares of common stock, (ii) each outstanding share of our Mandatory Redeemable Class A Junior Preferred Stock (the "Class A Preferred") was reclassified as, and converted into, 8.478683 shares of newly issued common stock and (iii) each outstanding share of our Redeemable Class B Senior Convertible Preferred Stock (the "Class B Preferred") was reclassified as, and converted into, 1.416566 shares of newly issued common stock. 32-------------------------------------------------------------------------------- Table of Contents In connection with the conversion of the Class A Preferred into common shares of our company, for financial reporting purposes related to the presentation of net loss attributable to common stockholders, for the year ended December 31, 2010, we recorded a non-cash adjustment to net loss of $29.7 million. The $29.7 million non-cash item is equal to the difference between i) the fair value of the common shares issued and ii) the carrying value of the Class A Preferred at the time of conversion; and was reflected in the Consolidated Statement of Stockholders' Equity as a reduction to accumulated deficit and a corresponding increase to paid-in capital. In connection with the conversion of the Class B Preferred into common stock of our company, for financial reporting purposes related to the presentation of net loss attributable to common stockholders, for the year ended December 31, 2010, we recorded a non-cash adjustment to net loss of $105.0 million. The $105.0 million non-cash item is equal to the difference between i) the fair value of the common shares issued and ii) the fair value of the number of common shares that would have been issued according to the terms of the Indenture governing the Class B Preferred without consideration of the Recapitalization Agreement; and was reflected in the Consolidated Statement of Stockholders' Equity as a reduction to accumulated deficit and a corresponding increase to paid-in capital. Business Overview As a component manufacturer, our sales trends generally reflect the market conditions in the industries we serve. In the automotive sector, we are adding capacity at our principal automotive qualified PCB manufacturing facilities i) as a result the closure of our manufacturing facility in Huizhou, China during the third quarter of 2012 and ii) in anticipation of long-term demand trends in the global automotive electronics systems market, which according to Prismark Partners LLC, a leading PCB industry research firm, is expected to grow at a compound annual growth rate of 7.7% from 2011 to 2016. Market growth of automotive electronics is expected to be driven primarily by growth in worldwide vehicle sales, particularly to customers in emerging markets such as China, increased sales of hybrid and electric vehicles, and increased electronic content per vehicle. In the industrial & instrumentation market, while we have experienced stable demand from our broad base of customers during 2012, we experienced reduced demand in certain customer programs and expect one of our largest customers to begin manufacturing a portion of what we supply in-house. As we work to add new customers and win new programs with our existing customers, we expect sales trends in this diverse market will follow global economic trends. In the computer and datacommunications end market, we continue to pursue new customers and programs for both our Printed Circuit Boards and Assembly segments, especially in the high-end server and storage sectors. The telecommunications end market remains dynamic as the customers we supply produce a mixture of products which include both new cutting edge applications as well as more mature products with varying levels of demand. We continue to try to position ourselves to take advantage of growth opportunities related to the introduction of next generation wireless technology standards, but this portion of the market has been slow to develop. In the military and aerospace market, we continue to pursue market share gains as a result of continuing customer qualification activity; however, overall demand trends in this market have been negatively impacted by the ongoing budget debate in Washington. While we believe the long-term growth prospects for our PCB and E-M Solutions products remain solid in all our end markets, economic uncertainty continues to exist, and our visibility to future demand trends and pricing pressures remains limited. With the acquisition of DDi, we have begun to market our high-volume, low-price China PCB manufacturing facilities to legacy DDi customers who had primarily purchased quick-turn PCBs as part of prototype development programs. At the same time, we have begun to market our newly acquired flexible circuit capabilities and expanded North America quick-turn capabilities to legacy Viasystems customers. In addition, we have begun to integrate the newly acquired North America PCB facilities into our global PCB operations and have, for example, been able to manage capacity constraints at one facility by shifting production to another. 33 -------------------------------------------------------------------------------- Table of Contents Results of Operations Year Ended December 31, 2012, Compared with Year Ended December 31, 2011 Net Sales. Net sales for the year ended December 31, 2012, were $1,159.9 million, representing a $102.6 million, or 9.7%, increase from net sales for the year ended December 31, 2011. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, net sales decreased by approximately $47.8 million, or 3.6%, for the year ended December 31, 2012, as compared with the same period in 2011. Net sales by end market on a historical basis for the years ended December 31, 2012 and 2011, and on a pro forma basis for the years ended December 31, 2012 and 2011, were as follows: Pro Historical Forma End Market (dollars in millions) 2012 2011 2012 2011 Automotive $ 376.7 $ 412.4 $ 378.6 $ 415.5 Industrial & Instrumentation 311.6 264.2 352.3 353.3 Computer and Datacommunications 199.1 155.3 224.3 208.5 Telecommunications 180.0 182.5 191.9 213.3 Military and Aerospace 92.5 42.9 125.8 130.1 Total Net Sales $ 1,159.9 $ 1,057.3 $ 1,272.9 $ 1,320.7 Our net sales of products for end use in the automotive market decreased by approximately $35.6 million, or 8.6%, during the year ended December 31, 2012, compared with 2011. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, net sales of products for end use in this market decreased by approximately $36.9 million, or 8.9%, for the year ended December 31, 2012, as compared to 2011. The decrease was a result of reduced global demand from our automotive customers, reduced sales to a customer that is transitioning a portion of their business to other suppliers and production delays as a result of a fire at one of our principal automotive PCB manufacturing facilities during the third quarter of 2012, partially offset by price increases implemented during the second quarter of 2011 and new customer and program wins. Net sales of products ultimately used in the industrial & instrumentation market increased by approximately $47.3 million, or 17.9%, during the year ended December 31, 2012, compared with 2011. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, net sales of products for end use in this market decreased by approximately $1.1 million, or 0.3%, for the year ended December 31, 2012, as compared with 2011. The decrease in net sales was driven primarily by a decline in sales in elevator controls related programs and inventory corrections at one of our larger customers, partially offset by increased demand from certain customers, including for wind power related programs, price increases implemented during the second half of 2011 and new customer and program wins. Net sales of our products for use in the computer and datacommunications markets increased by approximately $43.8 million, or 28.2%, during the year ended December 31, 2012, as compared with 2011. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, net sales of products for use in this end market increased by approximately $15.8 million, or 7.6%, for the year ended December 31, 2012, as compared with 2011, driven by increased global demand and new customer and programs wins. Net sales of products ultimately used in the telecommunications market decreased by approximately $2.5 million, or 1.4%, during the year ended December 31, 2012, as compared with 2011. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, net sales of products for use in this end market decreased by approximately $21.3 million, or 10.0%, for the year ended December 31, 2012, as compared with 2011. The sales decline is primarily a result of reduced demand for certain programs we supply, partially offset by last-buy sales increases on end-of-life programs and new program wins. While we continue to pursue new customers and programs in this end market, the global telecommunications industry remains volatile. Net sales to customers in the military and aerospace market increased by approximately $49.6 million, or 115.4%, during the year ended December 31, 2012, compared with 2011. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, net sales of products for use in this market decreased by approximately $4.3 million, or 3.3%, for the year ended December 31, 2012, as compared with 2011. The pro forma sales decline is a result of ongoing budget pressures on U.S. government defense spending, which has continued to hamper demand and apply downward pricing pressures. 34-------------------------------------------------------------------------------- Table of Contents Net sales by segment on a historical basis for the years ended December 31, 2012 and 2011, and on a pro forma basis for the years ended December 31, 2012 and 2011, were as follows: Pro Historical Forma Segment (dollars in millions) 2012 2011 2012 2011 Printed Circuit Boards $ 967.2 $ 865.9 $ 1,080.2 $ 1,129.3 Assembly 200.1 201.0 200.1 201.0 Eliminations (7.4 ) (9.6 ) (7.4 ) (9.6 ) Total net sales $ 1,159.9 $ 1,057.3 $ 1,272.9 $ 1,320.7 Printed Circuit Boards segment net sales, including intersegment sales, for the year ended December 31, 2012, increased by $101.3 million, or 11.7%, to $967.2 million. Assuming the DDi Acquisition had occurred on January 1, 2011, on a pro forma basis, Printed Circuit Boards net sales, including intersegment sales, for the year ended December 31, 2012, decreased by $49.1 million, or 4.4%. This decrease is a result of decreases in net sales in all end markets except the computer and datacommunications end market. Assembly segment net sales decreased by $0.9 million, or 0.4%, to $200.1 million for the year ended December 31, 2012, compared with 2011. The decrease was primarily the result of reduced demand in our telecommunications end market and reduced demand in elevator controls related programs in our industrial & instrumentation end market, partially offset by improved demand in wind power and industrial manufacturing equipment programs in our industrial & instrumentation end market. Cost of Goods Sold. Cost of goods sold, exclusive of items shown separately in the consolidated statement of operations and comprehensive (loss) income for year ended December 31, 2012, was $927.2 million, or 79.9%, of consolidated net sales. This represents a 0.7 percentage point increase from the 79.2% of consolidated net sales for the year ended December 31, 2011. In accordance with purchase accounting rules, the inventory acquired from DDi of as part of the DDi Acquisition was written up to its fair value, which for work in progress and finished goods approximated its selling price less an estimated profit from the selling effort. As a result, cost of goods sold during the year ended December 31, 2012, reflected the inventory fair value adjustment of approximately $3.9 million, which negatively impacted the ratio of cost of goods sold to net sales. Excluding this adjustment, cost of goods sold relative to consolidated net sales increased by 0.4 percentage points to 79.6%. Cost of goods sold as a percentage of sales was also impacted during the period by i) approximately $11 million to $13 million of net costs related to estimated manufacturing inefficiencies at our Guangzhou, China PCB facility as a result of a fire in September 2012 and ii) a $0.5 million charge to write off inventory which was impaired as a result of the closure of our Huizhou manufacturing facility. The costs of materials, labor and overhead in our Printed Circuit Boards segment can be impacted by trends in global commodities prices and currency exchange rates, as well as other cost trends which can impact minimum wage rates, electricity and diesel fuel costs in China. Economies of scale can help to offset any adverse trends in these costs. Our results for the year ended December 31, 2012, reflect a stabilization of material and labor costs which had increased in 2011. While we expect short-term stability in labor costs, with anticipated changes in minimum wage laws in China, we expect our labor costs will increase during 2013. As part of our ongoing efforts to better align overhead costs and operating expenses with market demand, during the third quarter of 2012, we gave notice and began to reduce staffing at certain of our PCB manufacturing facilities in China. We expect these headcount reductions will be completed by the end of the first quarter of 2013. Cost of goods sold in our Assembly segment relates primarily to component materials costs. As a result, trends in sales volume for the segment drive similar trends in cost of goods sold. Costs as a percentage of sales during the year ended December 31, 2012, were negatively impacted by inefficiencies associated with the closure of our Qingdao, China facility and increased overhead costs at our Juarez, Mexico facility as it prepares for new product introductions at its new larger location. 35-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Costs. As a percent of sales, selling, general and administrative costs increased to 9.4% for the year ended December 31, 2012, as compared with 7.6% for the year ended December 31, 2011. In dollar terms, selling, general and administrative costs increased $29.2 million, or 36.3%, to $109.5 million for the year ended December 31, 2012, compared with 2011. The increase in selling, general and administrative costs is a result of professional fees and other costs relating to the DDi Acquisition, costs associated with new manufacturing, sales and administrative sites acquired in the DDi Acquisition and increased non-cash stock compensation expense. Depreciation. Depreciation expense for the year ended December 31, 2012, was $80.0 million, including $75.5 million related to our Printed Circuit Boards segment and $4.5 million related to our Assembly segment. Depreciation expense in our Printed Circuit Boards segment increased by approximately $13.5 million, or 21.8%, compared to the same period last year primarily as a result of increased investments in new equipment during the past twelve months and the effect of additional depreciation during the period on fixed assets acquired through the DDi Acquisition as compared to the same period in 2011. Depreciation expense in our Assembly segment increased by $0.6 million as compared to the same period in the prior year, primarily as a result of investments in the fourth quarter of 2011 to relocate and expand our Juarez, Mexico facility. Restructuring and Impairment. During 2012, we initiated certain restructuring activities as a result of the expiration of the lease of our Huizhou, China PCB manufacturing facility, the integration of the DDi business we acquired in May 2012 and to achieve general cost savings as part of our ongoing efforts to align capacity, overhead costs and operating expenses with market demand. For the year ended December 31, 2012, we recognized $18.4 million of restructuring and impairment charges in our Printed Circuit Boards segment, $0.8 million in our Assembly segment and $0.3 million in our "Other" segment. Restructuring and impairment charges incurred in the Printed Circuit Boards segment during the year ended December 31, 2012, included i) $10.6 million related to the closure of our Huizhou facility, ii) $0.8 million associated with integrating the newly acquired DDi business, iii) $6.0 million related to general cost savings and iv) a $1.0 million of impairment charges and other costs related to fire damage at our Guangzhou PCB facility. Restructuring and impairment charges incurred in the Assembly segment during the year ended December 31, 2012, related to general cost savings activities which primarily included the closure of our Qingdao, China facility. Huizhou PCB Facility Closure The district where our Huizhou facility was located is being redeveloped away from industrial use, and we were unable to renew our lease of the facility beyond its December 31, 2012 expiration date. During the third quarter of 2012, we completed the process of transitioning this facility's customers to our other China PCB manufacturing facilities and the Huizhou facility ceased operations. During the fourth quarter of 2012, we decommissioned the facility and in January 2013 returned it to its landlord. During the year ended December 31, 2012, we recorded charges of $10.6 million related to the closure of the Huizhou facility, of which $8.7 million relate to personnel and severance, $0.7 million relate to the impairment of fixed assets and $1.2 million related to lease terminations and other costs. We do not expect that we will incur significant additional costs related to the closure of the facility. Integration of the DDi Business In connection with the integration of the DDi business, we identified potential annualized cost saving synergies of approximately $10.0 million, and during 2012 we initiated certain actions to realize these synergies. These actions primarily include staff reductions, and we expect that the total related restructuring charges will not exceed $2.0 million. In addition, at the time of the DDi Acquisition, DDi was in the process of building a new PCB manufacturing facility in Anaheim, California with plans to relocate its existing Anaheim operations from a leased facility. We expect the new facility will be completed and the Anaheim operations will be relocated during the first half of 2013. In connection with the relocation of the Anaheim operations, we expect to incur restructuring costs in our Printed Circuit Boards segment of approximately $1.0 million. 36 -------------------------------------------------------------------------------- Table of Contents General Cost Savings Activities During the third quarter of 2012, the Company gave notice it would reduce staffing at certain of its manufacturing facilities in China in order to better align overhead costs and operating expenses with market demand for its products. During 2012, we incurred related charges of $5.8 million in our Printed Circuit Boards segment and $0.1 million in our Assembly segment. We do not expect to incur additional significant costs related to the activities announced in 2012. Our Qingdao, China facility had primarily operated as a satellite facility supporting the operations of our E-M Solutions facility in Shanghai, China. In order to achieve operational efficiencies and cost reductions, we consolidated the operations of the Qingdao facility into our other E-M Solutions facilities in China. The Qingdao facility ceased operations in July 2012, and the facility was decommissioned and returned to its landlord during the third quarter of 2012. Total related restructuring and impairment charges were $0.6 million, which primarily related to personnel and severance costs. We do not expect that we will incur significant additional cost related to the closure of this facility. Guangzhou Fire On September 5, 2012, we experienced a fire contained to a part of one building on the campus of our PCB manufacturing facility in Guangzhou, China which resulted in the loss of inventory with a carrying value of approximately $4.7 million and property, plant and equipment with a net book value of approximately $2.0 million. As of December 31, 2012, we had restored a portion of the manufacturing capacity lost as a result of the fire damage, and completed our recovery in January 2013. We maintain insurance coverage for property losses caused by fire which is subject to certain deductibles. We expect we will recover the net book value of machinery and equipment destroyed through insurance proceeds, and as of December 31, 2012, recorded an impairment charge of $0.9 million for amount of the inventory loss we expect will not be covered by insurance. In addition, we maintain business interruption insurance to protect us from disruptions as a result of fires. As of the date of this Report, we are working with our insurance carrier as they evaluate our losses due to business interruption; however, we have not recorded a receivable for any potential claim payments which may result. The primary components of restructuring and impairment expense for the years ended December 31, 2012 and 2011, are as follows: Restructuring Activity (dollars in millions) 2012 2011 Personnel and severance $ 16.1 $ (0.1 ) Lease and other contractual commitment expenses 1.7 0.9 Asset impairment 1.7 - Total expense, net $ 19.5 $ 0.8 Operating Income. Operating income of $19.3 million for the year ended December 31, 2012, represents a decrease of $51.6 million compared with operating income of $70.9 million during the year ended December 31, 2011. The primary sources of operating income for the years ended December 31, 2012 and 2011, are as follows: Source (dollars in millions) 2012 2011 Printed Circuit Boards segment $ 27.4 $ 65.5 Assembly segment 1.6 6.7 Other (9.7 ) (1.3 ) Operating income $ 19.3 $ 70.9 The decrease in operating income in our Printed Circuit Boards segment was primarily the result of higher levels of cost of goods sold relative to sales, increased restructuring costs, higher levels of selling, general and administrative expense and increased depreciation expense, partially offset by higher sales levels and lower levels of cost of goods sold relative to sales. Operating income during the second quarter of 2012 reflected a one-time inventory fair value adjustment of approximately $3.9 million related to the DDi Acquisition, which negatively impacted cost of goods sold. 37-------------------------------------------------------------------------------- Table of Contents Operating income from our Assembly segment was $1.6 million for the year ended December 31, 2012, compared to $6.7 million in the year ended December 31, 2011. The decrease is primarily the result of restructuring costs associated with the closure of our Qingdao, China facility, increased depreciation expense and overhead costs at our Juarez, Mexico facility as it prepares for new product introductions at its new larger facility. The $9.7 million operating loss in the "Other" segment for the year ended December 31, 2012, relates primarily to professional fees and other expenses associated with the DDi Acquisition. The $1.3 million operating loss in the "Other" segment for the year ended December 31, 2011, relates primarily to professional fees associated with acquisitions and equity registrations. Adjusted EBITDA. We measure our performance primarily through our operating income. In addition to our consolidated financial statements presented in accordance with U.S. GAAP, management uses certain non-GAAP financial measures, including "Adjusted EBITDA." Adjusted EBITDA is not a recognized financial measure under U.S. GAAP, and does not purport to be an alternative to operating income or an indicator of operating performance. Adjusted EBITDA is presented to enhance an understanding of our operating results and is not intended to represent cash flows or results of operations. Our board of directors, lenders and management use Adjusted EBITDA primarily as an additional measure of performance for matters including executive compensation and competitor comparisons. In addition, the use of this non-U.S. GAAP measure provides an indication of our ability to service debt, and we consider it an appropriate measure to use because of our leveraged position. Adjusted EBITDA has certain material limitations, primarily due to the exclusion of certain amounts that are material to our consolidated results of operations, such as interest expense, income tax expense and depreciation and amortization. In addition, Adjusted EBITDA may differ from the Adjusted EBITDA calculations of other companies in our industry, limiting its usefulness as a comparative measure. We use Adjusted EBITDA to provide meaningful supplemental information regarding our operating performance and profitability by excluding from EBITDA certain items that we believe are not indicative of our ongoing operating results or will not impact our future operating cash flows as follows: • Stock Compensation-non-cash charges associated with recognizing the fair value of stock options and restricted stock awards granted to employees and directors. We exclude these charges to more clearly reflect comparable year-over-year cash operating performance. • Restructuring and Impairment Charges-which consist primarily of facility closures and other headcount reductions. Historically, a significant amount of these restructuring and impairment charges have been non-cash charges related to the write-down of property, plant and equipment to estimated net realizable value. We exclude these restructuring and impairment charges to more clearly reflect our ongoing operating performance. • Costs Relating to Acquisitions and Equity Registrations - professional fees and other non-recurring costs and expenses associated with mergers and acquisition activity as well as costs associated with capital transactions, such as equity registrations. We exclude these costs and expenses because they are not representative of our customary operating expenses. Reconciliations of operating income to Adjusted EBITDA for the years ended December 31, 2012 and 2011, were as follows: December 31, Source (dollars in millions) 2012 2011 Operating income $ 19.3 $ 70.9 Add-back: Depreciation and amortization 84.6 67.6 Non-cash stock compensation expense 10.6 7.7 Restructuring and impairment 19.9 0.8 Costs relating to acquisitions and equity registrations 13.6 1.0 Adjusted EBITDA $ 148.0 $ 148.0 Adjusted EBITDA was $148.0 million for both of the years ended December 31, 2012 and 2011. Higher sales levels were offset by higher cost of goods sold relative to sales in 2012, as compared to 2011, and increased selling, general and administrative costs. Adjusted EBITDA for the year ended December 31, 2012, has not been adjusted to exclude net costs of approximately $11 million to $13 million related to manufacturing inefficiencies stemming from the 2012 fire at our Guangzhou facility. 38 -------------------------------------------------------------------------------- Table of Contents Interest Expense, net. Interest expense, net of interest income, was $42.2 million for the year ended December 31, 2012, compared to $28.9 million, for the year ended December 31, 2011. On April 30, 2012, we issued $550.0 million in aggregate principal amount of 7.875% senior secured notes due 2019 and on May 30, 2012, we redeemed our $220.0 million in the aggregate principal amount of 12.0% senior secured notes due 2015. The increase in interest expense is primarily due to i) interest expense incurred during the one month period when both the 2019 Notes and the 2015 Notes were outstanding, ii) the incremental interest expense associated with the 2019 Notes over the 2015 Notes and iii) interest expense associated with mortgage debt assumed in the DDi Acquisition. Income Taxes. Our income tax provision relates to i) taxes provided on our pre-tax earnings based on the effective tax rates in the jurisdictions where the income is earned and ii) other tax matters, including changes in tax-related contingencies and changes in the valuation allowance established for deferred tax assets. For the year ended December 31, 2012, our tax provision includes net expense of $9.3 million, or 19%, related to pre-tax earnings, and a expense of $3.5 million related to other tax matters, including a reversal of $2.7 million of uncertain tax positions due to lapsing of the applicable statute of limitations. For the year ended December 31, 2011, our tax provision included net expense of $13.3 million, or 34%, related to our pre-tax earnings and net benefit of $4.8 million related to other tax matters. As of December 31, 2012, we have established a full valuation allowance in both the U.S. and Canada for the deferred tax asset for net operating loss carryforwards. During the year ended December 31, 2012, we increased the valuation allowance by $32.0 million and during the year ended December 31, 2011, we released $3.4 million of the valuation allowance. The amount released in 2011 represented the amount of the deferred tax asset we believed would be realized in 2012 and was recorded as reduction to our income tax expense in that year. We continually evaluate our ability to realize our deferred tax assets and may, in the future, reverse the valuation allowance if sufficient supporting evidence exists. Noncontrolling Interest. Net income attributable to noncontrolling interest of $0.1 million for the year ended December 31, 2012, compares to net income attributable to noncontrolling interest of $1.8 million in 2011, and reflects a noncontrolling interest holder's 5.0% interest in the profits from our PCB manufacturing facility in Huiyang, China and the same noncontrolling interest holder's 15.0% interest in the profits from our PCB manufacturing facility in Huizhou, China for the period prior to our buyout of that interest for $10.1 million in May 2012 in connection with the closure of that facility. For the year ended December 31, 2012, $0.6 million of net income attributable to noncontrolling interest at our Huiyang facility was partially offset by $0.5 million of loss attributable to noncontrolling interest at our Huizhou facility. Year Ended December 31, 2011, Compared with Year Ended December 31, 2010 Net Sales. Net sales for the year ended December 31, 2011, were $1,057.3 million, representing a $128.0 million, or 13.8%, increase from net sales for the year ended December 31, 2010. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, net sales increased by approximately $86.1 million, or 8.9%, for the year ended December 31, 2011, as compared with the same period in 2010. This increase is due to increased demand across all but our telecommunications end markets, price increases implemented during the second quarter in our Printed Circuit Boards segment and premium pricing to certain customers and programs in the automotive end market during the fourth quarter. 39 -------------------------------------------------------------------------------- Table of Contents Net sales by end market on a historical basis for the years ended December 31, 2011 and 2010, and on a pro forma basis for the year ended December 31, 2010, were as follows: Pro Historical Forma End Market (dollars in millions) 2011 2010 2010 Automotive $ 412.4 $ 332.8 $ 341.0 Industrial & Instrumentation 264.2 220.2 229.5 Telecommunications 182.5 218.4 230.1 Computer and Datacommunications 155.3 121.7 129.3 Military and Aerospace 42.9 36.2 41.3 Total Net Sales $ 1,057.3 $ 929.3 $ 971.2 Our net sales of products for end use in the automotive market increased by approximately $79.6 million, or 23.9%, during the year ended December 31, 2011, compared with 2010. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, net sales of products for end use in this market increased by approximately $71.4 million, or 20.9%, for the year ended December 31, 2011, as compared to 2010. The increase was driven by i) increased demand, including demand in the fourth quarter from customers whose supply chain had been impacted by the flooding in Thailand and who sought to diversify their supplier base for certain programs, ii) price increases implemented during the second quarter of 2011 and iii) premium pricing to one customer as we assisted them with their transition to other suppliers. Net sales of products ultimately used in the industrial & instrumentation market, increased by approximately $44.0 million, or 20.0%, during the year ended December 31, 2011, compared with 2010. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, net sales of products for end use in this market increased by approximately $34.7 million, or 15.1%, for the year ended December 31, 2011, as compared with 2010. The increase in net sales was driven primarily by increased global demand, including programs related to wind power and elevator controls, as well as new customer and program wins. Net sales of products ultimately used in the telecommunications market decreased by approximately $35.9 million, or 16.4%, during the year ended December 31, 2011, as compared with 2010. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, net sales of products for use in this end market decreased by approximately $47.6 million, or 20.7%, for the year ended December 31, 2011, as compared with 2010. The sales decline was primarily a result of reduced demand for certain programs we supply, inventory corrections from one of our larger customers and the loss of one customer in our Assembly segment which elected to bring manufacturing of the parts we supplied in-house. Net sales of our products for use in the computer and datacommunications markets increased by approximately $33.6 million, or 27.6%, during the year ended December 31, 2011, as compared with 2010. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, net sales of products for use in this end market increased by approximately $26.0 million, or 20.1%, for the year ended December 31, 2011, as compared with 2010, driven by increased global demand from our computer and datacommunication customers as well as new customer and program wins. Net sales to customers in the military and aerospace market increased by approximately $6.7 million, or 18.5%, during the year ended December 31, 2011, compared with 2010. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, net sales of products for use in this market increased by approximately $1.6 million, or 3.9%, for the year ended December 31, 2011, as compared with 2010. This modest growth in sales was a result of increased demand from existing customers and new customer wins; however, budget pressures on U.S. government defense spending had hampered demand. 40 -------------------------------------------------------------------------------- Table of Contents Net sales by segment on a historical basis for the year ended December 31, 2011 and 2010, and on a pro forma basis for the year ended December 31, 2010, were as follows: Pro Historical Forma Segment (dollars in millions) 2011 2010 2010 Printed Circuit Boards $ 865.9 $ 763.9 $ 805.8 Assembly 201.0 177.3 177.3 Eliminations (9.6 ) (11.9 ) (11.9 ) Total net sales $ 1,057.3 $ 929.3 $ 971.2 Printed Circuit Boards segment net sales, including intersegment sales, for the year ended December 31, 2011, increased by $102.0 million, or 13.4%, to $865.9 million. Assuming the Merix Acquisition had occurred on January 1, 2010, on a pro forma basis, Printed Circuit Boards net sales, including intersegment sales, for the year ended December 31, 2011, increased by $60.1 million, or 7.5%. The increase is a result of a greater than 1.4% increase in volume that affected all but our telecommunication end markets, as well as price increases introduced during the second quarter of 2011. Assembly segment net sales increased by $23.7 million, or 13.4%, to $201.0 million for the year ended December 31, 2011, compared with 2010. The increase was primarily the result of improved demand in wind power and elevator controls related programs in our industrial and instrumentation end market, partially offset by a sales decline in our telecommunications end market. Cost of Goods Sold. Cost of goods sold, exclusive of items shown separately in the consolidated statement of operations and comprehensive (loss) income for the year ended December 31, 2011, was $837.7 million, or 79.2% of consolidated net sales. This represents a 1.9 percentage point increase from the 77.3% of consolidated net sales achieved during 2010. The increase was due primarily to rising costs of materials and labor and manufacturing inefficiencies associated with government mandated power rationing in China, partially offset by sales price increases. To compensate for rising costs, we began to implement price increases during the second quarter of 2011; however, our costs for materials and labor grew faster than we could implement price increases. While material costs stabilized during the fourth quarter of 2011, market forces may again cause increases during 2012. The costs of materials, labor and overhead in our Printed Circuit Boards segment can be impacted by trends in global commodities prices and currency exchange rates, as well as other cost trends that can impact minimum wage rates, electricity and diesel fuel costs in China. Economies of scale can help to offset any adverse trends in these costs. Our results for 2011 reflect increased costs of labor and materials, significant unscheduled maintenance at one of our PCB facilities during the first quarter of 2011, inefficiencies in connection with restarting production after scheduled shutdowns around the time of the Chinese New Year holiday in February 2011, as well as inefficiencies associated with power rationing in China. The increase in labor costs was due to minimum wage increases and newly implemented employment-based social taxes in China, as well as a labor shortage in some parts of China that contributed to higher than usual attrition, resulting in increased overtime costs and the payment of retention bonuses. The increase in materials costs was due to increased costs for commodities, including copper and gold, as well as a sustained high demand for electronic components in our industry, which allowed our materials suppliers to command higher prices for their products. Cost of goods sold in our Printed Circuit Boards segment during the 2010 reflected an inventory fair value adjustment of approximately $0.9 million related to the Merix Acquisition, which negatively impacted the ratio of cost of goods sold to net sales. Cost of goods sold in our Assembly segment relates primarily to component materials costs. As a result, trends in sales volume for the segment drive similar trends in cost of goods sold. Cost of goods sold as a percent of sales during the year ended December 31, 2011, were negatively impacted by increased labor and material costs. 41 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Costs. As a percent of sales, selling, general and administrative costs decreased to 7.6% for the year ended December 31, 2011, as compared with 8.3% for the year ended December 31, 2010. In dollar terms, selling, general and administrative costs increased $2.8 million, or 3.7%, to $80.3 million for the year ended December 31, 2011, compared with 2010. The net increase in selling, general and administrative costs was primarily a result of i) a $4.4 million increase in non-cash stock compensation expense related to awards granted under our 2010 Equity Incentive Plan, ii) costs associated with annual management meetings during 2011, which had been suspended in 2010, and iii) the impact of a full year of selling, general and administrative costs associated with the legacy Merix operations as compared with approximately ten and one-half months of costs incurred subsequent to the mid-February acquisition date in 2010, partially offset by a $4.6 million decline in costs relating to acquisitions and equity registrations and reduced incentive compensation expense. Depreciation. Depreciation expense for the year ended December 31, 2011, was $65.9 million, including $62.0 million related to our Printed Circuit Boards segment and $3.9 million related to our Assembly segment. Depreciation expense in our Printed Circuit Boards segment increased by $10.0 million compared with 2010 primarily as a result of increased investments in new equipment during 2010 and 2011; and we expect depreciation expense will continue to increase in 2012 as a result of significant new investments in capital equipment during 2011 and expected investments during 2012. Depreciation expense in our Assembly segment decreased by $0.5 million compared with 2010, as a result of reduced capital expenditures in 2010 and through the first half of 2011. With approximately $6.0 million of capital expenditures in our Assembly segment during the second half of 2011, including $4.0 million related to the new Juarez, Mexico facility, we expect depreciation expense in our Assembly segment for 2012 will return to levels similar to 2010. Restructuring and Impairment. During the year ended December 31, 2011, we incurred net restructuring charges of $0.8 million, which included approximately $0.5 million in our Assembly segment related to the relocation of our manufacturing operations in Juarez, Mexico to a new facility, approximately $0.4 million in "Other" related to an increase in estimated long-term obligations associated with previously closed manufacturing facilities, and a reversal of accrued severance costs of approximately $0.1 million in our Printed Circuit Boards segment as a result of lower than planned involuntary terminations in connection with the integration of the Merix business after its acquisition in 2010. The costs incurred in the Assembly and "Other" segments all related to contractual commitments. During the year ended December 31, 2010, in connection with the integration of the Merix business, we identified potential annualized cost synergies of approximately $20.0 million, and took certain actions to realize those cost synergies. These actions included staff reductions and the consolidation of certain administrative offices. For the year ended December 31, 2010, we recorded net restructuring charges of approximately $8.5 million, of which approximately $4.6 million was incurred in the Printed Circuit Boards segment related to achieving cost synergies with the integration of the Merix business, and approximately $3.9 million was incurred in the "Other" segment primarily related to the cancellation of a monitoring and oversight agreement in connection with the Recapitalization Agreement. The charges incurred in the Printed Circuit Boards segment include $3.5 million related to personnel and severance and $1.1 million related to lease termination and other costs. The charges incurred in the "Other" segment include $4.4 million related to contractual commitments and a reversal of $0.5 million related to personnel and severance costs. The primary components of restructuring and impairment expense for the years ended December 31, 2011 and 2010, are as follows: Restructuring Activity (dollars in millions) 2011 2010 Personnel and severance $ (0.1 ) $ 3.0 Lease and other contractual commitment expenses 0.9 5.5 Total expense, net $ 0.8 $ 8.5 Operating Income. Operating income of $70.9 million for the year ended December 31, 2011, represents an increase of $4.4 million compared with operating income of $66.5 million during the year ended December 31, 2010. The primary sources of operating income for the years ended December 31, 2011 and 2010, are as follows: Source (dollars in millions) 2011 2010 Printed Circuit Boards segment $ 65.5 $ 68.9 Assembly segment 6.7 6.2 Other (1.3 ) (8.6 ) Operating income $ 70.9 $ 66.5 42 -------------------------------------------------------------------------------- Table of Contents Operating income from our Printed Circuit Boards segment decreased by $3.4 million to $65.5 million for the year ended December 31, 2011, compared with operating income of $68.9 million for the prior year. The decrease is primarily the result of higher levels of material and labor costs in cost of goods sold relative to sales and increased depreciation expense partially offset by increased sales volume, price increases and a reduction in restructuring charges. Operating income from our Assembly segment was $6.7 million for the year ended December 31, 2011, compared with operating income of $6.2 million in 2010. The increase is primarily the result of increased sales volumes and reduced depreciation expenses, partially offset by higher levels of cost of goods sold relative to sales and restructuring cost. The $1.3 million operating loss in the "Other" segment for the year ended December 31, 2011, relates primarily to restructuring charges of $0.4 million and professional fees and other costs associated with equity registrations and the pursuit of acquisition opportunities. The operating loss in the "Other" segment of $8.6 million for the year ended December 31, 2010, relates to $3.9 million of net restructuring charges and $4.7 million of transaction costs related to the Merix Acquisition. Adjusted EBITDA. Reconciliations of operating income to Adjusted EBITDA for the years ended December 31, 2011 and 2010, were as follows: December 31, Source (dollars in millions) 2011 2010 Operating income $ 70.9 $ 66.5 Add-back: Depreciation and amortization 67.6 58.1 Non-cash stock compensation expense 7.7 2.9 Restructuring and impairment 0.8 8.5 Costs relating to acquisitions and equity registrations 1.0 5.6 Adjusted EBITDA $ 148.0 $ 141.6 Adjusted EBITDA increased by $6.4 million, or 4.5%, primarily as a result of an 13.8% increase in net sales partially offset by a 1.9 percentage point increase in cost of goods sold relative to net sales, and increased selling, general and administrative expense. Interest Expense, net. Interest expense, net of interest income, was $28.9 million and $30.9 million for the years ended December 31, 2011 and 2010, respectively. Interest expense related to the $220 million aggregate principal amount of 12% Senior Secured Notes due 2015 ("the 2015 Notes") is approximately $28.0 million in each year, including $26.4 million cash interest based on the $220 million principal and 12.0% interest rate, and $1.6 million non-cash amortization of the $8.2 million original issue discount which is being amortized to interest expense over the life of the 2015 Notes. The $2.0 million decrease in interest expense for the year ended December 31, 2011, as compared with the prior year, is primarily a result of reduced interest expense associated with the Class A Preferred, which was exchanged for common stock during the first quarter of 2010. Income Taxes. Our income tax provision relates to i) taxes provided on our pre-tax earnings based on the effective tax rates in the jurisdictions where the income is earned and ii) other tax matters, including changes in tax-related contingencies and changes in the valuation allowance established for deferred tax assets. For the year ended December 31, 2011, our tax provision includes net expense of $13.3 million, or 34%, related to pre-tax earnings, and a net benefit of $4.8 million related to other tax matters, including a reversal of $6.2 million of uncertain tax positions due to lapsing of the applicable statute of limitations. For the year ended December 31, 2010, our tax provision included net expense of $18.0 million, or 57%, related to our pre-tax earnings and net benefit of $1.9 million related to other tax matters. During the years ended December 31, 2011 and 2010, we released $3.4 million and $1.6 million, respectively, of the valuation allowance which had been established against our deferred tax asset for net operating loss carryforwards. The amounts released represent the amount of the deferred tax asset we believe would be realized over the next respective year and were recorded as reduction to our income tax expense in each year. 43-------------------------------------------------------------------------------- Table of Contents Noncontrolling Interest. Net income attributable to noncontrolling interest of $1.8 million for the year ended December 31, 2011, reflects a noncontrolling interest holder's 5% and 15% interest in the profits from our facilities in Huiyang, China and Huizhou, China, respectively, and compares to $2.0 million in 2010. For the year ended December 31, 2011, $0.5 million and $1.3 million of net income attributable to noncontrolling interest related to our Huiyang and Huizhou facilities, respectively. Liquidity and Capital Resources Cash Flow Net cash provided by operating activities was $78.1 million, $71.4 million and $74.9 million for the years ended December 31, 2012, 2011 and 2010, respectively. Net operating cash flows increased from 2011 to 2012 as the result of changes in working capital partially offset by lower net income. The reduced level of net cash from operating activities in 2011, as compared with 2010, was primarily due to changes in working capital related to higher sales levels and our building of inventory levels at the end of 2011 to supply customer orders during planned shutdowns at the beginning of 2012, surrounding public holidays in China, partially offset by increased income from operations. Net cash used in investing activities was $371.0 million, $101.1 million and $68.8 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in the level of net cash used in investing activities in 2012, as compared to 2011, relates primarily to $253.5 million of cash consideration paid, net of cash acquired, in the DDi Acquisition, $10.1 million of cash consideration paid to acquire the remaining 15% interest in our Huizhou, China facility and increased capital expenditures. The increase in the level of net cash used in investing activities in 2011, as compared with 2010, was due to higher capital expenditures, partially offset by the non-recurrence of acquisition costs which were incurred in 2010 related to the Merix Acquisition. Our Printed Circuit Boards segment is a capital-intensive business that requires annual spending to keep pace with customer demands for new technologies, cost reductions and product quality standards. The spending needed to meet our customer's requirements is incremental to recurring repair and replacement capital expenditures required to maintain our existing production capacities and capabilities. While we are prepared to make appropriate investments in facilities to meet growing demand, given the ongoing uncertainty about global economic conditions, we have and will continue to focus on managing capital expenditures to respond to changes in demand or other economic conditions. Investing cash flows include capital expenditures by our Printed Circuit Boards segment of $102.1 million, $93.4 million and $54.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in capital expenditures in our Printed Circuit Boards segment in 2012, as compared with 2011, reflects spending to increase manufacturing capacity in anticipation of the planned closure of our Huizhou, China facility and spending to replace equipment destroyed in a fire in our PCB manufacturing facility in Guangzhou, China. Increased capital spending during 2011 as compared to 2010 reflects spending to increase manufacturing capacity in anticipation of increased customer demand and the planned closure of our Huizhou, China facility. Capital expenditures related to our Assembly segment for the years ended December 31, 2012, 2011 and 2010 were $6.0 million, $7.7 million and $1.6 million, respectively. Capital expenditures in our Assembly segment declined by $1.7 million in 2012, as compared to 2011, due to reduced spending following the completion of our new facility in Juarez, Mexico. The increase in capital expenditures in our Assembly segment in 2011, as compared with 2010, primarily relates to a $4.7 million investment to build a new Juarez, Mexico facility and investments at our other E-M Solutions facilities to support sales growth. Net cash provided by financing activities was $296.5 million for year ended December 31, 2012, which related to the issuance of $550.0 million aggregate principal amount of our 2019 Notes, partially offset by i) $16.2 million of related debt issuance costs, ii) the payment of $236.3 million to redeem our 2015 Notes, iii) net repayments of $0.7 million on credit facilities and mortgage debt and iv) a $0.3 million distribution to the noncontrolling interest holder. 44 -------------------------------------------------------------------------------- Table of Contents Net cash used in financing activities was $2.6 million for the year ended December 31, 2011, which related primarily to a $2.4 million distribution to our noncontrolling interest holder of previously declared but unpaid dividends and repayments of capital lease obligations. In addition, during 2011, in connection with the renewal of our Zhongshan 2010 Credit Facility, we repaid and reborrowed $10.0 million. Net cash used in financing activities was $11.6 million for the year ended December 31, 2010, which related to $5.2 million of net repayments of credit facilities, $2.3 million of financing fees on our Senior Secured 2010 Credit Facility, a $0.8 million distribution to our noncontrolling interest holder, the repurchase of $0.5 million principal amount of our Senior Subordinated Convertible Notes due 2013 and $2.6 million of repayments of capital lease obligations. The repayment of the 2011 Notes in January 2010 was funded by restricted cash placed in escrow in connection with the issuance of the 2015 Notes in late 2009. Financing Arrangements As of December 31, 2012, including indebtedness assumed in the DDi Acquisition, our financing arrangements included the following: Shelf Registration Statement We filed a shelf registration statement with the Securities and Exchange Commission that went effective on April 7, 2011, and will allow us to sell up to $150 million of equity or other securities described in the registration statement in one or more offerings. The shelf registration statement gives us greater flexibility to raise funds from the sale of our securities, subject to market conditions and our capital needs. In addition, the shelf registration statement includes shares of our common stock currently owned by VG Holdings, LLC, such that VG Holdings, LLC may offer and sell, from time to time, up to 15,562,558 shares of our common stock. We will not receive any proceeds from the sale of common stock by VG Holdings, LLC, but we may incur expenses in connection with the sale of those shares. Senior Secured Notes due 2019 On April 30, 2012, our subsidiary, Viasystems, Inc., completed an offering of $550.0 million of 7.875% Senior Secured Notes due 2019. We incurred $16.2 million of deferred financing fees related to the 2019 Notes that have been capitalized and will be amortized over the life of the notes. Interest on the 2019 Notes is due semiannually on May 1 and November 1 of each year, beginning on November 1, 2012. At any time prior to May 1, 2015, we may use the cash proceeds from one or more equity offerings to redeem up to $192.5 million of the aggregate principal amount of the notes at a redemption price of 107.875% plus accrued and unpaid interest. In addition, at any time from March 1, 2013 to May 1, 2015, but not more than once in any twelve-month period, we may redeem up to $55.0 million of the aggregate principal amount of the notes at a redemption price of 103% plus accrued and unpaid interest. In addition, at any time prior to May 1, 2015, we may redeem all or part of the notes, at a redemption price of 100% plus a "make-whole" premium equal to the greater of a) 1% of the principal amount, or b) the excess of i) the present value at the redemption rate of 105.906% of the principal amount redeemed calculated using a discount rate equal to the treasury rate (as defined) plus 50 basis points, over ii) the principal amount of the notes. On or after May 1, 2015, we may redeem all or part of the notes during the twelve month periods ended April 30, 2016, 2017 and 2018 at redemption prices of 105.906%, 103.938% and 101.969%, respectively, plus accrued and unpaid interest. Subsequent to May 1, 2018, we may redeem the 2019 Notes at the redemption price of 100% plus accrued and unpaid interest. In the event of a Change in Control (as defined), we are required to make an offer to purchase the 2019 Notes at a redemption price of 101%, plus accrued and unpaid interest. The 2019 Notes are guaranteed, jointly and severally, by all of Viasystems, Inc.'s current and future material domestic subsidiaries (the "Subsidiary Guarantors") and by Viasystems Group, Inc. through a parent guarantee. The 2019 Notes are collateralized by all of the equity interests of each of the Subsidiary Guarantors and by liens on substantially all of Viasystems, Inc.'s and the Subsidiary Guarantors' assets. The indenture governing the 2019 Notes contains restrictive covenants which, among other things, limit our ability and certain of our subsidiaries, including of Viasystems, Inc. and the Subsidiary Guarantors, to: a) incur additional indebtedness or issue disqualified stock or preferred stock; b) create liens; c) pay dividends, make investments or make other restricted payments; d) sell assets; e) consolidate, merge, sell or otherwise dispose of all or substantially all of the assets of Viasystems, Inc. and its subsidiaries; f) enter into certain transactions with affiliates. 45-------------------------------------------------------------------------------- Table of Contents Senior Secured 2010 Credit Facility Our senior secured revolving credit agreement, as amended, (the "Senior Secured 2010 Credit Facility"), with Wells Fargo Capital Finance, LLC provides a secured revolving credit facility in an aggregate principal amount of up to $75.0 million with an initial maturity in 2014. The annual interest rates applicable to loans under the Senior Secured 2010 Credit Facility are, at our option, either the Base Rate or Eurodollar Rate (each as defined in the Senior Secured 2010 Credit Facility) plus, in each case, an applicable margin. The applicable margin is tied to our Quarterly Average Excess Availability (as defined in the Senior Secured 2010 Credit Facility) and ranges from 0.75% to 1.75% for Base Rate loans and 2.25% to 2.75% for Eurodollar Rate loans. In addition, we are required to pay an Unused Line Fee and other fees as defined in the Senior Secured 2010 Credit Facility. Effective as of June 30, 2011, we amended the Senior Secured 2010 Credit Facility primarily for the purpose of removing a limit on permitted capital expenditures, and increasing the amount of eligible collateral allowed for certain receivables. The Senior Secured 2010 Credit Facility is guaranteed by and secured by substantially all of the assets of our current and future material domestic subsidiaries, subject to certain exceptions as set forth in the Senior Secured 2010 Credit Facility. The Senior Secured 2010 Credit Facility contains certain negative covenants restricting and limiting our ability to, among other things: • incur debt, incur contingent obligations and issue certain types of preferred stock; • create liens; • pay dividends, distributions or make other specified restricted payments; • make certain investments and acquisitions; • enter into certain transactions with affiliates; and • merge or consolidate with any other entity or sell, assign, transfer, lease, convey or otherwise dispose of assets. Under the Senior Secured 2010 Credit Facility, if the Excess Availability (as defined in the Senior Secured 2010 Credit Facility) is less than $15 million, we must maintain, on a monthly basis, a minimum fixed charge coverage ratio of 1.1 to one. We incurred $2.3 million deferred financing fees related to the Senior Secured 2010 Credit Facility which were capitalized and are being amortized over the life of the facility. As of December 31, 2012, the Senior Secured 2010 Credit Facility supported letters of credit totaling $0.7 million, and approximately $74.3 million was unused and available based on eligible collateral. Zhongshan 2010 Credit Facility Our unsecured revolving credit facility between our Kalex Multi-layer Circuit Board (Zhongshan) Limited ("KMLCB") subsidiary and China Construction Bank, Zhongshan Branch (the "Zhongshan 2010 Credit Facility"), provides for borrowing denominated in Renminbi ("RMB") and foreign currency including the U.S. dollar. Borrowings are guaranteed by KMLCB's sole Hong Kong parent company, Kalex Circuit Board (China) Limited. This revolving credit facility is renewable annually upon mutual agreement. Loans under the credit facility bear interest at the rate of i) LIBOR plus a margin negotiated prior to each U.S. dollar denominated loan or ii) the interest rate quoted by the Peoples Bank of China for Chinese RMB denominated loans. The Zhongshan 2010 Credit Facility has certain restrictions and other covenants that are customary for similar credit arrangements; however, there are no financial covenants contained in this facility. As of December 31, 2012, $10.0 million in U.S. dollar loans was outstanding under the Zhongshan 2010 Credit Facility at an interest rate of LIBOR plus 4.9%, and approximately $29.8 million of the revolving credit facility was unused and available. Huiyang 2009 Credit Facility During the third quarter of 2012, the Company allowed its revolving credit facility between its Merix Printed Circuits Technology Limited (Huiyang) subsidiary and Industrial and Commercial Bank of China, Limited to expire. 46-------------------------------------------------------------------------------- Table of Contents Senior Subordinated Convertible Notes due 2013 Our $0.9 million principal amount of 4.0% convertible senior subordinated notes (the "2013 Notes") have a maturity date of May 15, 2013. Interest is payable semiannually in arrears on May 15 and November 15 of each year. Pursuant to the terms of the indenture governing the 2013 Notes and the merger agreement governing the Merix Acquisition, the 2013 Notes are convertible at the option of the holder into shares of our common stock at a ratio of 7.367 shares per one thousand dollars of principal amount, subject to certain adjustments. This is equivalent to a conversion price of $135.74 per share. The 2013 Notes are general unsecured obligations and are subordinate in right of payment to all existing and future senior debt. North America Mortgage Loans In connection with the DDi Acquisition, we assumed mortgage loans which had been used historically to finance the acquisition, construction and improvement of certain of DDi's manufacturing facilities. These loans include: Toronto Mortgages Our mortgage loans with Business Development Bank of Canada ("BDC") consists of two loan agreements, one denominated in U.S. dollars and the second denominated in Canadian dollars, which are secured by the land, building and certain equipment at our manufacturing facility in Toronto, Canada. The loan agreements contain a covenant requiring us to maintain an available funds coverage ratio of 1.5 to 1.0. As of December 31, 2012, the balance of the U.S. dollar loan was $1.2 million. The loan bears interest at a variable rate equal to the applicable BDC floating base rate less 0.4% (3.35% as of December 31, 2012), and will mature in September 2028. As of December 31, 2012, the U.S. dollar equivalent balance of the Canadian dollar loan was $4.2 million. The loan bears interest at a variable rate equal to the applicable BDC floating base rate less 0.75% (4.25% as of December 31, 2012), and will mature in October 2015. Anaheim Mortgage Our mortgage loan with Wells Fargo Bank is secured by the land and building at our manufacturing facility in Anaheim, California which is currently under construction. The loan agreement contains a covenant requiring us to maintain a minimum fixed charge coverage ratio of 1.25 to 1.0. As of December 31, 2012, the balance of the loan was $5.4 million. The loan bears interest at a fixed rate of 4.326%, and will mature in March 2019, when a balloon principal payment of $3.4 million will be due. Cleveland Mortgage Our mortgage loan with Zions Bank is secured by the land and building of at our manufacturing facility in Cuyahoga Falls, Ohio. As of December 31, 2012, the balance of the loan was $1.5 million. The loan bears interest at a variable rate equal to the Federal Home Loan Bank of Seattle prime rate plus 2% (3.25% as of December 31, 2012), and will mature in November 2032. Denver Mortgage Our mortgage loan with GE Real Estate is secured by the land and building at our manufacturing facility in Littleton, Colorado. As of December 31, 2012, the balance of the loan was $1.3 million. The loan bears interest at a fixed rate of 7.55%, and will mature in July 2032. North Jackson Mortgage Our mortgage loan with Key Bank is secured by the land and building at our manufacturing facility in North Jackson, Ohio. As of December 31, 2012, the balance of the loan was $0.6 million. The loan bears interest at a variable rate equal to 30 Day LIBOR plus 1.5% (1.73% as of December 31, 2012), and will mature in April 2015. 47 -------------------------------------------------------------------------------- Table of Contents Liquidity We had cash and cash equivalents at December 31, 2012 and 2011, of $74.8 million and $71.3 million, respectively, of which $37.0 million and $42.3 million, respectively, were held outside the United States. Liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from fluctuations related to global economics and markets. Cash balances are generated and held in many locations throughout the world. We permanently reinvest the earnings of our foreign subsidiaries outside the United States, and our current plans do not demonstrate a need to repatriate them to fund our United States operations. If these funds were to be needed for our operations in the United States, we would be required to record and pay significant United States income taxes to repatriate these funds. At December 31, 2012, we had outstanding borrowings and letters of credit of $10.0 million and $0.7 million, respectively, under various credit facilities; and approximately $104.1 million of the credit facilities were unused and available. We believe that cash flow from operations, availability on credit facilities and available cash on hand will be sufficient to fund our recurring capital expenditure requirements and other currently anticipated cash needs for the next 12 months. Our ability to meet our cash needs through cash generated by our operating activities will depend on the demand for our products, as well as general economic, financial, competitive and other factors, many of which are beyond our control. We cannot be assured that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule, that future borrowings will be available to us under our credit facilities or that we will be able to raise third party financing in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness. Our principal liquidity requirements over the next twelve months will be for i) $21.7 million semi-annual interest payments required in connection with the 2019 Notes, payable in May and November each year, ii) capital expenditure needs of our continuing operations, iii) working capital needs, iv) debt service requirements in connection with our credit facilities and other debt, including $0.9 million payable upon the maturity of our 2013 Notes, and v) costs to integrate the acquired DDi business, including the relocation of our Anaheim, California facility. In addition, the potential for acquisitions of other businesses in the future may require additional debt or equity financing. We continue to explore certain strategic alternatives that may impact our liquidity, including but not limited to acquisitions, debt refinancing, debt retirement and equity offerings. We can give no assurance about our ability to execute any of these alternatives. Off Balance Sheet Arrangements We do not have any off balance sheet arrangements as defined under Securities and Exchange Commission rules. Backlog We estimate that our backlog of unfilled orders as of December 31, 2012, was approximately $200.0 million, which includes $170.5 million and $29.5 million from our Printed Circuit Boards and Assembly segments, respectively. This compares with our backlog of unfilled orders of $216.8 million at December 31, 2011, which included $168.9 million and $47.9 million from our Printed Circuit Boards and Assembly Segments, respectively. Because unfilled orders may be cancelled prior to delivery, the backlog outstanding at any point in time is not necessarily indicative of the level of business to be expected in the ensuing period. Related Party Transactions Noncontrolling Interest Holder We purchase consulting and other services from the noncontrolling interest holder which owns 5% of the subsidiary that operates our PCB manufacturing facility in Huiyang, China. Through December 31, 2012, we leased a manufacturing facility in Huizhou, China from the noncontrolling interest holder, and, in May 2012, purchased the noncontrolling interest holder's 15% interest in that facility for $10.1 million in connection with the closure of the Huizhou, China facility. During the years ended December 31, 2012, 2011 and 2010 we paid the noncontrolling interest holder $0.8 million, $0.9 million and $1.1 million, respectively, related to rental and service fees, In addition, during the year ended December 31, 2012 and 2011, we made distributions of $0.3 million and $2.4 million, respectively, to the noncontrolling interest holder. 48-------------------------------------------------------------------------------- Table of Contents Monitoring and Oversight Agreement Effective as of January 31, 2003, we entered into a monitoring and oversight agreement with Hicks, Muse & Co. Partners L.P. ("HM Co."), an affiliate of HMTF. On February 11, 2010, under the terms and conditions of the Recapitalization Agreement, the monitoring and oversight agreement was terminated in consideration for the payment of a cash termination fee of approximately $4.4 million. The consolidated statements of operations and comprehensive (loss) income include expense related to the monitoring and oversight agreement of approximately $4.4 million for the years ended December 31, 2010, and we made cash payments of approximately $5.6 million to HM Co. related to these and prior year expenses during the year ended December 31, 2010. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. GAAP requires that management make certain estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results may differ from those estimates and assumptions and the differences may be material. Significant accounting policies, estimates and judgments that management believes are the most critical to aid in fully understanding and evaluating the reported financial results are discussed below. Revenue Recognition We recognize revenue when all of the following criteria are satisfied: persuasive evidence of an arrangement exists; risk of loss and title transfer to the customer; the price is fixed and determinable; and collectability is reasonably assured. Sales and related costs of goods sold are included in income when goods are shipped to the customer in accordance with the delivery terms and the above criteria are satisfied. All services are performed prior to invoicing customers for any products manufactured by us. We monitor and track product returns, which have historically been within our expectations and the provisions established. Reserves for product returns are recorded based on historical trend rates at the time of sale. Despite our efforts to improve our quality and service to customers, we cannot guarantee that we will continue to experience the same or better return rates than we have in the past. Any significant increase in returns could have a material negative impact on our operating results. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable balances represent customer trade receivables generated from our operations. We evaluate collectability of accounts receivable based on a specific case-by-case analysis of larger accounts; and based on an overall analysis of historical experience, past due status of the entire accounts receivable balance and the current economic environment. Based on this evaluation, we make adjustments to the allowance for doubtful accounts for expected losses. We also perform credit evaluations and adjust credit limits based upon each customer's payment history and creditworthiness. While credit losses have historically been within our expectations and the provisions established, actual bad debt write-offs may differ from our estimates, resulting in higher or lower charges in the future for our allowance for doubtful accounts. Inventories Inventories are stated at the lower of cost (valued using the first-in, first-out (FIFO) and average cost methods) or market value. Cost includes raw materials, labor and manufacturing overhead. We apply judgment in valuing our inventories by assessing the net realizable value of our inventories based on current expected selling prices, as well as factors such as obsolescence and excess stock. We provide valuation allowances as necessary. Should we not achieve our expectations of the net realizable value of our inventory, future losses may occur. 49-------------------------------------------------------------------------------- Table of Contents Long-Lived Assets, Excluding Goodwill We review the carrying amounts of property, plant and equipment, definite-lived intangible assets and other long-lived assets for potential impairment if an event occurs or circumstances change that indicates the carrying amount may not be recoverable. In evaluating the recoverability of a long-lived asset, we compare the carrying values of the assets with corresponding estimated undiscounted future operating cash flows. In the event the carrying values of long-lived assets are not recoverable by future undiscounted operating cash flows, impairments may exist. In the event of impairment, an impairment charge would be measured as the amount by which the carrying value of the relevant long-lived assets exceeds their fair value. During 2012 we recognized an impairment loss to fixed assets of $0.7 million as a result of the closure of our Huizhou, China PCB manufacturing facility. No impairments were recorded in 2011 and 2010. Goodwill At December 31, 2012, our goodwill balance relates entirely to our Printed Circuit Boards segment. We conduct an assessment of the carrying value of goodwill annually, as of the first day of our fourth fiscal quarter, or more frequently if circumstance arise which would indicate the fair value of a reporting unit is below its carrying amount. During 2012, we performed a qualitative assessment to screen for potential impairment of goodwill. A qualitative assessment requires us to consider a number of relevant factors and conclude whether it is more likely than not that the fair value of a reporting unit is more than its carrying amount. In performing our qualitative assessment to screen for potential impairment of goodwill, we considered a number of factors, including i) macroeconomic conditions, ii) factors impacting our industry and the end markets we serve, iii) factors impacting our costs to manufacture products and operate our business, iv) the financial performance of reporting units compared with projections and prior periods, v) reporting unit specific events which could impact future operating results, vi) the market value of our debt and equity securities, and vii) other relevant events and circumstances identified at the time of the assessment. No adjustments were recorded to the balance of goodwill as a result of this assessment. In any given year we may elect to perform a quantitative impairment test for impairment, or if, as a result of the qualitative assessment, we are not able to conclude it is more likely than not that the fair value of a reporting unit is more than its carrying amount, then we would be required to perform a quantitative test for impairment. The performance of a quantitative test would require us to make certain assumptions and estimates in determining fair value of our reporting units. When performing such a test, we use multiple methods to estimate the fair value of our reporting units, including discounted cash flow analyses and an EBITDA-multiple approach, which derives an implied fair value of a business unit based on the market value of comparable companies expressed as a multiple of those companies' earnings before interest, taxes, depreciation and amortization ("EBITDA"). Discounted cash flow analyses require us to make significant assumptions about discount rates, sales growth, profitability and other factors. The EBITDA-multiple approach requires us to judgmentally select comparable companies based on factors such as their nature, scope and size. Significant judgment is required in making assumptions and estimates to perform a qualitative impairment screen and a quantitative impairment test, and should our assumptions change in the future, our fair value models could result in lower fair values, which could materially affect the value of goodwill and our operating results. Income Taxes We record a valuation allowance to reduce our deferred tax assets to the amount that we believe will more likely than not be realized. We have considered future taxable income and ongoing prudent, feasible tax planning strategies in assessing the need for the valuation allowance, but in the event we were to 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 net deferred tax assets would be charged to income in the period such determination was made. Similarly, should we determine that we would be able to realize our deferred tax assets in the future in excess of the net deferred tax assets recorded, an adjustment to the net deferred tax asset would increase net income in the period such determination was made. 50 -------------------------------------------------------------------------------- Table of Contents Derivative Financial Instruments and Fair Value Measurements We conduct our business in various regions of the world, and export and import products to and from several countries. Our operations may, therefore, be subject to volatility because of currency fluctuations. Sales are primarily denominated in U.S. dollars, while expenses are frequently denominated in local currencies, and results of operations may be adversely affected as currency fluctuations affect our product prices and operating costs or those of our competitors. From time to time, we enter into foreign exchange forward contracts and cross-currency swaps to minimize the short-term impact of foreign currency fluctuations. We do not engage in hedging transactions for speculative investment reasons. Gains or losses from our hedging activities have not historically been material to our cash flows, financial position or results from operations. There can be no assurance that our hedging operations will eliminate or substantially reduce risks associated with fluctuating currencies. The foreign exchange forward contracts and cross-currency swaps designated as cash flow hedges are accounted for at fair value. We record deferred gains and losses related to cash flow hedges based on their fair value using a market approach and Level 2 inputs. The effective portion of the change in each cash flow hedge's gain or loss is reported as a component of other comprehensive income, net of taxes. The ineffective portion of the change in the cash flow hedge's gain or loss is recorded in earnings at each measurement date. Gains and losses on derivative contracts are reclassified from accumulated other comprehensive income (loss) to current period earnings in the line item in which the hedged item is recorded in the same period the hedged foreign currency cash flow affects earnings. Accounting for Acquisitions The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their estimated fair value as of that date. Extensive use of estimates and judgments are required to allocate the consideration paid in a business combination to the assets acquired and liabilities assumed. If necessary, these estimates can be revised during an allocation period when information becomes available to further define and quantify the value of assets acquired and liabilities assumed. The allocation period does not exceed a period of one year from the date of acquisition. To the extent additional information to refine the original allocation becomes available during the allocation period, the purchase price allocation would be adjusted accordingly. Should information become available after the allocation period, the effects would be reflected in operating results. Recently Adopted Accounting Pronouncements As of January 1, 2012, we adopted an accounting standard which changes the way other comprehensive income is presented in our financial statements, and elected to begin reporting other comprehensive income in a continuous statement of operations and comprehensive income. In December 2011, the Financial Accounting Standards Board deferred the date by which certain other aspects of the new standard must be implemented. The adoption of this standard had no affect on our financial condition or results of operations. Recently Issued Accounting Pronouncements In December 2011, the FASB issued a final standard which will require us to disclose additional information about financial instruments that have been offset for presentation on our balance sheet. Assets and liabilities for financial instruments, such as cash flow hedge contracts, which are covered by master netting agreements, are reported net, with gross positive fair values netted with gross negative fair values by counterparty. While the new standard will impact our disclosures, it will not change the way we account for such financial instruments and will have no effect on our financial condition or results of operations upon adoption. We are required to adopt this new standard beginning in 2013. 51 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table provides a summary of future payments due under contractual obligations and commitments as of December 31, 2012: Payments due by period Less than 1-3 3-5 More than Contractual Obligations (dollars in millions) 1 year years years 5 years Total 2019 Notes $ - $ - $ - $ 550.0 $ 550.0 Interest on 2019 Notes 43.3 86.6 86.6 57.6 274.1 2013 Notes 0.9 - - - 0.9 North America Mortgage Loans 1.6 3.0 1.9 10.0 16.5 Capital lease payments 0.1 0.3 0.3 0.4 1.1 Zhongshan 2010 Credit Facility 10.0 - - - 10.0 Operating leases 8.0 11.7 5.6 4.5 29.8 Restructuring payments 4.2 0.2 0.2 1.9 6.5 Management fees 0.3 0.7 0.7 11.4 13.1 Deferred compensation 1.1 0.2 0.2 2.1 3.6 Purchase orders 62.0 - - - 62.0 Total (a) $ 131.5 $ 102.7 $ 95.5 $ 637.9 $ 967.6 (a) The liability for unrecognized tax benefits of $25.6 million included in other non-current liabilities at December 31, 2012, has been excluded from the above table as we cannot make a reasonably reliable estimate of the timing of future payments. |