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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED JULY 31, 1998,
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM
--------------- TO
--------------- .
COMMISSION FILE NUMBER: 0-26942
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SMART MODULAR TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
CALIFORNIA 77-0200166
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
4305 CUSHING PARKWAY
FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 623-1231
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
At September 1, 1998, there were 44,508,840 shares of the Registrant's
common stock, no par value, outstanding.
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SMART MODULAR TECHNOLOGIES, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets --
As of July 31, 1998 and October 31, 1997.................... 3
Consolidated Condensed Statements of Income --
For the Three and Nine Months Ended July 31, 1998 and
1997........................................................ 4
Consolidated Condensed Statements of Cash Flows --
For the Nine Months Ended July 31, 1998 and 1997............ 5
Notes to Consolidated Condensed Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 22
Item 2. Changes in Securities....................................... 22
Item 3. Defaults upon Senior Securities............................. 22
Item 4. Submission of Matters to a Vote of Security Holders......... 22
Item 5. Other Information........................................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 22
Signatures............................................................ 23
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JULY 31, OCTOBER 31,
1998 1997
-------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $101,689 $111,331
Short term investments.................................... 87,096 38,672
Accounts receivable, net.................................. 63,271 95,366
Inventories............................................... 33,298 39,336
Deferred income taxes..................................... 5,325 5,325
Prepaid expenses and other................................ 7,013 12,992
-------- --------
Total current assets.............................. 297,692 303,022
Property and equipment, net................................. 41,924 24,604
Other....................................................... 636 359
-------- --------
Total assets...................................... $340,252 $327,985
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 47,369 $ 73,833
Accrued bonuses........................................... 4,087 6,761
Other accrued expenses.................................... 9,140 9,001
Income taxes payable...................................... 10,482 7,312
-------- --------
Total current liabilities......................... 71,078 96,907
Long-term Liabilities:
Deferred income taxes and other........................... 606 758
-------- --------
Total liabilities................................. 71,684 97,665
-------- --------
Shareholders' Equity:
Common stock, no par value --
Authorized -- 200,000,000 shares
Outstanding -- 44,516,509 and 42,334,260 shares,
respectively.......................................... 133,856 135,123
Retained earnings........................................... 134,712 95,197
-------- --------
Total shareholders' equity........................ 268,568 230,320
-------- --------
Total liabilities and shareholders' equity........ $340,252 $327,985
======== ========
</TABLE>
See the accompanying notes to these consolidated condensed financial statements.
3
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SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------- --------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales....................................... $150,406 $201,923 $534,668 $477,187
Cost of sales................................... 126,027 171,047 444,099 399,539
-------- -------- -------- --------
Gross profit.................................... 24,379 30,876 90,569 77,648
-------- -------- -------- --------
Operating Expenses:
Research and development........................ 2,235 2,496 6,676 6,390
Sales, general and administrative............... 10,485 9,926 31,074 26,262
-------- -------- -------- --------
Total operating expenses.............. 12,720 12,422 37,750 32,652
-------- -------- -------- --------
Income from operations.......................... 11,659 18,454 52,819 44,996
Other income, net............................... 1,777 412 5,292 1,421
-------- -------- -------- --------
Income before provision for income taxes........ 13,436 18,866 58,111 46,417
Provision for income taxes...................... 4,305 6,414 18,596 15,787
-------- -------- -------- --------
Net income...................................... $ 9,131 $ 12,452 $ 39,515 $ 30,630
======== ======== ======== ========
Diluted net income per share.................... $ 0.20 $ 0.29 $ 0.84 $ 0.71
======== ======== ======== ========
Weighted average common and common equivalent
shares outstanding............................ 46,566 43,620 46,995 43,274
======== ======== ======== ========
Basic net income per share...................... $ 0.21 $ 0.32 $ 0.92 $ 0.80
======== ======== ======== ========
Weighted average common shares outstanding...... 43,828 38,652 43,064 38,295
======== ======== ======== ========
</TABLE>
See the accompanying notes to these consolidated condensed financial statements.
4
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SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JULY 31,
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES......... $ 67,163 $ (6,104)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments available-for-sale............... (74,297) (5,810)
Maturities of investments available-for-sale.............. 25,873 4,718
Purchases of property and equipment....................... (24,286) (12,915)
Proceeds from sale of property and equipment.............. 36 90
-------- --------
Net cash used in investing activities.................. (72,674) (13,917)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from line of credit.............................. 5,000 --
Payments on line of credit................................ (5,000) --
Payments of capital lease obligations..................... (829) (1,202)
Proceeds from sale of common stock........................ 3,940 2,231
Purchases of common stock................................. (7,242) --
-------- --------
Net cash (used in) provided by financing activities.... (4,131) 1,029
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (9,642) (18,992)
CASH AND CASH EQUIVALENTS, beginning of period.............. 111,331 52,568
-------- --------
CASH AND CASH EQUIVALENTS, end of period.................... $101,689 $ 33,576
======== ========
</TABLE>
See the accompanying notes to these consolidated condensed financial statements.
5
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SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The Interim Consolidated Condensed Financial Statements of SMART Modular
Technologies, Inc., a California corporation, and subsidiaries (the "Company")
have been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in the financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. These Interim Consolidated Condensed
Financial Statements should be read in conjunction with the audited financial
statements and notes thereto included in the Company's fiscal 1997 Report on
Form 10-K as filed with the Securities and Exchange Commission on January 29,
1998.
The Interim Consolidated Condensed Financial Statements for the third
quarter of fiscal 1998 reflect, in the opinion of management, all adjustments
(which include only the normal recurring adjustments) necessary for a fair
presentation of financial position, results of operations and cash flows for
such period. The Interim Consolidated Condensed Financial Statements for fiscal
1997 are provided for information purposes only. The results of operations for
the three and nine month periods ended July 31, 1998 are not necessarily
indicative of the results that may be expected for the entire fiscal year ending
October 31, 1998, or any other future periods.
Revenue Recognition
Revenue is recognized upon shipment to the customer. The Company provides
for estimated future returns for inventory rebalancing, stock rotation,
established price protection arrangements and the estimated costs of warranty at
the time of sale.
Net Income Per Share
The Company computes net income per share in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No.
128 requires companies to compute net income per share under two different
methods, basic and diluted, and present per share data for all periods in which
a statement of operations is presented. Basic net income per share is computed
by dividing net income by the weighted average number of shares of common stock
outstanding during the period. Diluted net income per share is computed using
the weighted average number of shares of common stock and common stock
equivalents outstanding during the period. Common stock equivalents consist of
preferred stock (using the "if converted" method), stock options and warrants
(using the treasury stock method). Preferred stock, stock options and warrants
are excluded from the computation of diluted net income per share if their
effect is anti-dilutive.
6
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SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The following table reconciles the amounts used in the computation of basic
and diluted net income per share (in thousands, except per share data):
<TABLE>
<CAPTION>
3 MONTHS ENDED 9 MONTHS ENDED
JULY 31, JULY 31,
----------------- ------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income available to common shareholders........... $ 9,131 $12,452 $39,515 $30,630
======= ======= ======= =======
Diluted net income per share:
Weighted average common shares outstanding.......... 43,828 38,652 43,064 38,295
Weighted average common stock options outstanding... 2,738 4,968 3,931 4,979
------- ------- ------- -------
Total weighted average common and common
equivalents outstanding........................ 46,566 43,620 46,995 43,274
======= ======= ======= =======
Diluted net income per share..................... $ 0.20 $ 0.29 $ 0.84 $ 0.71
======= ======= ======= =======
Basic net income per share:
Weighted average common shares outstanding.......... 43,828 38,652 43,064 38,295
------- ------- ------- -------
Total weighted average common shares
outstanding.................................... 43,828 38,652 43,064 38,295
======= ======= ======= =======
Basic net income per share....................... $ 0.21 $ 0.32 $ 0.92 $ 0.80
======= ======= ======= =======
</TABLE>
Effect of Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Investments and Hedging Activities." The statement
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement also requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedge
item in the income statement, and requires that a company formally document,
designate and assess the effectiveness of transactions that receive hedge
accounting. SFAS No. 133 is effective for fiscal years beginning after June 15,
1999. The Company does not expect the adoption of SFAS No. 133 to have a
material effect on the Company's consolidated financial statements.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and include material, labor and manufacturing costs. Inventories consist of the
following (in thousands):
<TABLE>
<CAPTION>
JULY 31, OCTOBER 31,
1998 1997
-------- -----------
<S> <C> <C>
Raw materials.......................................... $19,427 $22,692
Work-in-process........................................ 5,219 5,266
Finished goods......................................... 8,652 11,378
------- -------
Total........................................ $33,298 $39,336
======= =======
</TABLE>
2. LINE OF CREDIT:
In June 1997, the Company entered into an unsecured revolving bank line of
credit agreement that expires in May 1999. Borrowings under this agreement are
limited to $20.0 million and bear interest at either the bank's prime rate (8.5%
at July 31, 1998) or a spread over LIBOR (5.7% at July 31, 1998), at the
Company's option. The Company is required to maintain specified levels of
tangible net worth and comply
7
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SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
with certain other covenants. As of July 31, 1998 and October 31, 1997, no
borrowings were outstanding under this agreement.
3. STOCK REPURCHASE:
On May 25, 1998, the Company's Board of Directors authorized the repurchase
from time to time of up to 4,000,000 shares of the Company's Common Stock
through open market purchases. During the third quarter of fiscal 1998, the
Company repurchased 520,000 shares of its Common Stock in the open market at an
average purchase price of $13.93 per share and a total cost of approximately
$7.2 million.
4. LITIGATION:
The Company and certain of its officers and directors have been named as
defendants in six securities class action lawsuits filed in the United States
District Court for the Northern District of California, Boren v. SMART Modular
Technologies, Inc., et al., No. C 98 20692 JW (PVT) (filed July 1, 1998),
Woszczak v. SMART Modular Technologies, Inc., et al., No. C 98 2617 JL (filed
July 2, 1998), Bisson v. SMART Modular Technologies, Inc., et. al., No. C 98
20714 JF (filed July 8, 1998), D'Amato v. SMART Modular Technologies, Inc., et.
al., No. C 98 2804 PJH (filed July 16, 1998), Cha v. SMART Modular Technologies,
Inc., et. al., No. C 98 2833 BZ (filed July 17, 1998) and Chang v. SMART Modular
Technologies, Inc., et. al., No. C 98 3151 SI (filed August 13, 1998)
(collectively, the "Securities Actions"). The plaintiffs in the Securities
Actions allege that defendants made material misrepresentations and omissions
during the period from July 1, 1997 through May 21, 1998 in violation of Section
10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder. The Company believes that all claims related to the Securities
Actions are without merit and intends to vigorously defend itself against the
Securities Actions. Currently, the Company is unable to estimate the financial
impact of the Securities Actions.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to other areas of this Management's Discussion and Analysis of
Financial Condition and Results of Operations, the fourth and fifth paragraphs
of the Overview Section; the Gross Profit Section; the Research and Development
Section; the Sales, General and Administrative Section; the Provision for Income
Taxes Section; and the first and third paragraphs of the Liquidity and Capital
Resources Section contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Actual results could differ
materially from those projected in the forward-looking statements as a result of
the factors set forth in "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Factors That May Affect Future
Results." In particular, note the factors entitled "Significant Customer
Concentration," "Product Concentration; Dependence on Memory Market,"
"Dependence on Semiconductor, Computer, Telecommunications and Networking
Industries," "Intense Competition," "Fluctuations in Operating Results,"
"Dependence on Sole or Limited Sources of Supply" and "Rapid Technological
Change." The discussion of those factors is incorporated herein by this
reference as if said discussion was fully set forth at this point.
OVERVIEW
SMART Modular Technologies, Inc., a California corporation (the "Company"
or "SMART"), commenced operations in 1989 and initially focused on the design
and manufacture of standard memory modules for OEMs and semiconductor
manufacturers. Standard memory modules implement industry standard
specifications, primarily utilize DRAM and are designed to be incorporated into
a wide variety of electronic equipment. In 1991, the Company expanded its
design, manufacturing and marketing efforts to offer specialty memory modules
and PC card memory products. The Company expanded its PC card communication
product line through the acquisition of Apex Data, Inc., a Delaware corporation,
in July 1995. The Company further expanded its product line to include embedded
computer modules through the acquisition of RISQ Modular Systems, Inc., a
California corporation, in July 1996.
Over the last eight fiscal quarters, SMART's gross margin has ranged from
15.3% to 18.2%. One of the primary factors affecting gross margin has been the
proportion of the Company's memory products manufactured on either a turnkey or
consignment basis. Products manufactured on a turnkey basis are designed and
manufactured by the Company with purchased memory devices. Products manufactured
on a consignment basis are generally designed and manufactured by the Company
with memory devices that are owned and supplied by the customer. While products
manufactured on a turnkey basis typically have lower gross margin than products
manufactured on a consignment basis, products manufactured on a turnkey basis
generally contribute greater net sales and higher gross profit per unit than
products manufactured on a consignment basis. Currently, a substantial majority
of the Company's net sales is derived from sales of products manufactured on a
turnkey basis.
The other primary factor affecting the Company's gross margin has been the
mix between sales of specialty memory modules, standard memory modules,
communication card products and embedded computer modules. In prior fiscal
periods, a significant majority of the Company's net sales were derived from the
sales of its specialty memory modules which typically have slightly higher gross
margin than the Company's standard memory modules. Currently, a majority of the
Company's net sales are derived from the sales of its standard memory modules.
The Company's embedded computer modules currently generate the Company's highest
gross margin, followed by the Company's PC card communication products. Both of
these product lines currently contribute a relatively small portion of the
Company's net sales.
The Company expects that its net sales and gross margin will continue to
vary based on these and other factors, including the mix of products sold and
the manufacturing services provided, the channels through which the Company's
products are sold, changes in product selling prices and component costs, the
level of manufacturing efficiencies achieved and pricing by competitors. The
selling prices of the Company's existing products have declined in the past and
the Company expects that prices will continue to decline in the future. In
particular, during fiscal 1997, the selling prices of the Company's existing
products declined due to significant declines in DRAM semiconductor prices and
declines in SRAM and Flash semiconductor prices.
9
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Moreover, since the fiscal 1997 year end, declines in the selling prices of
certain of the Company's existing products have continued due to significant
declines in DRAM semiconductor prices and declines in SRAM and Flash
semiconductor prices which has adversely impacted the Company's net sales.
Because a substantial portion of the Company's net sales are attributable to the
resale of semiconductor memory devices, a continued decline in the prices of
these components would have a material adverse effect on the Company's net sales
and could have a material adverse effect on the Company's business, financial
condition and results of operations. Accordingly, the Company's ability to
maintain or increase net sales will be highly dependent upon its ability to
increase unit sales volumes of existing products and to introduce and sell new
products in quantities sufficient to compensate for the anticipated declines in
selling prices. Declining product selling prices may also materially and
adversely affect the Company's gross margin unless the Company is able to reduce
its cost per unit to offset declines in product selling prices. There can be no
assurance that the Company will be able to increase unit sales volumes,
introduce and sell new products or reduce its cost per unit. In addition, the
Company's business has in the past been subject to seasonality, although the
Company believes such seasonality has been masked by its growth. The Company
expects that its business will experience more significant seasonality as it
expands its sales and marketing efforts in Europe and to the extent its exposure
to the personal computer market remains significant.
The Company primarily sells its products to OEMs and semiconductor
manufacturers in the computer, networking and telecommunications industries. A
relatively small number of customers have accounted for a significant percentage
of the Company's net sales. For fiscal 1997, fiscal 1996 and fiscal 1995, the
Company's ten largest customers accounted for 86%, 71% and 68% of net sales,
respectively. For fiscal 1997, the Company's three largest customers were Compaq
Computer Corporation ("Compaq"), Cisco System, Inc. ("Cisco") and
Hewlett-Packard Company ("Hewlett-Packard"), which accounted for 53%, 12% and
11% of net sales, respectively. In fiscal 1996, the Company's three largest
customers were Cisco, Hewlett-Packard and IBM Corporation ("IBM"), which
accounted for 19%, 15% and 12% of net sales, respectively. In fiscal 1995, the
Company's three largest customers were Cisco, IBM and Hewlett-Packard, which
accounted for 18%, 15% and 10% of net sales, respectively. During these periods,
no other customers accounted for more than 10% of net sales. The Company expects
that sales to relatively few customers will continue to account for a
significant percentage of its net sales in the foreseeable future. However,
there can be no assurance that any of these customers or any of the Company's
other customers will continue to utilize the Company's products at current
levels, if at all. The Company has experienced significant changes in the
composition of its major customer base and expects that this variability will
continue in the future. For example, sales to Compaq, which represented less
than 10% of net sales in fiscal 1996 and fiscal 1995, represented 53% of the
Company's net sales in fiscal 1997. The loss of any major customer or any
reduction in orders by any such customer would have a material adverse effect on
the Company's business, financial condition and results of operations. Recently,
certain of the Company's customers announced that they intend to reduce their
inventory levels in the distribution channel for certain products that
incorporate the Company's products, which has resulted in lower than anticipated
orders for the Company's products and could continue to have a material adverse
impact on the Company's sales to those customers. Any adverse changes in the
business of the Company's customers could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
one of the Company's largest customers has recently reduced the Company's market
share levels for certain of the products the Company sells to the customer,
which had, and could continue to have, a material adverse effect on the
Company's business, financial condition and results of operations.
10
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RESULTS OF OPERATIONS:
The following table sets forth certain consolidated condensed statements of
income data of the Company expressed as a percentage of net sales:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------ ------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net sales..................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales................................. 83.8 84.7 83.1 83.7
----- ----- ----- -----
Gross profit.................................. 16.2 15.3 16.9 16.3
Operating expenses:
Research and development.................... 1.5 1.2 1.2 1.3
Selling, general and administrative......... 7.0 4.9 5.8 5.5
----- ----- ----- -----
Total operating expenses............ 8.5 6.2 7.1 6.8
----- ----- ----- -----
Income from operations........................ 7.8 9.1 9.9 9.4
Other income, net............................. 1.2 0.2 1.0 0.3
----- ----- ----- -----
Income before provision for income taxes...... 8.9 9.3 10.9 9.7
Provision for income taxes.................... 2.9 3.2 3.5 3.3
----- ----- ----- -----
Net income.................................... 6.1% 6.2% 7.4% 6.4%
===== ===== ===== =====
</TABLE>
Net Sales
Net sales consist of sales of specialty and standard memory products, PC
cards, embedded computer modules and communication card products, less returns
and discounts. Net sales for the third quarter of fiscal 1998 decreased 25.5% to
$150.4 million from $201.9 million for the same period of fiscal 1997. The
decrease in net sales for the three months ended July 31, 1998 reflects an
overall reduction in demand for the Company's memory products resulting from,
among other things, ongoing efforts by certain OEMs served by the Company to
reduce factory and channel inventories and an industry-wide excess supply of
standard memory modules. A portion of the decrease in net sales also resulted
from a substantial decline in the cost of certain memory devices used in the
production of the Company's products. Net sales for the nine months ended July
31, 1998 increased 12.0% to $534.7 million from $477.2 million for the same
period of fiscal 1997. The increase in net sales for the nine month period ended
July 31, 1998 reflects an overall increase in demand for the Company's products
from both new and existing customers as compared to the same period of fiscal
1997. This increase was partially offset by a decrease in net sales resulting
from a substantial decline in the cost of certain memory devices used in the
production of the Company's products.
Gross Profit
Cost of sales includes the costs of semiconductor devices and other
components and materials purchased by the Company for its products, as well as
the direct labor and overhead costs associated with manufacturing. Gross profit
decreased 21.0% to $24.4 million for the third quarter of fiscal 1998 from $30.9
million for the same period of fiscal 1997. Gross margin increased to 16.2% for
the third quarter of fiscal 1998 from 15.3% for the comparable period of fiscal
1997. Gross profit for the first nine months of fiscal 1998 increased 16.6% to
$90.6 million from $77.6 million for the same period of fiscal 1997. Gross
margin increased to 16.9% for the first nine months of fiscal 1998 from 16.3%
for the comparable period of fiscal 1997. The increase in gross margin for the
three and nine month periods ended July 31, 1998 was principally due to a
decrease in the cost of certain memory chips used in the production of the
Company's products as compared to the same periods of fiscal 1997. Further
contributing to these increases was a decrease in the proportion of the
Company's net sales derived from its lower margin standard memory products as
compared to the same periods of fiscal 1997. The Company expects gross margin to
continue to be affected in future periods by, among other things, changes in the
cost of memory devices used in the production of the Company's products, changes
in the sales mix of the Company's products and changes in the proportion of
products manufactured on a turnkey basis versus those manufactured on a
consignment basis.
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Research and Development
Research and development expenses consist primarily of the costs associated
with the design and testing of new products. These costs relate primarily to
compensation of personnel involved with development efforts, materials and
outside design and testing services. Research and development expenses decreased
10.5% to $2.2 million for the third quarter of fiscal 1998 from $2.5 million
during the same period of fiscal 1997 and totaled 1.5% and 1.2% of net sales for
the third quarter of fiscal 1998 and fiscal 1997, respectively. For the first
nine months of fiscal 1998, research and development expenses increased 4.5% to
$6.7 million from $6.4 million during the same period of fiscal 1997 and totaled
1.2% and 1.3% of net sales for the first nine months of fiscal 1998 and fiscal
1997, respectively. The Company expects that its research and development
expenses will increase in absolute dollars in future periods to the extent that
the Company expands its research and development efforts.
Sales, General and Administrative
Sales, general and administrative expenses consist primarily of personnel
costs (including salaries, performance-based bonuses, commissions and employee
benefits), facilities and equipment costs, costs related to advertising and
marketing and other support costs including utilities, insurance and
professional fees. Sales, general and administrative expenses incurred during
the third quarter of fiscal 1998 totaled $10.5 million, representing an increase
of 5.6% from $9.9 million for the same period of fiscal 1997. Sales, general and
administrative expenses totaled 7.0% and 4.9% of net sales for the third quarter
of fiscal 1998 and fiscal 1997, respectively. For the first nine months of
fiscal 1998, sales, general and administrative expenses totaled $31.1 million,
representing an increase of 18.3% from $26.3 million for the same period of
fiscal 1997. Sales, general and administrative expenses totaled 5.8% and 5.5% of
net sales for the first nine months of fiscal 1998 and fiscal 1997,
respectively. The increases in sales, general and administrative expenses as a
percentage of net sales for the three and nine month periods ended July 31, 1998
were principally due to a reduction in net sales from OEM customers for those
periods as discussed in the "Net Sales" section of "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The Company expects
that its sales, general and administrative expenses will increase in absolute
dollars in future periods to the extent that the Company expands its staffing,
information systems and other systems and personnel in connection with the
expansion of the Company's infrastructure.
Other Income, Net
Other income, net consists primarily of interest income, less interest
expense. Interest expense is attributable to the Company's utilization of its
line of credit and interest paid on certain capital lease obligations. Interest
income results from investment of cash balances. As compared to the same periods
of fiscal 1997, interest income earned during the three and nine month periods
ended July 31, 1998 increased due to higher cash balances generated from
operations and proceeds from the Company's secondary public offering of common
stock completed in September 1997.
Provision for Income Taxes
Provisions for income taxes were $4.3 million and $6.4 million for the
third quarter of fiscal 1998 and fiscal 1997, respectively, resulting in
effective tax rates of 32.0% and 34.0%, respectively. For the first nine months
of fiscal 1998 and fiscal 1997, the Company provided $18.6 million and $15.8
million for income taxes, respectively, resulting in respective effective tax
rates of 32% and 34%. The decrease in the Company's consolidated effective tax
rate for the three and nine month periods ended July 31, 1998 was principally
due to anticipated contributions to income from the Company's Puerto Rican and
international operations as compared to the same periods of fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, SMART has used funds generated primarily from operations,
certain borrowings, capital leases and equity financings to support its
operations, acquire capital equipment and finance inventory and
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accounts receivable. For the first nine months of fiscal 1998, the Company
generated cash from operating activities totaling $67.2 million. The increase in
cash provided by operating activities primarily resulted from net income
generated during the period, a decrease in accounts receivable, inventories and
prepaid expenses and an increase in taxes payable and was partially offset by a
decrease in accounts payable. For the first nine months of fiscal 1997, the
Company used cash in operations totaling $6.1 million. At July 31, 1998, the
Company had $188.8 million of cash, cash equivalents and short-term investments,
and $226.6 million of working capital. At October 31, 1997, the Company had
$150.0 million of cash, cash equivalents and short-term investments and $206.1
million of working capital. The Company primarily funds its liquidity
requirements from utilization of existing cash balances and amounts borrowed
under its existing line of credit. The Company expects to fund any future
liquidity requirements from a combination of available cash balances and certain
short-term borrowings under its line of credit. The Company currently
anticipates that its working capital requirements will continue to increase in
future periods to the extent that the Company's operations continue to expand.
The Company has a revolving line of credit agreement (the "Credit Line")
with a term expiring in May 1999. Borrowings under the Credit Line are limited
to $20.0 million. Borrowings under the Credit Line bear interest at either the
bank's prime rate or a spread over LIBOR, at the Company's option. The Company
is required to maintain specified levels of tangible net worth and comply with
certain other covenants. As of July 31, 1998, the Company was in compliance with
all covenants related to the line of credit. The Credit Line is unsecured and no
borrowings were outstanding under the Credit Line as of July 31, 1998.
Capital expenditures totaled $24.3 million for the first nine months of
fiscal 1998 and $17.1 million for the fiscal year ended October 31, 1997. These
expenditures were primarily for manufacturing and test equipment and the
expansion of the Company's existing manufacturing operations. SMART anticipates
spending between $30.0 million and $35.0 million on capital expenditures during
all of fiscal 1998 related to the continued expansion of the Company's
manufacturing operations and related equipment.
SMART has entered into certain capital lease arrangements. The outstanding
principal on these obligations was approximately $0.3 million and $1.2 million
at July 31, 1998 and October 31, 1997, respectively.
On May 25, 1998, the Company's Board of Directors authorized the repurchase
from time to time of up to 4,000,000 shares of the Company's Common Stock
through open market purchases. During the third quarter of fiscal 1998, the
Company repurchased 520,000 shares of its Common Stock in the open market at an
average purchase price of $13.93 per share and a total cost of approximately
$7.2 million.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's business, financial condition and results of operations could
be impacted by a number of factors including without limitation the following
factors.
Significant Customer Concentration
A relatively small number of customers have accounted for a significant
percentage of the Company's net sales. For fiscal 1997, fiscal 1996 and fiscal
1995, the Company's ten largest customers accounted for 86%, 71% and 68% of net
sales, respectively. For fiscal 1997, the Company's three largest customers were
Compaq, Cisco and Hewlett-Packard, which accounted for 53%, 12% and 11% of net
sales, respectively. In fiscal 1996, the Company's three largest customers were
Cisco, Hewlett-Packard and IBM, which accounted for 19%, 15% and 12% of net
sales, respectively. In fiscal 1995, the Company's three largest customers were
Cisco, IBM and Hewlett-Packard, which accounted for 18%, 15% and 10% of net
sales, respectively. During these periods, no other customers accounted for more
than 10% of net sales. The Company expects that sales to relatively few
customers will continue to account for a significant percentage of its net sales
in the foreseeable future. However, there can be no assurance that any of these
customers or any of the Company's other customers will continue to utilize the
Company's products at current levels, if at all. The Company has experienced
significant changes in the composition of its major customer base and expects
that this variability will continue in the future. For example, sales to Compaq,
which represented less than 10% of net sales in fiscal 1996 and
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fiscal 1995, represented 53% of the Company's net sales in fiscal 1997. The loss
of any major customer or any reduction in orders by any such customer would have
a material adverse effect on the Company's business, financial condition and
results of operations. Recently, certain of the Company's customers announced
that they intend to reduce their inventory levels in the distribution channel
for certain products that incorporate the Company's products, which has resulted
in lower than anticipated orders for the Company's products and could continue
to have a material adverse impact on the Company's sales to those customers. Any
adverse changes in the business of the Company's customers could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, one of the Company's largest customers has recently
reduced the Company's market share levels for certain of the products the
Company sells to the customer, which had, and could continue to have, a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company has no firm long-term volume commitments from any of its major
customers and generally enters into individual purchase orders with its
customers, in certain cases under master agreements governing the terms and
conditions of the relationship. The Company has experienced cancellations of
orders and fluctuations in order levels from period to period and expects it
will continue to experience such cancellations and fluctuations in the future.
Customer purchase orders may be canceled and order volume levels can be changed,
canceled or delayed with limited or no penalties. The replacement of canceled,
delayed or reduced purchase orders with new business cannot be assured.
Moreover, the Company's business, financial condition and results of operations
will depend in significant part on its ability to obtain orders from new
customers, as well as on the financial condition and success of its customers.
Therefore, any adverse factors affecting any of the Company's major customers or
their customers could have a material adverse effect on the Company's business,
financial condition and results of operations.
Product Concentration; Dependence on Memory Market
A substantial majority of the Company's net sales is derived from memory
products. The market for memory products is characterized by frequent
transitions in which products rapidly incorporate new features and performance
standards. A failure to develop products with required feature sets or
performance standards or a delay as short as a few months in bringing a new
product to market could significantly reduce the Company's net sales for a
substantial period, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
The market for semiconductor memory devices has been cyclical. The industry
has experienced significant economic downturns at various times, characterized
by diminished product demand, accelerated erosion of average selling prices and
production overcapacity. During fiscal 1997, there were significant declines in
DRAM semiconductor prices and declines in SRAM and Flash semiconductor prices.
Since the fiscal 1997 year end, there have been continued significant declines
in DRAM semiconductor prices and declines in SRAM and Flash semiconductor prices
which have adversely impacted net sales. Because a substantial portion of the
Company's net sales are attributable to the resale of semiconductor memory
devices, a continued decline in the prices of these components would have a
material adverse effect on the Company's net sales and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Semiconductor, Computer, Telecommunications and Networking
Industries
The Company may experience substantial period-to-period fluctuations in
future operating results due to factors affecting the semiconductor, computer,
telecommunications and networking industries. From time to time, each of these
industries has experienced downturns, often in connection with, or in
anticipation of, declines in general economic conditions. A decline or
significant shortfall in growth in any one of these industries could have a
material adverse impact on the demand for the Company's products and therefore a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, changes in end user demand for the products
sold by any individual OEM customer can have a rapid and exaggerated effect on
demand for the Company's products from that customer in any given period,
particularly in the event that the OEM customer has accumulated excess
inventories of products purchased from the
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Company. There can be no assurance that the Company's net sales and results of
operations will not be materially and adversely affected in the future due to
changes in demand from individual customers or cyclical changes in the
semiconductor, computer, telecommunications, networking or other industries
utilizing the Company's products.
Intense Competition
The memory module, communication card and embedded computer subsystem
industries are intensely competitive. Each of these markets includes a large
number of competitive companies, several of which have achieved a substantial
market share. Certain of the Company's competitors in each of these markets have
substantially greater financial, marketing, technical, distribution and other
resources, greater name recognition, lower cost structures and larger customer
bases than the Company. In the memory module market, the Company competes
against semiconductor manufacturers that maintain captive memory module
production capabilities, including Samsung Electronics Company Ltd. ("Samsung").
The Company also competes with independent memory module manufacturers,
including Celestica Inc., PNY Electronics, Inc. and Simple Technology
Incorporated. In the computer systems reseller market for memory modules, the
Company primarily competes with companies such as Kingston Technology, Inc.,
Viking Technology, Inc. and Vision Tek, Inc. In the communication card market,
the Company competes with GVC, TDK and U.S. Robotics, Inc. (a subsidiary of 3Com
Corporation), among others. In the embedded computer subsystem market, the
Company competes with Force Computers Inc. (a subsidiary of Solectron
Corporation), Motorola Inc. and Radisys Corporation, among others. The Company
faces competition from current and prospective customers that evaluate the
Company's capabilities against the merits of manufacturing products internally.
In addition, certain of the Company's competitors, such as Samsung, are
significant suppliers to the Company. These suppliers have the ability to
manufacture competitive products at lower costs than the Company as a result of
their higher levels of integration and therefore have the ability to sell
competitive products at lower prices than the Company's products. The Company
also faces competition from new and emerging companies that have recently
entered or may in the future enter the markets in which the Company
participates.
The Company expects its competitors to continue to improve the performance
of their current products, to reduce their current product sales prices and to
introduce new products that may offer greater performance and improved pricing,
any of which could cause a decline in sales or loss of market acceptance of the
Company's products. There can be no assurance that enhancements to or future
generations of competitive products will not be developed that offer better
prices or technical performance features than the Company's products. To remain
competitive, the Company must continue to provide technologically advanced
products and manufacturing services, maintain quality levels, offer flexible
delivery schedules, deliver finished products on a reliable basis, reduce
manufacturing and testing costs and compete favorably on the basis of price. In
addition, increased competitive pressure has led in the past and may continue to
lead to intensified price competition, resulting in lower prices and gross
margin, which could materially adversely affect the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will be able to compete successfully in the future.
Fluctuations in Operating Results
The Company's results of operations and gross margin have fluctuated
significantly from period to period in the past and may in the future continue
to fluctuate significantly from period to period. The primary factors that have
affected and may in the future affect the Company's results of operations
include the partial or complete loss of a principal customer or the reduction in
orders from a customer due to among other things excess product inventory
accumulation by such customer, the adverse changes in the mix of products sold
by the Company, and the inability to procure required components. Other factors
that have affected and may in the future affect the Company's results of
operations include fluctuating market demand for and declines in the selling
prices of the Company's products, market acceptance of new products and enhanced
versions of the Company's products, the Company's competitors selling products
that compete with the Company's products at lower prices or on better terms than
the Company's products, delays in the introduction of new products and
enhancements to existing products, manufacturing inefficiencies associated with
the start up of new product
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introductions, and the Company's semiconductor customers manufacturing memory
modules, internally or with other third parties, outside of the United States
due to concerns about United States antidumping investigations and laws.
Recently, certain of the Company's customers announced that they intend to
reduce their inventory levels in the distribution channel for certain products
that incorporate the Company's products, which has resulted in lower than
anticipated orders for the Company's products and could continue to have a
material adverse impact on the Company's sales to those customers. Any adverse
changes in the business of the Company's customers could have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, one of the Company's largest customers has recently reduced the
Company's market share levels for certain of the products the Company sells to
the customer, which had, and could continue to have, a material adverse effect
on the Company's business, financial condition and results of operations.
The Company's operating results may also be affected by the timing of new
product announcements and releases by the Company or its competitors, the timing
of significant orders, the ability to produce products in volume, delays,
cancellations or reschedulings of orders due to customer financial difficulties
or other events, inventory obsolescence, including the reduction in value of the
Company's inventories due to unexpected price declines, unexpected product
returns, the timing of expenditures in anticipation of increased sales,
cyclicality in the Company's targeted markets, and expenses associated with
acquisitions. In particular, declines in DRAM, SRAM and Flash semiconductor
prices could affect the valuation of the Company's inventory which could result
in adverse changes in the Company's business, financial condition and results of
operations. The concentration of the Company's assets in its Fremont, California
facility could make the Company's exposure to business disruptions greater than
if the Company's assets were more geographically dispersed.
The Company's net sales and gross margin have varied and will continue to
vary significantly based on a variety of factors, including the mix of products
sold and the manufacturing services provided, the channels through which the
Company's products are sold, changes in product selling prices and component
costs, the level of manufacturing efficiencies achieved and pricing by
competitors. The selling prices of the Company's existing products have declined
in the past and the Company expects that prices will continue to decline in the
future. In particular, during fiscal 1997, the selling prices of the Company's
existing products declined due to significant declines in DRAM semiconductor
prices and declines in SRAM and Flash semiconductor prices. Moreover, since the
fiscal 1997 year end, declines in the selling prices of certain of the Company's
existing products have continued due to significant declines in DRAM
semiconductor prices and declines in SRAM and Flash semiconductor prices which
has adversely impacted the Company's net sales. Because a substantial portion of
the Company's net sales are attributable to the resale of semiconductor memory
devices, a continued decline in the prices of these components would have a
material adverse effect on the Company's net sales and could have a material
adverse effect on the Company's business, financial condition and results of
operations. Accordingly, the Company's ability to maintain or increase net sales
will be highly dependent upon its ability to increase unit sales volumes of
existing products and to introduce and sell new products in quantities
sufficient to compensate for the anticipated declines in selling prices.
Declining product selling prices may also materially and adversely affect the
Company's gross margin unless the Company is able to reduce its cost per unit to
offset declines in product selling prices. There can be no assurance that the
Company will be able to increase unit sales volumes, introduce and sell new
products or reduce its cost per unit. In addition, the Company's business has in
the past been subject to seasonality, although the Company believes such
seasonality has been masked by its growth. The Company expects that its business
will experience more significant seasonality as it expands its sales and
marketing efforts in Europe and to the extent its exposure to the personal
computer market remains significant.
Sales of the Company's individual products and product lines toward the end
of a product's life cycle are typically characterized by steep declines in
sales, pricing and gross margin, the precise timing of which may be difficult to
predict. The Company could experience unexpected reductions in sales of products
as customers anticipate new product purchases. In addition, to the extent that
the Company manufactures products in anticipation of future demand that does not
materialize, or in the event a customer cancels outstanding orders during a
period of either declining product selling prices or decreasing demand, the
Company could experience an unanticipated decrease in sales of products. These
factors could give rise to charges for obsolete or excess
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inventory, returns of products by distributors, or substantial price protection
charges or discounts. In the past, the Company has had to write-down and
write-off excess or obsolete inventory. To the extent that the Company is
unsuccessful in managing product transitions, its business, financial condition
and results of operations could be materially and adversely affected.
The need for continued significant expenditures for capital equipment
purchases, research and development and ongoing customer service and support,
among other factors, will make it difficult for the Company to reduce its
operating expenses in any particular period if the Company's expectations for
net sales for that period are not met. The Company has significantly increased
its expense levels to support its recent growth, and there can be no assurance
that the Company will maintain its current level of net sales or rate of growth
for any period in the future. Accordingly, there can be no assurance that the
Company will be able to continue to be profitable. The Company believes that
period-to-period comparisons of the Company's financial results are not
necessarily meaningful and should not be relied upon as indications of future
performance. Due to the foregoing factors, it is likely that in some future
period the Company's operating results will be below the expectations of public
market analysts or investors. In such event, the market price of the Company's
securities would be materially and adversely affected.
Dependence on Sole or Limited Sources of Supply
The Company is dependent on certain suppliers, including limited and sole
source suppliers, to provide key components used in the Company's products. In
particular, the Company is dependent in significant part upon certain limited or
sole source suppliers for critical components in the Company's memory module,
communication card and embedded computer module products. The Company also
depends on sole source third party manufacturers to produce certain of the
Company's embedded computer module products. The electronics industry has
experienced in the past, and may experience in the future, shortages in
semiconductor devices, including DRAM, SRAM and Flash memory. The Company has
experienced and may continue to experience delays in component deliveries and
quality problems with respect to certain component deliveries which have caused
and could in the future cause delays in product shipments and have required and
could in the future require the redesign of certain products. The Company
generally has no written agreements with its suppliers. There can be no
assurance that the Company will receive adequate component supplies on a timely
basis in the future. The inability to continue to obtain sufficient supplies of
components as required, or to develop alternative sources if required, could
cause delays, disruptions or reductions in product shipments or require product
redesigns which could damage relationships with current or prospective
customers, could increase costs and/or prices and could have a material adverse
effect on the Company's business, financial condition and results of operations.
Management of Growth; Expansion of Operations
The Company has significantly expanded its operations over the last several
years. This growth has resulted in a significant increase in responsibility for
existing management which has placed, and may continue to place, a significant
strain on the Company's limited personnel and management, manufacturing and
other resources. The Company's ability to manage the recent and any possible
future growth will require an expansion of its manufacturing capacity,
accounting and other internal management systems and the implementation of a
variety of procedures and controls. There can be no assurance that significant
problems in these areas will not occur. Any failure to expand these systems and
implement such procedures and controls in an efficient manner and at a pace
consistent with the Company's business could have a material adverse effect on
the Company's business, financial condition and results of operations.
The Company has licensed a new management information system and intends to
replace its existing management information system with the new system as early
as the first quarter of fiscal 1999. The implementation of the new system will
impact almost all phases of the Company's operations (e.g., planning,
manufacturing, finance and accounting). Implementation of the new system and
transition from the existing system to the new system will require substantial
financial resources, time and personnel. There can be no assurance that the
Company will not experience problems, delays or unanticipated additional costs
in implementing the new management information system or in the use of its
existing system that could have a
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material adverse effect on the Company's business, financial condition and
results of operations, particularly in the period in which the new system is
brought online.
In connection with the Company's recent growth, the Company's operating
expenses have increased significantly, and the Company anticipates that
operating expenses will continue to increase in absolute dollars in the future.
In particular, in order to continue to provide quality products and customer
service and to meet any anticipated demand of its customers, the Company will be
required to continue to increase staffing and other expenses, including
expenditures on capital equipment, sales and marketing. Should the Company
increase its expenditures in anticipation of a future level of sales that does
not materialize, the Company's business, financial condition and results of
operations would be materially and adversely affected. Certain customers have
required and may continue to require rapid increases in production and
accelerated delivery schedules which have placed and may continue to place a
significant burden on the Company's resources. In order to achieve anticipated
sales levels and profitability, the Company will continue to be required to
manage its assets and operations efficiently. In addition, should the Company
continue to expand geographically, it may experience certain inefficiencies from
the management of geographically dispersed facilities.
In May 1998, the Company opened a new manufacturing facility in Penang,
Malaysia, which will result in higher operating expenses. There can be no
assurance that enough future sales will exist to support the operating expenses
of the new facility or that the production lines of the new facility will be
efficient or that they will result in an increase in output. Any delay or
unexpected difficulties arising from the start-up of the new facility could
materially and adversely affect the Company's business, financial condition and
results of operations.
Year 2000; Information Technology Transition
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. Beginning with 21st
century dates, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result computer
systems and software used by many companies may need to be upgraded to comply
with such "Year 2000" requirements. Significant uncertainty exists concerning
the potential effects associated with such compliance. The Company believes its
existing management information system is not Year 2000 compliant. The Company
has licensed a new management information system and intends to replace its
existing management information system with the new system as early as the first
quarter of fiscal 1999. The implementation of the new system will impact almost
all phases of the Company's operations (e.g., planning, manufacturing, finance
and accounting). Implementation of the new system and transition from the
existing system to the new system will require substantial financial resources,
time and personnel. There can be no assurance that the new system will be
implemented in time to avoid any Year 2000 compliance problems, or that the
Company will not experience problems, delays or unanticipated additional costs
in implementing the new management information system or in the use of its
existing system that could have a material adverse effect on the Company's
business, financial condition and results of operations, particularly in the
period in which the new system is brought online.
During the second quarter of fiscal 1998, the Company began a Year 2000
assessment of its management information system, other information technology
systems, non-information technology systems, products and key suppliers. Items
identified and under review include manufacturing and test equipment,
telecommunications systems and equipment and computer systems and equipment. In
addition, the Company is assessing the Year 2000 compliance of its products. The
Company intends to have its Year 2000 assessment, testing, remediation efforts
and development of necessary contingency plans complete by the year 2000, the
total cost of which has not yet been determined. To date, however, costs
incurred to address Year 2000 compliance issues have not been material. Costs
related to Year 2000 compliance issues continue to be funded through operating
cash flows. There can be no assurance that the Company will be able to complete
its Year 2000 assessment, testing, remediation efforts and development of
necessary contingency plans by the year 2000. Any failure to complete the Year
2000 assessment, testing, remediation efforts and development of necessary
contingency plans prior to the year 2000 could have a material adverse effect on
the Company's business, financial condition and results of operations.
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During the third quarter of fiscal 1998, the Company initiated formal
communications with its key suppliers of raw materials and services. Although a
number of respondents indicated that their products are or will be Year 2000
compliant prior to the year 2000 and that they expect their operations and
services will continue uninterrupted, there can be no assurance that the
Company's key suppliers have, or will have information technology systems,
non-information technology systems and products that are Year 2000 compliant.
Similarly, there can be no assurance that the Company's customers have or will
have information technology systems, non-information technology systems and
products that are Year 2000 compliant. Any Year 2000 compliance problem facing
the Company, its customers or suppliers could have a material adverse effect on
the Company's business, financial condition and results of operations.
Rapid Technological Change
The semiconductor, computer, telecommunications and networking industries
are subject to rapid technological change, short product life cycles, frequent
new product introductions and enhancements, changes in end user requirements and
evolving industry standards. The Company's ability to be competitive in these
markets will depend in significant part upon its ability to invest significant
amounts of resources for research and development efforts, to successfully
develop, introduce and sell new products and enhancements on a timely and
cost-effective basis and to respond to changing customer requirements that meet
evolving industry standards. For example, the semiconductor memory market is
currently transitioning from fast page mode ("FPM") and EDO memory to SDRAM, and
the industry standard modem is currently changing from a 33.6 kbps synchronous
modem to a 56 kbps asynchronous modem. The Company is currently focusing its
research and development resources on the development of SDRAM, Flash and SRAM
products, 56 kbps asynchronous modem products and various embedded computer
modules. The success of the Company in developing new and enhanced products will
depend upon a variety of factors, including integration of various elements of
complex technology, timely and efficient completion of product design, timely
and efficient implementation of manufacturing and assembly processes,
availability of production capacity, achievement of acceptable manufacturing
yields and product performance, quality and reliability. The Company has
experienced, and may in the future experience, delays from time to time in the
development and introduction of new products. Moreover, there can be no
assurance that the Company will be successful in selecting, developing,
manufacturing and marketing new products or enhancements. There can be no
assurance that defects or errors will not be found in the Company's products
after commencement of commercial shipments, which could result in the delay in
market acceptance of such products. The inability of the Company to introduce
new products or enhancements that contribute to net sales could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Key Personnel
The Company's future operating results depend in significant part upon the
continued contributions of its key technical and senior management personnel,
many of whom would be difficult to replace. None of such persons, including the
executive officers, has an employment agreement with the Company. The Company's
future operating results also depend in significant part upon its ability to
attract, train and retain qualified management, manufacturing and quality
assurance, engineering, marketing, sales and support personnel. The Company is
actively recruiting such personnel. However, competition for such personnel is
intense, and there can be no assurance that the Company will be successful in
attracting, training or retaining such personnel now or in the future. There may
be only a limited number of persons with the requisite skills to serve in these
positions and it may be increasingly difficult for the Company to hire such
persons over time. The loss of any key employee, the failure of any key employee
to perform in his or her current position, the Company's inability to attract,
train and retain skilled employees as needed or the inability of the officers
and key employees of the Company to expand, train and manage the Company's
employee base could materially and adversely affect the Company's business,
financial condition and results of operations.
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International Sales
International sales accounted for 18%, 8% and 14% of net sales in fiscal
1997, fiscal 1996 and fiscal 1995, respectively. The Company anticipates that
international sales will increase in future periods and will account for an
increasing portion of net sales. As a result, an increasing portion of the
Company's sales may be subject to certain risks, including changes in regulatory
requirements, tariffs and other barriers, timing and availability of export
licenses, political and economic instability, difficulties in accounts
receivable collections, natural disasters, difficulties in staffing and managing
foreign subsidiary and branch operations, difficulties in managing distributors,
difficulties in obtaining governmental approvals for telecommunications and
other products, foreign currency exchange fluctuations, the burden of complying
with a wide variety of complex foreign laws and treaties, potentially adverse
tax consequences and uncertainties relative to regional, political and economic
circumstances. In particular, recent instability in certain Asian economies and
financial markets could have an adverse effect on the Company's business,
financial condition and results of operations in future quarters. In fiscal
1997, the Company's net sales to customers in Asia accounted for less than one
percent of all net sales. In addition to exporting products to Asia, the Company
maintains strategic supply relationships with companies located in Asia.
Moreover and as a result of currency changes and other factors, certain of the
Company's competitors may have the ability to manufacture competitive products
in Asia at lower costs than the Company. There can be no assurance that current
economic instability in Asia will not have a material adverse effect on the
Company's net sales, its ability to compete or its ability to receive raw
materials for its products.
The Company is also subject to the risks associated with the imposition of
legislation and regulations relating to the import or export of high technology
products. The Company cannot predict whether quotas, duties, taxes or other
charges or restrictions upon the importation or exportation of the Company's
products will be implemented by the United States or other countries. Because
sales of the Company's products have been denominated to date primarily in
United States dollars, increases in the value of the United States dollar could
increase the price of the Company's products so that they become relatively more
expensive to customers in the local currency of a particular country, leading to
a reduction in sales and profitability in that country. Future international
activity may result in increased foreign currency denominated sales. Gains and
losses on the conversion to United States dollars of accounts receivable,
accounts payable and other monetary assets and liabilities arising from
international operations may contribute to fluctuations in the Company's results
of operations. Some of the Company's customer's purchase orders and agreements
are governed by foreign laws, which may differ significantly from United States
laws. Therefore, the Company may be limited in its ability to enforce its rights
under such agreements and to collect damages, if awarded. There can be no
assurance that any of these factors will not have a material adverse effect on
the Company's business, financial condition and results of operations.
Uncertainty Regarding Protection of Proprietary Rights
In the semiconductor, computer, telecommunications and networking
industries, it is typical for companies to receive notices from time to time
alleging infringement of patents, copyrights or other intellectual property
rights of others. The Company is currently being sued by a party who alleges
that certain of the Company's communication card products have infringed and
continue to infringe upon the party's intellectual property rights. Moreover,
the Company has been and may from time to time continue to be notified of claims
that it may be infringing patents, copyrights or other intellectual property
rights owned by other third parties. There can be no assurance that these or
other companies will not in the future pursue claims against the Company with
respect to the alleged infringement of patents, copyrights or other intellectual
property rights. In addition, litigation may be necessary to protect the
Company's intellectual property rights and trade secrets, to determine the
validity of and scope of the proprietary rights of others or to defend against
third party claims of invalidity. The current litigation or any other litigation
could result in substantial costs and diversion of resources and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
There can be no assurance that additional infringement, invalidity, right
to use or ownership claims by third parties or claims for indemnification
resulting from infringement claims will not be asserted in the future.
20
<PAGE> 21
The Company has entered into license agreements in the past regarding certain
alleged infringement claims asserted by third parties. In response to the
current litigation or if any other claims or actions are asserted against the
Company, the Company may again seek to obtain a license under a third party's
intellectual property rights. There can be no assurance, however, that a license
will be available under reasonable terms or at all. The failure to obtain a
license under a patent or intellectual property right from a third party for
technology used by the Company could cause the Company to incur substantial
liabilities and to suspend the manufacture of the products utilizing the
intellectual property. In addition, should the Company decide to litigate the
current claim or such other claims, such litigation could be extremely expensive
and time consuming and could materially and adversely affect the Company's
business, financial condition and results of operations, regardless of the
outcome of the litigation.
The Company attempts to protect its intellectual property rights through a
variety of measures including non-disclosure agreements, trademarks, trade
secrets and to a lesser extent, patents. There can be no assurance, however,
that such measures will provide adequate protection for the Company's trade
secrets or other proprietary information, that disputes with respect to the
ownership of its intellectual property rights will not arise, that the Company's
trade secrets or proprietary technology will not otherwise become known or be
independently developed by competitors or that the Company can otherwise
meaningfully protect its intellectual property rights.
Risks Associated with Acquisitions
As part of its business strategy, the Company expects to acquire or make
significant investments in businesses that offer complementary products and
technologies. Any such future acquisitions or investments would expose the
Company to the risks commonly encountered in acquisitions of businesses. Such
risks include, among others, difficulty of assimilating the operations,
information systems and personnel of the acquired businesses, the potential
disruption of the Company's ongoing business, the inability of management to
maximize the financial and strategic position of the Company through the
successful incorporation of acquired employees and customers, the maintenance of
uniform standards, controls, procedures and policies and the impairment of
relationships with employees and customers as a result of any integration of new
management personnel. There can be no assurance that any potential acquisition
will be consummated or, if consummated, that it will not have a material adverse
effect on the Company's business, financial condition and results of operations.
Volatility of Stock Prices
There has been a history of significant volatility in the market prices of
the common stock of technology companies, including the Common Stock of the
Company, and it is likely that the market price of the Company's Common Stock
will continue to be subject to significant fluctuations. Factors such as the
timing and market acceptance of new product introductions by the Company, demand
for products of the Company's customers, the introduction of new products by the
Company's competitors, variations in quarterly operating results, changes in
securities analysts' recommendations regarding the Company's Common Stock,
developments in the technology industry and general economic conditions may have
a significant impact on the market price of the Company's Common Stock. In
addition, the equity markets in recent years have experienced significant price
and volume fluctuations that have affected the market prices of technology
companies and that have often been unrelated to the operating performance of
such companies.
21
<PAGE> 22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and certain of its officers and directors have been named as
defendants in six securities class action lawsuits filed in the United States
District Court for the Northern District of California, Boren v. SMART Modular
Technologies, Inc., et al., No. C 98 20692 JW (PVT) (filed July 1, 1998),
Woszczak v. SMART Modular Technologies, Inc., et al., No. C 98 2617 JL (filed
July 2, 1998), Bisson v. SMART Modular Technologies, Inc., et. al., No. C 98
20714 JF (filed July 8, 1998), D'Amato v. SMART Modular Technologies, Inc., et.
al., No. C 98 2804 PJH (filed July 16, 1998), Cha v. SMART Modular Technologies,
Inc., et. al., No. C 98 2833 BZ (filed July 17, 1998) and Chang v. SMART Modular
Technologies, Inc., et. al., No. C 98 3151 SI (filed August 13, 1998)
(collectively, the "Securities Actions"). The plaintiffs in the Securities
Actions allege that defendants made material misrepresentations and omissions
during the period from July 1, 1997 through May 21, 1998 in violation of Section
10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder. The Company believes that all claims related to the Securities
Actions are without merit and intends to vigorously defend itself against the
Securities Actions. Currently, the Company is unable to estimate the financial
impact of the Securities Actions.
ITEM 2. CHANGES IN SECURITIES
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
For a list of exhibits to this Form 10-Q see the exhibit index located on
pages 24 - 26.
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the three months ended July
31, 1998.
22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
SMART MODULAR TECHNOLOGIES, INC.
By: /s/ DAVID B. MULLIN
------------------------------------
David B. Mullin
Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: September 11, 1998
23
<PAGE> 24
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
------- --------
<C> <S>
2.1(1) Agreements and Plan of Reorganization among the Registrant,
Apex Data, Inc. and SMART Acquisition Inc. dated April 24,
1995.
3.1(7) Registrant's Amended and Restated Articles of Incorporation.
3.2(1) Registrant's Amended Bylaws.
4.1(1) Registration Rights Agreement dated July 26, 1995.
4.2(1) Registrant's specimen stock certificate.
4.3(3) Termination to the Registration Rights Agreement dated July
26, 1995.
10.1(1) 1989 Incentive Stock Plan, as amended, and forms of
agreements attached thereto.
10.2(1) 1995 Employee Stock Purchase Plan, and forms of agreements
attached thereto.
10.3(1) 1995 Director Option Plan, and forms of agreements attached
thereto.
10.4(1) 1995 Stock Plan, and forms of agreements attached thereto.
10.5(1) Form of Indemnification Agreement between the Registrant and
its officers, directors and certain significant employees.
10.6(1) Standard Triple Net Industrial Lease between the Registrant
and Pactel Properties dated November 18, 1991.
10.7(1) First Amendment to Lease between the Registrant and Pactel
Properties dated July 19, 1993.
10.8(1) Second Amendment to Lease between the Registrant and Riggs
National Bank of Washington, D.C. as Trustee of the
Multi-Employer Property Trust Northport Business Park, a
National Banking Association dated May 31, 1994.
10.9(1) Third Amendment to Lease between the Registrant and Riggs
National Bank of Washington, D.C. as Trustee of the
Multi-Employer Property Trust Northport Business Park, a
National Banking Association dated November 1994.
10.10(1) Standard Triple Net Industrial Lease between the Registrant
and Riggs National Bank of Washington, D.C., as Trustee of
the Multi-Employer Property Trust, dated June 18, 1995.
10.11(1) Lease Contract between the Registrant and The Puerto Rico
Industrial Development Company dated April 24, 1995.
10.12(1) Note, Loan and Security Agreement between the Registrant and
Merrill Lynch Business Financial Services Inc. dated May 19,
1993.
10.13(1) Letter Agreement between the Registrant and Merrill Lynch
Business Financial Services Inc. dated December 28, 1994.
10.14(1) Letter Agreement between the Registrant and Merrill Lynch
Business Financial Services Inc. dated June 27, 1995.
10.15(1) Intercreditor Agreement among the Registrant, Merrill Lynch
Business Financial Services Inc. and Imperial Bank dated
June 27, 1995.
10.16(1) Security and Loan Agreement between the Registrant and
Imperial Bank dated July 19, 1995.
*10.17(1) License and Supply Agreement between the Registrant and
Krypton Isolation, Inc. dated July 22, 1994.
10.18(1) Warrant Purchase Agreement between the Registrant and
Krypton Isolation, Inc. dated July 27, 1994.
10.19(1) Holders' Agreement dated July 27, 1994 by and among Krypton
Isolation, Inc. and certain individuals and entities
identified on Exhibit A attached thereto.
</TABLE>
24
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
------- --------
<C> <S>
10.20(1) Common Stock Purchase Agreement dated July 27, 1994 by and
among Krypton Isolation, Inc. and the individuals identified
on Exhibit A attached thereto.
10.21(1) First Amendment to the Krypton Isolation, Inc. Warrant to
Purchase 2,000,000 Shares of Series A Preferred Stock
between the Registrant and Krypton Isolation, Inc. dated
October 24, 1995.
10.22(1) Letter of Intent dated as of October 24, 1995 by and among
Krypton Isolation, Inc., the Registrant and certain
individuals identified on the signature pages thereto.
**10.23(2) License and Supply Agreement between the Registrant and
Krypton Isolation, Inc. dated January 29, 1996.
10.24(2) Warrant Purchase Agreement between the Registrant and
Krypton Isolation, Inc. dated January 29, 1996.
10.25(2) First Amended and Restated Holders' Agreement dated January
29, 1996 by and among Krypton Isolation, Inc. and certain
individuals and entities identified on Exhibit A attached
thereto.
10.26(2) Common Stock Agreement dated January 29, 1996 by and among
Krypton Isolation, Inc. and the entities identified on
Exhibit A attached thereto.
10.27(2) First Amendment to the License and Supply Agreement between
the Registrant and Krypton Isolation, Inc. dated January 29,
1996.
10.28(3) 1989 Incentive Stock Plan, as amended, dated March 25, 1996.
10.29(4) Fourth Amendment to Lease between the Registrant and Riggs
Bank N.A. dated September 27, 1996.
10.30(5) Revolving Line of Credit Note between the Registrant and
Wells Fargo Bank, National Association dated May 29, 1997.
10.31(5) Credit Agreement between the Registrant and Wells Fargo
Bank, National Association dated May 29, 1997.
10.32(5) Subfeature Note between the Registrant and Wells Fargo Bank,
National Association dated May 29, 1997.
10.33(6) Lease Contract between the Registrant and The Puerto Rico
Industrial Development Company dated October 9, 1997.
10.34(6) Second Amendment to the Krypton Isolation, Inc. Warrant to
Purchase 2,000,000 Shares of Series A Preferred Stock
between the Registrant and Krypton Isolation, Inc. dated
January 21, 1998.
10.35(7) Revolving Line of Credit Note between the Registrant and
Wells Fargo Bank, National Association dated May 1, 1998.
10.36(7) Credit Agreement between the Registrant and Wells Fargo
Bank, National Association dated May 1, 1998.
10.37(7) Subfeature Note between the Registrant and Wells Fargo Bank,
National Association dated May 1, 1998.
10.38 Sublease Contract between the Registrant and Philips
Consumer Communications, L.P. dated June 30, 1998.
27.1 Financial Data Schedule for the Quarter Ended July 31, 1998.
</TABLE>
- ---------------
(1) Incorporated by reference to exhibit filed with the Registrant's
Registration Statement on Form S-1 (No. 33-97748) filed October 4, 1995,
Amendment No. 1 thereto filed October 24, 1995, Amendment No. 2 thereto
filed November 6, 1995, Amendment No. 3 thereto filed November 14, 1995 and
25
<PAGE> 26
Amendment No. 4 thereto filed November 16, 1995, which Registration
Statement became effective November 16, 1995.
(2) Incorporated by reference to exhibit filed with the Registrant's Report on
Form 10-Q filed March 16, 1996.
(3) Incorporated by reference to exhibit filed with the Registrant's Report on
Form 10-Q filed June 14, 1996.
(4) Incorporated by reference to exhibit filed with the Registrant's Report on
Form 10-Q filed June 16, 1997.
(5) Incorporated by reference to exhibit filed with the Registrant's Report on
Form 10-Q filed August 28, 1997.
(6) Incorporated by reference to exhibit filed with the Registrant's Report on
Form 10-K filed January 29, 1998.
(7) Incorporated by reference to exhibit filed with the Registrant's Report on
Form 10-Q filed June 15, 1998.
* Pursuant to Rule 406(b) under the Securities Act of 1933, confidential
treatment has been granted to certain portions of this exhibit, which
portions have been deleted and filed separately with the Securities and
Exchange Commission.
** Pursuant to Rule 24b-2 under the Securities Exchange Act of 1934,
confidential treatment has been granted to certain portions of this exhibit,
which portions have been deleted and filed separately with the Securities
and Exchange Commission.
26
<PAGE> 1
EXHIBIT 10.38
SUBLEASE
This Sublease is entered into as of this 30th day of June, 1998, by and
between Philips Consumer Communications, L.P. with offices at 535 Mountain
Avenue, P.O. Box 1, Murray Hill, NJ 07974-0001, a Delaware limited partnership
(hereinafter "Sublandlord") and SMART Modular Technologies, Inc., a California
corporation, with offices at 4305 Cushing Parkway, Fremont, California 94538
(hereinafter "Subtenant").
INTRODUCTORY STATEMENTS
A. By Lease dated August 14, 1996, as amended by First Amendment to
Lease dated April 2, 1997, and Second Amendment to Lease dated September 5, 1997
(collectively the "Prime Lease") Berg & Berg Enterprises, Inc., a California
corporation (the "Prime Landlord") leased to Philips Electronics North America
Corporation certain space in the building known as Building I located at 45700
Northport Loop East, Fremont, CA (hereinafter called the "Building"). By
Assignment and Assumption of Lease dated October 1, 1997 Philips Electronics
North America assigned the lease to Sublandlord.
B. Subtenant has agreed to sublet from Sublandlord certain portions of
the Building.
C. The parties desire to enter into this Sublease defining their
respective rights, duties and liabilities relating to the Subleased Premises
(defined below).
<PAGE> 2
WITNESSETH
NOW THEREFORE, Sublandlord and Subtenant, in consideration of the
mutual promises and covenants contained herein and other good and valuable
consideration, the receipt and sufficiency of which is hereby acknowledged, and
each with intent to be legally bound, for themselves and their respective
successors and assigns, agree as follows:
1. SUBLEASE
Sublandlord, for and in consideration of the Subtenant's payment of the
rent and performance of the covenants contained in this Sublease, does hereby
demise and lease to Subtenant the following portion of the Building: 22,555 sq.
ft. of the first floor of the Building as shown on the floor plan which is
attached hereto as Exhibit A (the "Subleased Premises").
2. PARKING
Subtenant shall be entitled to use eighty-four (84) of the Building's
parking spaces on a first come first basis in the parking lot designated on
Exhibit B.
3. PRIME LEASE
A true copy of the Prime Lease (with certain financial provisions
deleted for reasons of confidentiality) is attached hereto as Exhibit C. Where
not expressly inconsistent with the terms hereof and except as otherwise stated
herein to the contrary, this Sublease shall be subject and subordinate to all of
the terms and conditions contained in the Prime Lease as said terms and
conditions affect the Subleased Premises, and all of
2
<PAGE> 3
the terms and conditions of the Prime Lease, except as otherwise set forth
herein, are hereby incorporated into this Sublease and shall be binding upon
Subtenant with respect to the Subleased Premises to the same extent as if
Subtenant were named as tenant and Sublandlord as landlord under the Prime
Lease. For purposes of this Sublease, references in the Prime Lease to the
"term" shall mean the Term of this Sublease and references to the "premises" in
the Prime Lease shall mean the Subleased Premises. Except as otherwise provided
herein, when any fraction, factor or formula, which is based on the number of
square feet leased, is expressed in the Prime Lease, it will be adjusted by
substituting the number of square feet of the Subleased Premises for the number
of square feet of the Premises leased in the Prime Lease. Each party agrees that
it shall not do or omit to do anything which would result in a default under the
Prime Lease, and each party agrees to indemnify and hold the other harmless from
and against all claims, demands or liabilities resulting from such party's
breach, violation or nonperformance of any of its obligations under the Prime
Lease, as incorporated herein. With the exceptions set forth herein, Subtenant
shall be entitled to all of the rights and privileges of the Sublandlord as
tenant under the terms of the Prime Lease with respect to the Subleased
Premises. The following provisions of the Prime Lease shall not be incorporated
into this Sublease: Premises, Term, Rent, Commencement Date Memorandum for Phase
I, Commencement Date Memorandum for Phase II, (1) Possession including (1.1) and
(1.2), (2) Lessee's Improvements including (2.1) and (2.2), (34)
3
<PAGE> 4
Brokers, (35) Option to Extend, (39) Expansion Agreement and Exhibits D, E.1,
E.2 and F.
4. DEFINITIONS
All terms not expressly defined in this Sublease shall have the
meanings given to them in the Prime Lease.
5. PRIME LANDLORD
Subtenant agrees to look solely to the Prime Landlord, and not to
Sublandlord, for the performance of all services and obligations of the Prime
Landlord under the Prime Lease with respect to the Subleased Premises. At
Subtenant's expense and request, Sublandlord will take all reasonable actions
necessary to enable Subtenant to enforce the Sublandlord's rights as tenant
under the Prime Lease with respect to the Subleased Premises.
6. TERM
The term of this Sublease (the "Original Term" or "Term") shall be
approximately Seventy eight (78) months commencing on the later of (i) July 15,
1998, (ii) upon Prime Landlord's consent or (iii) completion of the demising
wall by Sublandlord (such later date, the "Commencement Date") and ending on
December 31, 2004.
Sublandlord shall grant Subtenant access to the Subleased Premises
solely for the installation of its tenant improvements after execution of this
Sublease, which may be prior to the Commencement Date. In exercising the
foregoing right, Subtenant shall work with Sublandlord to minimize disruption or
interference with Sublandlord's business or Sublandlord's use and occupancy of
the Premises, and Subtenant shall obtain all
4
<PAGE> 5
necessary approvals prior to commencing any tenant improvements. Subtenant shall
defend, indemnify and save harmless the Sublandlord, its affiliates and partners
against all claims, liabilities, fines, penalties, damages, costs and expenses,
including reasonable attorneys' fees and other costs of litigation because of
injury, including death, to any person, or damage to any real property or
personal property caused by any action or omission of Subtenant, Subtenant's
employees and/or representatives except to the extent caused by the negligence
or willful misconduct of Sublandlord, Sublandlord's employees and/or
representatives. Subtenant shall provide Sublandlord with insurance certificates
pursuant to Paragraph 15 prior to Sublandlord granting Subtenant access to the
Subleased Premises.
7. RENT
a. The basic rent during the Original Term hereunder shall be in the
amount of Two million, three hundred three thousand, three hundred sixteen and
60/00ths Dollars ($2,303,316.60) payable in lawful money of the United States of
America. The basic rent shall accrue at the rate of Twenty seven thousand, nine
hundred sixty eight and 26/00 Dollars ($27,968.26) per month for months 1-26,
Twenty nine thousand, five hundred forty seven and 05/00 Dollars ($29,547.05)
per month for months 27-56, and Thirty one thousand, three hundred fifty one and
45/00 Dollars ($31,351.45) per month for months 57-78 and shall be payable in
advance on the first day of each calendar month during the Original Term except
that a proportionately lesser sum may be paid for the first and last months of
the Term of this Sublease
5
<PAGE> 6
if the Term commences on a date other than the first day of the month or ends on
other than the last day of a month.
b. In addition to the basic rent set forth in section 7.a. above,
Subtenant shall pay Sublandlord (as and when due under the terms of the Prime
Lease), as additional rent, its proportionate share of electric, gas and water
expenses, triple net expenses of taxes, insurance, common area maintenance, and
other utilities and expenses, which Sublandlord is obligated to pay to Prime
Landlord under the terms of the Prime Lease. Subtenant's "Proportionate Share"
shall be forty seven percent (47%), which is the number of square feet in
Subleased Premises divided by number of square feet in the premises leased by
Sublandlord.
c. The terms "basic rent" and "additional rent" are sometimes referred
to herein as "Rent" or "rent" and shall include all sums due from Subtenant to
Sublandlord under the terms of this Sublease. All Rent shall be payable at the
office of the Sublandlord at the following address:
535 Mountain Avenue,
P.O. Box 1
Murray Hill, New Jersey 07974-0001
Attention: Loranza Rooker
or at such other address as directed by written notice from Sublandlord to
Subtenant.
8. REFUNDS
Provided Subtenant is not in default under this Sublease, Sublandlord
shall pay to Subtenant Subtenant's Proportionate Share of any sums which
Sublandlord is entitled to receive from
6
<PAGE> 7
the Prime Landlord under the Prime Lease with respect to the Subleased Premises
during the Term, including, but not limited to, any refunds of basic rent or
additional rent which have been paid by Subtenant; however, such sums shall be
paid to Subtenant only if Sublandlord has received payment of same from Prime
Landlord. Payment (less any sums expended by Sublandlord for collection thereof)
shall be made by Sublandlord to Subtenant within thirty (30) days of
Sublandlord's receipt of any such sum.
9. SECURITY DEPOSIT
Subtenant has deposited with Sublandlord the sum of Twenty seven
thousand nine hundred sixty eight and 26/00 Dollars ($27,968.26) as security for
the full and faithful performance of every portion of this Sublease to be
performed by Subtenant. If Subtenant defaults with respect to any provision of
this Sublease, Sublandlord may use, apply or retain an amount necessary of this
security deposit to remedy such default. If any portion of said deposit is so
used or applied, Subtenant shall, within ten (10) days after demand therefor,
deposit funds with Sublandlord in an amount sufficient to restore the security
deposit to its original amount, and Subtenant's failure to do so shall be a
material breach of this Sublease. Sublandlord shall not be required to keep this
security deposit separate from its general funds, and Subtenant shall not be
entitled to interest on such deposit. If Subtenant shall fully and faithfully
perform every provision of this Sublease to be performed by it, the security
deposit or such remaining balance thereof shall be
7
<PAGE> 8
returned to Subtenant within thirty (30) days of termination of the Term.
10. SUBTENANT FIT-UP
Sublandlord shall construct, at Sublandlord's sole cost and expense, a
demising wall to demise the Premises as shown on Exhibit A (subject to Prime
Landlord's approval). Such construction shall be done in compliance with the
Americans with Disabilities Act (ADA) and all applicable state and local laws.
Sublandlord shall segregate the electrical, mechanical and HVAC systems that
control each individual space, at Sublandlord's sole cost and expense.
Sublandlord shall deliver the Subleased Premises vacant of all
occupants, clean and free of debris, with all carpets cleaned, and with all
building systems (e.g., mechanical, HVAC, electrical, plumbing and roof) in good
operating condition and repair. Sublandlord shall repair and maintain all such
building systems throughout the Term of the Sublease.
11. ALTERATIONS
Subtenant shall not make any alterations, improvements or installations
in or to the Subleased Premises without the prior written consent of
Sublandlord. All alterations and improvements shall be subject to the terms and
conditions of the Prime Lease, and in those instances, if required, shall be
subject to the Prime Landlord's approval as provided in the Prime Lease. Any
8
<PAGE> 9
alterations, improvements or installations consented to by Sublandlord shall be
made by Subtenant's contractors approved by Sublandlord, at the sole cost and
expense of Subtenant. Subtenant shall carry or cause its contractors to carry
(i) worker's compensation insurance in statutory limits covering all persons
employed in connection with such Alterations, and (ii) general commercial
liability insurance covering any occurrence in or about the Subleased Premises
in connection with such Alterations, which comply with the requirements of
Paragraph 15. Subtenant shall indemnify Sublandlord against liability for any
and all mechanics' and other liens filed in connection with the Alterations.
12. REPAIRS AND MAINTENANCE
Except as otherwise provided in this Sublease, any repair and
maintenance obligations with respect to the Subleased Premises which are the
responsibility of the Sublandlord, as tenant under the Prime Lease, shall be
performed by Subtenant at Subtenant's sole cost and expense. Subtenant agrees
that it will notify Sublandlord promptly of the need for any repair to the
Subleased Premises, even if Sublandlord is not responsible for any such repair.
Notwithstanding anything contained herein to the contrary, in the event that a
condition exists in the Subleased Premises that Prime Landlord is obligated to
repair under the terms of the Prime Lease, Subtenant shall so advise
Sublandlord, and Sublandlord, in turn, shall promptly advise
9
<PAGE> 10
Prime Landlord thereof. Sublandlord shall have no liability to Subtenant for
Prime Landlord's failure to make any such repair, provided, however, Sublandlord
shall make good faith efforts to encourage Prime Landlord to fulfills its
obligation under the Prime Lease to perform such repair.
Subtenant shall defend, indemnify and save harmless the Sublandlord,
affiliates and its partners, against all claims, liabilities, fines, penalties,
damages, costs and expenses (including reasonable attorney's fees and other
costs of litigation) caused by any negligent action or negligent omission of
Subtenant, or any failure on the part of Subtenant to perform its obligations
under this Section 12.
13. UTILITIES AND SERVICES
Subtenant shall be entitled to all those services and utilities which
Prime Landlord is required to provide under the terms of the Prime Lease.
Subtenant shall look solely to the Prime Landlord for the provision of such
services and utilities, and Sublandlord shall not be responsible for Prime
Landlord's failure to provide the same nor shall any such failure constitute an
abrogation of any other terms or conditions of this Sublease. In addition to
Subtenant's obligation to pay its Proportionate Share of the cost of such
utilities and services, to the extent that Prime Landlord charges Sublandlord
for any services or utilities or increases the cost of such services or
utilities and such charge or increase is due to Subtenant's use of the Subleased
Premises or such utilities or services, Subtenant
10
<PAGE> 11
agrees to pay the charges therefore promptly upon receipt of Sublandlord's bill.
14. ASSIGNMENT AND SUBLEASING
Subtenant shall not have the right to assign this Sublease or sublet
the Subleased Premises, in whole or in part, without the prior written consent
of Sublandlord and the Prime Landlord. In the event that the assignment or
sublet of the Subleased Premises by Subtenant result in a profit, after related
costs of subletting have been deducted, and unless otherwise claimed by Prime
Landlord, such profits shall be split 50/50 between Sublandlord and Subtenant.
Subtenant shall have the right of first offer to sublease additional
space that may become available in the Building by the Sublandlord under the
same terms and conditions contained herein. Subtenant shall have fifteen (15)
business days from receipt of written notice from Sublandlord to respond in
writing of its intentions to sublease the additional space. In the event
Sublandlord does not receive notice from Subtenant within said fifteen (15) days
Sublandlord shall have the right to sublease to a third party.
15. INSURANCE
Subtenant agrees to comply with all of the insurance requirements and
obligations of Sublandlord as set forth in the Prime Lease and to name both
Sublandlord and Prime Landlord as additional insureds on any required insurance
policies.
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<PAGE> 12
16. NON-BINDING MEDIATION
a. If a dispute arises out of or relates to this Sublease, or its
breach, and the parties have not been successful in resolving such dispute
through negotiation, the parties agree to attempt to resolve the dispute through
non-binding mediation by submitting the dispute to a sole mediator selected by
the parties or, at the option of a party, to mediation by the American
Arbitration Association ("AAA"). If such dispute is not resolved by such
non-binding mediation, the parties shall have the right to resort to any
remedies permitted by law. All defenses based on passage of time shall be tolled
during the mediation.
b. The direct expenses of the mediation, including the compensation and
expenses of the mediator and the fees of the AAA, shall be borne equally by the
parties. All other costs incurred by the parties to this Sublease, including the
parties' legal expenses and their witnesses' expenses, shall be borne by the
party incurring the expense. The parties, their representatives, other
participants and the mediator shall hold the existence, content and result of
the mediation in confidence.
17. COMPLIANCE WITH LAWS
In addition to any obligations under the Prime Lease, Subtenant shall
promptly comply with all statutes, ordinances, rules, orders, regulations and
requirements of the Federal, State and municipal Governments and of any and all
their Departments and Bureaus applicable to the use and occupancy of the
Subleased Premises by Subtenant or any subtenant or assignee of Subtenant, for
the prevention and abatement of nuisances, violation or other
12
<PAGE> 13
grievances, in, upon or connected with the Subleased Premises to the extent
caused by Subtenant during the Term or any renewal thereof, including without
limitation all laws relating to environmental matters and the Americans with
Disabilities Act to the extent such ADA requirements arise out of or relate to
any new improvements made to the Subleased Premises by Subtenant and Subtenant's
use and occupancy of the Subleased Premises, and shall also promptly comply
with, and execute all rules, orders and regulations of the Board of Fire
Underwriters for the prevention of fires (collectively referred to as "Legal
Requirements") at its own cost and expense.
If Subtenant shall fail or neglect to comply with the aforesaid Legal
Requirements, or if Subtenant shall fail or neglect to make any repairs required
by the terms of this Sublease, during its use and occupancy of the Subleased
Premises, and if such breach continues for a period of thirty (30) days after
written notice from Prime Landlord or Sublandlord regarding same, or, if the
breach cannot be cured within thirty (30) days, if Subtenant has not begun to
cure the breach within such period and does not thereafter diligently prosecute
the cure to completion, then Sublandlord or its agents may (but shall not be
obligated to) enter the Subleased Premises and take such actions as necessary to
cure the breach and comply with any and all of the said Legal Requirements, at
the cost and expense of Subtenant; and, in case of Subtenant's failure to pay
therefor, the said cost and expense shall be added to the next month's Rent and
be due and payable as such.
13
<PAGE> 14
Subtenant shall defend, indemnify and save harmless the Sublandlord,
affiliates and its partners, against all claims, liabilities, fines, penalties,
damages, costs and expenses (including reasonable attorney's fees and other
costs of litigation) caused by any action or omission of Subtenant, or any
failure on the part of Subtenant to perform its obligations under this Section
17.
Sublandlord represents and warrants that it has delivered all documents
in its possession relating to non-compliance or alleged non-compliance with
Legal Requirements to Subtenant.
18. LIMITATIONS ON SUBLANDLORD'S LIABILITY
a. Subtenant acknowledges that Sublandlord has made no representations
or warranties with respect to the environmental condition or compliance with
Legal Requirements of the Building or the Subleased Premises except as provided
in this Sublease and Subtenant accepts the Subleased Premises in AS IS
condition.
b. If Sublandlord assigns its leasehold estate in the Building,
Sublandlord shall have no obligation to Subtenant that arises after that
assignment. Subtenant shall then recognize Sublandlord's assignee as Sublandlord
of this Sublease.
c. Sublandlord shall not be required to perform any of the covenants
and obligations of the Prime Landlord under the Prime Lease, and insofar as any
of the obligations of the Sublandlord hereunder are required to be performed
under the Prime Lease by the Prime Landlord thereunder, Subtenant shall rely on
and look solely to the Prime Landlord for the performance thereof, provided,
however, Sublandlord shall make good faith efforts to
14
<PAGE> 15
encourage Prime Landlord to fulfills its covenants and obligations under the
Prime Lease. If the Prime Landlord shall default in the performance of any of
its obligations under the Prime Lease or breach any provision of the Prime Lease
pertaining to the Subleased Premises, Subtenant shall have the right, at
Subtenant's expense and upon prior notice to Sublandlord, and in the name of
Sublandlord to make any demand or institute any action or proceeding, in
accordance with and not contrary to any provision of the Prime Lease, against
the Prime Landlord under the Prime Lease for the enforcement of the Prime
Landlord's obligations thereunder. Subtenant shall defend, indemnify and hold
Sublandlord harmless from and against any suit, action, cost, expense, damage or
liability which arises out of or results from or is alleged to arise out of or
result from Subtenant's exercise of its rights under this paragraph.
19. ESTOPPEL CERTIFICATES
Either party hereto (the requested party) agrees that from time to time
upon not less than fifteen (15) days prior notice by the other party (requesting
party), the requested party or its duly authorized representative having
knowledge of the following facts will deliver to the requesting party, or to
such person or persons as the requesting party may designate, a statement in
writing certifying (a) that this Sublease is unmodified and in full force and
effect (or if there have been modifications, that the Sublease as modified is in
full force and effect); (b) the date to which the Rent and other charges have
been paid; (c) that to the best of the requested party's knowledge, the
requesting
15
<PAGE> 16
party is not in default under any provision of this Sublease or if in default,
the nature thereof in detail.
20. SUBORDINATION
This Sublease shall be subject and subordinate to the Prime Lease, any
ground lease and to any mortgage or deed of trust thereon or on the fee simple
interest in the Building or the land on which the Building is located.
21. CASUALTY AND CONDEMNATION
If the Prime Lease is terminated with respect to the Subleased Premises
pursuant to the provisions of the Prime Lease upon the occurrence of a casualty
or condemnation, this Sublease shall automatically terminate at the same time
and Subtenant shall have no claim against Sublandlord or Prime Landlord for the
loss of its subleasehold interest or any of Subtenant's property. If the Prime
Lease is not terminated with respect to the Subleased Premises upon the
occurrence of a casualty or condemnation, the provisions of the Prime Lease with
respect to casualty or condemnation shall apply to this Sublease and the
Subleased Premises.
22. CONSENT OR APPROVAL OF PRIME LANDLORD
If the consent or approval of Prime Landlord is required under the
Prime Lease with respect to any matter relating to the Subleased Premises,
Subtenant shall be required first to obtain the consent or approval of
Sublandlord with respect thereto and, if Sublandlord grants such consent or
approval, Sublandlord or Subtenant may forward a request for consent or approval
to the Prime Landlord, but Sublandlord shall not be responsible for
16
<PAGE> 17
obtaining such consent or approval. Sublandlord shall have no liability to
Subtenant for the failure of Prime Landlord to give its consent.
23. NOTICES
All notices given pursuant to the provisions of this Sublease shall be
in writing, addressed to the party to whom notice is given and sent registered
or certified mail, return receipt requested, in a postpaid envelope or by
nationally recognized overnight delivery service as follows:
To Subtenant:
SMART Modular Technologies, Inc.
4305 Cushing Parkway
Fremont, CA 94538
Attn: General Counsel
To Sublandlord:
Philips Consumer Communications, L.P.
535 Mountain Avenue
P.O. Box 1
Murray Hill, NJ 07974-0001
Attention: Loranza Rooker, Global Facilities Director
Attention: General Counsel
It is understood and agreed that unless specifically modified by this
Sublease, Sublandlord shall be entitled to the length of notice required to be
given Prime Landlord under the Prime Lease plus five (5) days and shall be
entitled to give Subtenant the amount of notice required to be given tenant
under the Prime Lease less five (5) days. All notices shall be deemed given upon
receipt or rejection.
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<PAGE> 18
Either party by notice to the other may change or add persons and
places where notices are to be sent or delivered. In no event shall notice have
to be sent on behalf of either party to more than three (3) persons.
24. BROKERS
The parties warrant that they have had no dealings with any real estate
broker or agent in connection with this Sublease, except Colliers Parrish
International, Inc. (the "Broker(s)"). Each party covenants to pay, hold
harmless and indemnify the other from and against any and all costs, expenses or
liabilities for any compensation, commissions and charges claimed by any other
broker or agent with respect to this Sublease or the negotiation thereof, based
upon alleged dealings with the indemnifying party. Sublandlord agrees to pay any
compensation, commissions and charges of the Broker(s) related to or arising out
of this Sublease, in accordance with separate agreement(s) entered into between
Sublandlord and Broker(s).
If Subtenant subleases additional space from Sublandlord under Section
14 above, then Sublandlord agrees to pay any and all compensation, commissions
and charges of the Broker(s) related to or arising out of such sublease of
additional space.
25. SUBLANDLORD'S AND SUBTENANT'S POWER TO EXECUTE
Sublandlord (subject to Prime Landlord's consent) and Subtenant
covenant, warrant and represent that they have full power and proper authority
to execute this Sublease.
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<PAGE> 19
26. TABLE OF CONTENTS - CAPTIONS
The Table of Contents and the captions appearing in this Sublease are
inserted only as a matter of convenience and do not define, limit, construe or
describe the scope or intent of the sections of this Sublease nor in any way
affect this Sublease.
27. CONSENT TO SUBLEASE BY PRIME LANDLORD
This Sublease shall not become operative until and unless the Prime
Landlord has given to Sublandlord its consent hereto. Sublandlord shall not be
responsible for Prime Landlord's failure to consent to this Sublease. Should
Prime Landlord not consent to this Sublease, each party shall be released from
all obligations with respect hereto and neither party shall have any further
rights in law or in equity with respect to this Sublease.
28. SIGNAGE
Sublandlord shall remove appropriate signage at its sole cost and
expense. Subtenant shall obtain all necessary approvals for any signage and
install same at its sole cost and expense.
29. ENTIRE AGREEMENT
This Sublease (which includes each of the Exhibits attached hereto)
contains the entire agreement between the parties with respect to the subject
matter hereof and all prior negotiations and agreements are merged into this
Sublease. This Sublease may not be changed, modified, terminated or discharged,
in whole or in part, nor any of its provisions waived except by a written
instrument which (a) shall expressly refer to this Sublease and
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<PAGE> 20
(b) shall be executed by the party against whom enforcement of the change,
modification, termination, discharge or waiver shall be sought.
IN WITNESS WHEREOF, the parties hereto have caused this Sublease to be
properly executed as of the day and year first above written.
ATTEST/WITNESS: SUBLANDLORD
By: /s/ L. Rooker (SEAL)
- --------------------------- -------------------------------
L. Rooker, Global Facilities Dir.
- --------------------------- -----------------------------------------
Name and Title Name and Title
ATTEST/WITNESS: SUBTENANT
By: /s/ Ajay Shah (SEAL)
- --------------------------- --------------------------------
Ajay Shah, President and CEO
- --------------------------- -----------------------------------------
Name and Title Name and Title
Prime Landlord executes this Sublease solely as evidence of its consent
to the Sublease. Prime Landlord's consent to this Sublease shall not in any way
be deemed a modification of the Prime Lease. Prime Landlord's consent to this
Sublease shall not relieve Sublandlord of the obligation to obtain Prime
Landlord's consent to any further subleasing.
ATTEST/WITNESS: PRIME LANDLORD
By:
- ---------------------------- -------------------------------------
- ---------------------------- -------------------------------------
Name and Title Name and Title
20
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTAINED IN THE COMPANY'S
FORM 10-Q FOR THE THIRD QUARTER ENDED JULY 31, 1998 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FORM 10-Q AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION ON SEPTEMBER 14, 1998.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS YEAR
<FISCAL-YEAR-END> OCT-31-1998 OCT-31-1998 OCT-31-1997
<PERIOD-START> APR-30-1998 NOV-01-1997 NOV-01-1996
<PERIOD-END> JUL-31-1998 JUL-31-1998 OCT-31-1997
<CASH> 0 101,689 111,331
<SECURITIES> 0 87,096 38,672
<RECEIVABLES> 0 63,271 95,366
<ALLOWANCES> 0 0 0
<INVENTORY> 0 33,298 39,336
<CURRENT-ASSETS> 0 297,692 303,022
<PP&E> 0 41,924 24,604
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 0 340,252 327,985
<CURRENT-LIABILITIES> 0 71,078 96,907
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 0 133,856 135,123
<OTHER-SE> 0 134,712 95,197
<TOTAL-LIABILITY-AND-EQUITY> 0 340,252 327,985
<SALES> 150,406 534,668 0
<TOTAL-REVENUES> 150,406 534,668 0
<CGS> 126,027 444,099 0
<TOTAL-COSTS> 126,027 444,099 0
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 0 0 0
<INCOME-PRETAX> 13,436 58,111 0
<INCOME-TAX> 4,305 18,596 0
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 9,131 39,515 0
<EPS-PRIMARY> 0.21<F1> 0.92<F!> 0<F1>
<EPS-DILUTED> 0.20 0.84 0
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT PRIMARY MEANS BASIC.
</FN>
</TABLE>
