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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED OCTOBER 31, 1997,
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
SMART MODULAR TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 77-0200166
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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4305 CUSHING PARKWAY
FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 623-1231
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) of the Act:
Common Stock, no par value
(Title of class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the common stock held by non-affiliates of
the Registrant was approximately $649,490,000 as of January 5, 1998 based upon
the closing price on the Nasdaq National Market System reported for such date.
Shares of common stock held by each executive officer and director and by each
person who owns 5% or more of the outstanding common stock have been excluded in
that such persons may under certain circumstances be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
Number of Shares of common stock outstanding as of January 5, 1998:
42,560,489
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the following document are incorporated by reference to Part III
of this Form 10-K: Proxy Statement for Registrant's Annual Meeting of
Shareholders to be held March 16, 1998.
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SMART MODULAR TECHNOLOGIES, INC.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
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PAGE
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Item 1. Business...................................................................... 3
Item 2. Properties.................................................................... 13
Item 3. Legal Proceedings............................................................. 13
Item 4. Submission of Matters to Vote of Security Holders............................. 13
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PART II
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Item 5. Market for Registrant's Common Equity and Related Shareholder Matters......... 14
Item 6. Selected Consolidated Financial Data.......................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................... 16
Item 8. Financial Statements and Supplementary Data................................... 28
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................... 28
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PART III
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Item 10. Directors and Executive Officers of the Registrant............................ 29
Item 11. Executive Compensation........................................................ 29
Item 12. Security Ownership of Certain Beneficial Owners and Management................ 29
Item 13. Certain Relationships and Related Transactions................................ 29
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PART IV
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Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............... 30
Signatures.................................................................... 33
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PART I
ITEM 1. BUSINESS
SMART Modular Technologies, Inc., a California corporation ("SMART" or the
"Company"), is a leading independent manufacturer of specialty and standard
memory modules and Flash memory cards and also manufactures high performance
embedded computer modules, as well as communication card solutions in PC card
and other form factors. SMART offers more than 500 products to leading original
equipment manufacturers ("OEMs") in the computer, networking and
telecommunications industries. The Company's principal customers include Cisco
Systems, Inc. ("Cisco"), Compaq Computer Corporation ("Compaq"), Data General
Corporation ("Data General"), Fujitsu Microelectronics ("Fujitsu"),
Hewlett-Packard Company ("Hewlett-Packard"), IBM Corporation ("IBM"), Motorola,
Inc. ("Motorola"), NCR Corp. ("NCR") and Solectron Corp. ("Solectron").
SMART has developed extensive design, manufacturing, testing and logistics
expertise that the Company believes enables it to respond to its customers'
rapidly changing product and service requirements; provide its customers with
timely access to new higher speed or higher performance modules or subsystems;
reduce its customers' time-to-market and capital requirements; and decrease its
customers' production and inventory costs.
INDUSTRY BACKGROUND
The demand for semiconductor memory devices and other subsystems in digital
electronic systems has grown dramatically over the last several years as a
result of the increasing importance of both of these components in determining
system performance. The demand for greater overall system performance, as well
as the increasing number and variety of electronic devices, has required that
electronics manufacturers increase the number and functionality of memory
devices and the performance of other subsystems.
The factors contributing to the increasing demand for memory devices and
communications and embedded computer subsystems include the expanding unit sales
of PCs in the business and consumer market segments; the increasing use of PCs
to perform memory-intensive graphics and multimedia functions; the volume of
memory required to support faster microprocessors; the proliferation of
increasingly complex operating system and applications software; the increased
use of local area network and wide area network routing and switching equipment
that incorporates complex memory and embedded computer subsystems; the growth in
on-line communications, such as e-mail and the Internet; and, in general, the
increasing performance requirements of workstations, servers and networking and
telecommunications equipment.
Memory integrated circuits ("ICs") and subsystems encompass several types
of devices designed to perform specific functions within computer and other
electronic systems. The three most significant categories of memory ICs are
DRAM, SRAM and non-volatile memory, including Flash. DRAM provides large
capacity "main" memory; SRAM provides specialized high speed memory; and Flash
and other non-volatile memory provide low power memory that retains data after a
system is turned off. Within each of these broad categories of memory products,
semiconductor manufacturers are offering an increasing variety of memory devices
that are designed for different application and performance requirements. For
example, the variety of DRAM memory ICs has increased in recent years with the
introduction and adoption of architectures such as SDRAM, Rambus DRAM, SGRAM,
VRAM, FPM and EDO. This increase in the variety of memory ICs has placed greater
demands on OEMs to maintain a current knowledge base and expertise. In addition,
other specialized subsystems, such as modems, networking devices and embedded
computer solutions, enable critical data transfer and data processing functions.
MARKETS
Memory Module Market. Memory modules are compact circuit board assemblies
consisting of DRAM, SRAM, Flash or other semiconductor memory devices and
related circuitry. Electronic systems increasingly employ memory modules as
building blocks in system design as a result of the many advantages memory
modules offer OEMs and end users. The use of memory modules enables OEMs to
easily configure a system
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with a variety of different levels of memory, thus increasing their flexibility
to address multiple price points or applications with a single base system
design. In addition, the use of memory modules enables OEMs to offer a
relatively easy path for upgradeability of a PC or workstation, a feature of
system design that is increasingly required by end users. To achieve this
flexibility and upgradeability, both PC and communications OEMs frequently
design their systems to use memory modules as a "daughter card," reducing the
need to include memory devices on the motherboard. This design structure frees
up space on the motherboard and enables the OEM to use a single motherboard as a
common central element for a variety of different systems, resulting in
significant cost savings. The use of memory modules further reduces costs by
reducing OEMs' work-in-process inventories by allowing them to add expensive and
increasingly diverse memory devices to products during the final stages of the
manufacturing process.
The market for memory modules includes both standard and specialty modules.
The high volume standard memory module market includes modules that can be
sourced from many module suppliers, and are designed to be incorporated into a
wide variety of equipment. These modules employ designs meeting widely used
industry specifications and are available with a variety of options to address
the needs of multiple OEMs. Standard memory modules are typically used in
desktop PCs and printers and are sold both to OEMs and through computer
resellers directly to end users.
Specialty memory modules include both custom and application specific
modules. The varying requirements of different electronic systems and the
increased number of memory device options have resulted in a market for
specialized memory modules that are designed to enhance the performance of a
particular system or a set of applications. These modules are based on either
DRAM, SRAM or Flash technologies and may include additional control circuitry.
Specialty memory modules are typically sourced from a limited number of
suppliers. Application specific and custom memory modules are generally used in
mobile computers, workstations and telecommunications devices, such as routers
and switches, and are primarily sold to OEMs.
Communication Card Market. Communication cards come in PC card, desktop
(ISA and PCI) and proprietary form factors. PC cards are small form factor cards
conforming to the Personal Computer Memory Card International Association
("PCMCIA") standards and are used as peripheral devices in products such as
notebook and subnotebook computers, personal digital assistants ("PDAs"),
cellular phones, pagers and digital cameras. The Company believes that growth in
the mobile computing market will expand the market for mobile computing
peripherals and communications (wireline and wireless data/fax modems).
Increasingly important aspects of PC card modem functionality are the abilities
to be easily configurable for use internationally and to provide high speed
connections over wireline and wireless networks such as ISDN, switched cellular,
digital cellular (GSM and CDMA) and personal communications services (PCS).
Embedded Computer Subsystem Market. Unlike PCs or workstations that serve
as general purpose computers, embedded computer subsystems are integrated into
larger systems and perform a single function or a closely related group of
functions such as input/output ("I/O") and data processing with high degrees of
repeatability, accuracy and reliability. Embedded computer subsystems are
incorporated into an ever-increasing array of products used in a variety of
markets, including telecommunications, networking, imaging, simulation, command
and control, industrial control and desktop publishing. Examples of embedded
computer subsystem applications include Digital Satellite Systems, set-top
boxes, video games, laser printers, scanners, network routers and switches,
robots, computer guided missiles, paint mixing systems, medical imaging
analyzers, automated toll collection systems and Global Positioning System
receivers. With current market conditions requiring shorter design cycles and
the options for implementation becoming more varied and complex, OEMs are
increasingly outsourcing their requirements for embedded computer subsystems to
specialists that complement the value added by the OEM.
Opportunity for Manufacturers of Memory Modules and Subsystems. As the
variety of memory devices and subsystems available to address specific
applications has expanded, the design and manufacture of memory modules,
communication cards and embedded computer subsystems have increasingly become
areas in which electronics OEMs employ outsourcing strategies. OEM outsourcing
practices for memory products range from contract manufacturing, in which the
OEM may turn to an outside supplier to procure third-party
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components and design, manufacture and distribute a specific product for the OEM
on a turnkey basis, to consignment, in which the OEM employs the outside
supplier to design and manufacture a product using memory or other components
supplied by the OEM. OEMs may also purchase memory modules or subsystems which
have been designed by a supplier for a specific application.
The use of outsourcing strategies has many benefits for OEMs. By
outsourcing design, manufacturing, testing and logistics functions, OEMs are
able to focus their resources on activities and technologies in which they add
the greatest value, such as system design, sales, marketing and distribution. In
addition, OEMs can reduce their time to market by utilizing the manufacturing
and logistics expertise of specialized manufacturers. In particular, the
increasing trend under which large PC OEMs are implementing build-to-order and
direct sales distribution strategies may create opportunities for independent
suppliers of memory modules, as these strategies place increased reliance on the
manufacturing, logistics and inventory management functions of these suppliers.
Moreover, as memory modules, communication cards, embedded computer subsystems
and other subsystems become more complex and differentiated, the design,
manufacturing and test processes become increasingly automated and more complex,
requiring a greater level of investment in capital equipment and skilled
engineers and specialists. Outsourcing enables OEMs to gain access to advanced
manufacturing facilities, thereby reducing the OEMs' overall capital equipment
requirements. Also, the proliferation of a wide variety of DRAM, SRAM and Flash
memory devices combined with frequent product design changes, short product life
cycles and component price fluctuations, have created increasing difficulties
for OEMs in planning, procuring and managing their inventories efficiently. By
using a manufacturing specialist's volume procurement capabilities and expertise
in inventory management, OEMs can reduce production and inventory costs.
THE SMART SOLUTION
SMART is a leading independent manufacturer of specialty and standard
memory modules and Flash memory cards and also manufactures high performance
embedded computer modules, as well as communication card solutions in PC card
and other form factors. SMART offers more than 500 products to leading OEMs in
the computer, networking and telecommunications industries. SMART has developed
extensive design, manufacturing, testing and logistics expertise that the
Company believes enables it to respond to its customers' rapidly changing
product and service requirements; provide its customers with timely access to
new higher speed or higher performance modules or subsystems; reduce its
customers' time-to-market and capital requirements; and decrease its customers'
production and inventory costs.
PRODUCTS
The Company designs and markets products consisting of memory modules,
communication cards and embedded computer modules. The Company's memory modules
include DRAM, SRAM and Flash memory-based products. The Company offers custom
and application specific memory modules, as well as standard memory modules that
comply with industry standards established by the Joint Electronic Development
Engineering Council ("JEDEC"). The Company's communication card products come in
PC card, ISA, PCI and proprietary form factors. They include wireless data
modems with international PTT approval and 56 kbps technology. The Company's
embedded computer module products include a range of standard and perfect fit
embedded computers for use in a variety of specialized computing applications.
Memory Modules
DRAM Modules. The Company offers a comprehensive line of DRAM memory
modules, including a wide range of single in-line memory modules ("SIMMs"), dual
in-line memory modules ("DIMMs") and small outline dual in-line memory modules
("SO DIMMs"). The Company's DRAM modules are available in various configurations
of up to 200 pins and densities of up to 256 MBytes. Many of these products are
offered in both 5.0 volt and 3.3 volt versions, with FPM, EDO, SDRAM and SGRAM
architectures.
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The following table summarizes certain of the Company's DRAM module product
offerings:
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DRAM
PRODUCT FAMILIES DENSITY FEATURES SPEED (MHZ) APPLICATIONS
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72 Pin SIMMs 4-64 MBytes FPM, EDO 10-33 Desktop PCs, Printers,
Embedded Controllers,
Routers, Servers
100 Pin DIMMs 4-64 MBytes FPM, EDO, 66-133 Networking, Printers
SDRAM
144 Pin SO DIMMs 4-64 MBytes FPM, EDO 10-33 Notebook PCs, Printers,
SDRAM, SGRAM 66-133 X-Window Terminals, 3D
Graphics
168 Pin DIMMs 8-256 MBytes FPM, EDO 10-33 Workstations, Routers,
PCs
SDRAM 66-133 Servers, Telecom
Equipment, PCs
Registered 168 Pin 8-256 MBytes SDRAM 66-133 Workstations, Servers,
DIMMs Routers
200 Pin DIMMs 16-64 MBytes FPM, SDRAM 10-150 Workstations, Super
Computers
VRAM Modules 2-16 MBytes RAM, High- 60-200 High Performance Graphics
Speed SRAM for Workstations
VME Bus Modules 256 KBytes- FPM, Low 10-33 Industrial Control
16 MBytes Profile Systems
Intel PC-100 DIMMs 8-256 Mbytes PC-100 SDRAM 100 Desktop PCs,
Workstations, Servers
Custom 1-256 MBytes Per Customer Per Customer Embedded Controllers,
Specifications Specifications Telecom Switches,
Notebook PCs
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SRAM Modules. The Company offers a comprehensive line of SRAM memory
modules, including L2 cache modules and other high speed and low power SRAM
modules. The Company's L2 cache modules are available in speeds from 33 to 83
MHz, in asynchronous and synchronous versions, with burst, pipelined burst and
serial access operating modes and in densities from 256 KBytes to 8 MBytes.
The following table summarizes certain of the Company's high speed SRAM L2
cache module product offerings:
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SRAM L2 CACHE CHIPSET
PRODUCT FAMILIES DENSITY COMPATIBILITY SPEED (MHZ) APPLICATIONS
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Synchronous 64 Bit 256 KBytes-1 MByte Intel, SIS, OPTi, VLSI 66-83 Desktop PCs, Embedded
Controllers
Synchronous 72 Bit 256 KBytes-1 MByte Intel, SIS, OPTi, VLSI 66-83 Desktop PCs,
Workstations, Servers,
Routers
Asynchronous 64 Bit 256 KBytes-1 MByte Intel, OPTi, VLSI 50-66 Desktop PCs, Embedded
Controllers
Asynchronous 72 Bit 256 KBytes-1 MByte Intel, OPTi, VLSI 50-66 Desktop PCs,
Workstations, Servers,
Routers
Custom 256 KBytes-8 MBytes Per Customer Per Customer Desktop PCs
Specifications Specifications
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The following table summarizes certain of the Company's other high speed
and low power SRAM module product offerings:
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SRAM
PRODUCT
FAMILIES DENSITY SPEED (NS) APPLICATIONS
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8 Bit I/O 256 KBytes-2 MBytes 100-20 Point of Sale Terminals, Electronic
Verification Equipment, Industrial
Instrumentation
16 Bit I/O 32 KBytes-1 MByte 120-15 Disk Drives, Medical Instruments
18 Bit I/O 768 KBytes 25-15 Disk Drives, Medical Instruments
24 Bit I/O 960 KBytes 25-15 Servers, Graphics
32 Bit I/O 32 KBytes-1 MByte 100-12 Graphics, Industrial Instrumentation
36 Bit I/O 32 KBytes-1 MByte 35-15 Servers, Workstations
44 Bit I/O 1.4-5.5 MBytes 20-15 Minicomputers
</TABLE>
Flash Modules. The Company offers a comprehensive line of Flash modules,
including 72 Pin DRAM-like SIMMs, 80 Pin synchronous SIMMs, 80 Pin asynchronous
SIMMs and 168 Pin synchronous and asynchronous DIMMs. The Company's Flash
modules are available in densities of up to 64 MBytes. The Company also offers
additional options such as an on-board active reset control, system reset
control and DC to DC power conversion which allows the use of 12.0 volt
components in a 5.0 volt system.
The following table summarizes certain of the Company's Flash module
product offerings:
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FLASH PRODUCT FAMILIES DENSITY FEATURES APPLICATIONS
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72 Pin DRAM-like SIMMs 4-8 MBytes Reads like DRAM Embedded Controllers
Plugs into DRAM Socket
80 Pin Synchronous SIMMs 8-32 MBytes Synchronized to System Clock Embedded Controllers
80 Pin Asynchronous 1-32 MBytes 12.0 Volt/5.0 Volt Programming Routers, Servers,
SIMMs 5.0 Volt/3.3 Volt Read Voltage Telecom Switches
5.0 Volt Only
3 Reset Options
168 Pin Asynchronous 4-64 MBytes 5.0 Volt/3.3 Volt Read Voltage Telecom Switches, Routers
DIMMs
Custom 1-64 MBytes Per Customer Specifications Industrial Applications
</TABLE>
Sales of memory modules accounted for a substantial majority of the
Company's net sales during fiscal 1997, fiscal 1996 and fiscal 1995.
PC CARD PRODUCTS
The Company sells PC card products that provide both memory, I/O and
communication functions. The Company offers a comprehensive line of memory PC
card products, including 68 Pin PC cards with densities ranging from 2 MBytes to
32 MBytes and 68 Pin ATA Flash memory PC cards with densities ranging from 2
MBytes to 112 MBytes. These cards provide additional memory for notebook and
subnotebook computers and PDAs. The Company's memory PC cards are PCMCIA Type I
compatible.
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The following table summarizes certain of the Company's PC card memory
product offerings:
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PC CARD MEMORY
PRODUCT FAMILIES DENSITY FEATURES APPLICATIONS
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68 Pin Linear 2-32 MBytes Plug & Play, Software Driver PDAs, Notebook PCs, Networking,
Flash Included Portable Medical Equipment
68 Pin ATA 2-112 MBytes 5.0 Volt, 3.3 Volt PDAs, Notebook PCs, Networking
Flash ATA Compliant
Compact Flash 2-16 MBytes 5.0 Volt, 3.3 Volt PDAs, Cellular Phones, Pagers,
ATA ATA Compliant Digital Cameras
Miniature 2-4 MBytes 5.0 Volt, 3.3 Volt PDAs, Cellular Phones, Pagers,
16 Bit Data Interface Digital Cameras
MCIF Specification Compliant
Custom 128 KBytes-20 MBytes Per Customer Specifications Portable Medical Equipment
</TABLE>
The Company also offers a comprehensive line of modem and communication
card products. These products include a full line of PC card data/fax modems for
notebook and PDA devices, as well as internal (ISA and PCI) modems for desktop
computers. The Company currently offers 56 kbps modems utilizing the K56flex(TM)
technology supported by Lucent Technologies, Inc. and Rockwell International
Corporation ("Rockwell"). To address the needs of users demanding international
mobility, the Company's world-approved modems allow users to have one modem that
can be used worldwide. The Company has added digital GSM technology to its
world-approved modems providing users with secure, digital, wireless
communications. In addition, the Company has added ISDN technology in both
United States and European interfaces.
The following chart summarizes certain of the Company's communication card
product offerings:
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COMMUNICATION CARD
PRODUCT FAMILIES FEATURES
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Mobile Plus V.34 33.6 kbps PC card Landline and Cellular-ready
Supports over 50 different types of
analog cellular phones
ClipperCom World V.34 33.6 kbps PC card Internal DAA certified in over 50
w/GSM countries
Country Select GUI software
Digital GSM wireless capabilities
Winperformer 56 kbps PC card HSP technology
Win95, NT
Rapid Transit 56 kbps PC Card K56flex(TM) technology
Software upgradable
Rapid Transit 56 kbps Internal (ISA) K56flex(TM) technology
Software upgradable
Full duplex speakerphone
Clippercom 56K World/ISDN PC card w/GSM International PTT approval, leading GSM
phone support, S/T and U-Interface,
K56flex(TM) technology, software
upgradable
PCI 56 kbps Data/Fax Voice Modem Supports PC 98 Compliance, K56flex(TM)
technology, software upgradable, full
duplex speakerphone
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EMBEDDED COMPUTER MODULES
The Company's SMARTengine family of products helps accelerate time to
market, reduce system cost, lower power requirements and provide a clear upgrade
path for OEMs. The Company offers a line of standard and perfect-fit embedded
computers with complete software support that offer varying price/performance
and industry standard bus interfaces. The Company's product line is processor
independent and operates in systems using 32 and 64 bit CPUs from several
vendors. This compatibility enhances flexibility to match price, performance and
power requirements to the customer's application. The Company has also used
industry
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standard buses, including ISA, EISA, PCI and Compact PCI, as well as custom
buses, where required. All products are supported by on-board software for
development and real-time operating systems support.
The following table summarizes certain of the Company's SMARTengine
embedded computer module product offerings:
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EMBEDDED COMPUTER
MODULE FAMILIES FEATURES APPLICATIONS
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SMARTengine/603cPCI Power PC 603, 6-U Compact PCI, Telecommunications,
16-128 Mbytes DRAM Networking,
Peripherals
SMARTengine/50cPCI R5000, 3-U Compact PCI, 16-128 Mbyte DRAM Internetworking,
10/100 Ethernet, FLASH Ethernet
Switch, 3-U Jupiter
SMARTengine/50cPCI R5000, 6-U Compact PCI, 8-128 MBytes DRAM, ATM Switch, Ethernet
FLASH, PROM, Ethernet, SCSI, RTC, Switch, Power PC
DUART
SMARTengine/50PCI R5000, Compact PCI, 8-128 MBytes DRAM, ATM Switch, Ethernet
FLASH, PROM, Ethernet, SCSI, RTC, Switch
DUART
SMARTengine/43PCI R4300, 8 MBytes EDO DRAM, FLASH, PROM, Imaging, Game,
RTC, 3 PCI slots Publishing
SMARTengine 43hPCI, R4300, 8 MBytes DRAM, FLASH, Networking, Printers,
PROM, RTC Datacom, Test and
Measurement
SMARTengine/43NET R4300, 2 Ethernets, 8 MBytes DRAM, Networking, Ethernet
FLASH, PROM, RTC, DUART Switch
SMARTengine/47PCI R4700, 2 PCI buses, 8-128 MBytes DRAM, Imaging
FLASH, PROM, RTC, DUART
SMARTengine/30ISA R3081, ISA bus, 8 MBytes DRAM Simulation
Custom Perfect-fit embedded computer for the Various
customer's application
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CUSTOMERS, SALES AND MARKETING
The Company's principal customers include major computing, networking and
telecommunication OEMs and semiconductor manufacturers. The Company's ten
largest customers accounted for approximately 86%, 71% and 68% of the Company's
net sales, in fiscal 1997, fiscal 1996 and fiscal 1995, respectively. In 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. No other customers accounted for more than 10% of net sales in
these periods.
The Company primarily sells its memory and embedded computer module
products directly to major OEM customers and uses a network of independent sales
representatives located throughout North America and Europe for sales to other
OEM customers. The Company's direct sales and marketing efforts are conducted in
an integrated process involving direct salespeople, customer service
representatives and senior executives. An important aspect of the Company's
sales and marketing efforts is that the Company's experienced applications
engineers work closely with OEM customers in designing the Company's products
into the OEM's systems. The Company's sales offices are located in California,
Colorado, Texas, Massachusetts, North Carolina, England, Australia, France and
Germany.
To address the needs of its OEM customers, the Company has developed and
maintains relationships with leading vendors of memory devices located in the
United States, Japan and South Korea. These include limited and sole source
suppliers of certain products, such as NEC Corporation, IBM, Intel Corporation
("Intel"), Oki Semiconductor, Inc., Rockwell and Samsung Electronics Company
Ltd. ("Samsung"). The
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Company frequently works jointly with these vendors in bidding for customers'
design-in opportunities. The Company's OEM marketing activities include
advertising in technical journals and direct mail solicitation.
The Company sells communication card products to OEMs and corporate end
users, as well as to small office/home office ("SOHO") and consumer end users.
The Company's OEM customers integrate the Company's communication cards into
their end products. Corporate end users typically buy the Company's
communication card products for mobile computing applications through computer
resellers, such as distributors and VARs. Distributors in North America include
Ingram Micro Inc., Merisel Inc., Microage, Inc. and Tech Data Corp. The Company
sells to SOHO and consumer end users through catalog sales organizations and
retailers including Mobile Planet in North America.
Sales are generally made pursuant to standard purchase orders. The Company
includes in its backlog only those customer orders for which it has accepted
purchase orders and it expects to ship within the next 12 months. Since orders
constituting the Company's current backlog are subject to changes in delivery
schedules and are subject to cancellation with only limited or no penalties,
backlog is not necessarily an accurate indication of future net sales. There can
be no assurance that current backlog will necessarily lead to net sales in any
future period. The Company's total backlog was $35.2 million and $57.1 million
as of October 31, 1997 and 1996, respectively.
DESIGN, MANUFACTURING AND TEST
The Company has a staff of engineers for applications development,
component selection, schematic design, layout, firmware and software driver
development. The layouts for memory modules, communication cards and embedded
computer modules are specialized due to their high component and trace
densities, particularly for high speed memory modules. To further enhance its
design capability, the Company established in fiscal 1995 a design center in
Bangalore, India.
The Company believes that the efficiency of its manufacturing operations
has benefited from its extensive experience and its library of proven designs
which stress high manufacturability and quality. Through its extensive library
of memory module designs and its experience in designing and manufacturing
memory modules, the Company is able to work closely with its customers and
suppliers to design competitive solutions to system memory problems and shorten
the time it takes its customers to get their products to market.
The Company's manufacturing processes rely on a high level of automation
and involve the use of a substantial base of fine pitch surface mount equipment
which is specialized for the production of memory modules, communication card
products and PC cards. The Company's surface mount manufacturing lines have been
optimized to support the placement and configuration of a high number of ICs on
each board, in contrast to surface mount equipment used in less specialized
electronics manufacturing which typically involves a fewer number of ICs and a
greater number of passive components on each printed circuit board. The Company
also has developed automated methods for PC card case assembly and test. As a
result of its design efficiencies, high level of automation and general
manufacturing expertise, the Company believes that it achieves relatively high
manufacturing yields. In addition, due to the high level of automation in the
Company's manufacturing approach, the Company maintains a relatively low
percentage of direct labor costs. The Company believes that it has achieved and
maintains a rapid manufacturing cycle and is able to offer its customers quick
turnaround of both small and large projects. The Company is frequently able to
provide turnaround on major customer orders within days or weeks.
An important aspect of the Company's manufacturing operations is its focus
on product testing. The Company tests 100% of its memory modules, communication
card products and embedded computer modules for full functionality, in contrast
with many other suppliers which the Company believes may test only at the system
level. The Company believes that it has established substantial technical
expertise in the testing of memory modules, communication card products and
embedded computer modules. The Company further believes that test capability
will grow in importance as the speed and complexity of memory devices and
modules utilizing those devices increase. The Company has a group of experienced
test engineers that develop proprietary testing routines and parameters which,
combined with the Company's continued investment in
10
<PAGE> 11
advanced test equipment, enable it to diagnose problems in system design or
memory components, to characterize the performance of new products and to
provide high quality products in volume.
The Company currently manufactures and tests the majority of its products
in a 62,250 square foot facility in Fremont, California. In addition, the
Company utilizes a 83,000 square foot manufacturing and test facility in Aguada,
Puerto Rico and a 25,000 square foot manufacturing and test facility in East
Kilbride, Scotland. The Company operates multiple production lines at these
facilities. The Company subcontracts a limited amount of production requirements
to third party manufacturers.
RESEARCH AND DEVELOPMENT
The Company believes that the timely development of new memory modules,
communication card products and embedded computer modules is essential to
maintaining the Company's competitive position. In the memory market, the
Company's research and development activities are focused primarily on new high
speed memory modules, the continual improvement in test routines and software
and the ongoing improvement in manufacturing processes and technologies. In
particular, the Company is focusing its research and development resources on
the development of SDRAM, Flash and SRAM products. The Company plans to continue
to devote substantial research and development efforts to the design of new
memory module products which address the requirements of OEMs and corporate end
users.
In the communication card market, the Company's research and development
efforts are focused primarily on the design and introduction of new
communication card products which provide improved functionality and the latest
technology in various form factors. The Company's research and development
efforts in the embedded computer market are focused on the design of standard
and custom embedded computer modules based primarily on the MIPS and PowerPC
computing architectures and standard or custom bus architectures.
The Company's research and development expenses totaled $8.5 million, $5.9
million and $5.3 million in fiscal 1997, fiscal 1996 and fiscal 1995,
respectively.
COMPETITION
The memory module, communications card and embedded computer subsystem
industries are intensely competitive. Each of these markets comprises a large
number of competitive companies, several of which have achieved a substantial
share of their respective markets. 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 Micron Electronics,
Inc. (a subsidiary of Micron Technology Inc.) and 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), Motorola 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 may have the
ability to manufacture competitive products at lower costs than the Company as a
result of their higher levels of integration. 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
11
<PAGE> 12
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.
INTELLECTUAL PROPERTY
The Company has one issued patent. The Company expects to file new patent
applications where appropriate to protect its proprietary technologies; however,
the Company believes that its continued success depends primarily on factors
such as the technological skills and innovation of its personnel rather than on
patent protection. 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. While there is currently no material pending
intellectual property litigation involving the Company, 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
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. Any 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 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. The Company has also
entered into license agreements in the past regarding certain alleged
infringement claims asserted by third parties. 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
such 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.
EMPLOYEES
As of October 31, 1997, the Company had 636 regular, full time employees of
which 459 were in manufacturing (including test, quality assurance and materials
work), 57 were in design and product development, 53 were in marketing and sales
and 67 were in finance and administration. The Company's future results 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's
12
<PAGE> 13
employees are not represented by any collective bargaining agreements and the
Company has never experienced a work stoppage. The Company believes that its
employee relations are good.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's business, financial condition and results of operations can
be impacted by a number of factors. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors that May
Affect Future Results." For the impact of recently issued Financial Accounting
Standards on the Company's financial position and results of operations, see
Note 2 to the Consolidated Financial Statements.
ITEM 2. PROPERTIES
The Company's corporate headquarters and a manufacturing facility are
located in a 62,250 square foot facility in Fremont, California. The lease on
this facility expires in January 2003. The Company leases an additional 25,000
square foot facility in Fremont, California. The lease on this facility expires
in January 2003. The Company also leases a 83,000 square foot manufacturing
facility in Aguada, Puerto Rico and a 25,000 square foot manufacturing facility
in East Kilbride, Scotland. The leases on these facilities expire in October
2007 and September 2006, respectively. In addition, the Company leases various
small facilities for its sales offices.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Not Applicable.
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<PAGE> 14
PART II
ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "SMOD." The following table sets forth, for the periods indicated,
the high and low closing sale prices for the Common Stock as reported by the
Nasdaq National Market. In December 1997, the Company consummated a stock split
effected as a stock dividend whereby each issued and outstanding share of the
Common Stock was converted into two shares of Common Stock. Accordingly, all
share and per share amounts presented herein have been retroactively adjusted to
reflect the stock split.
<TABLE>
<CAPTION>
HIGH LOW
--- ---
<S> <C> <C>
Fiscal year ended October 31, 1996
First Quarter (from November 17, 1995)........................ $ 65/16 $ 4 3/4
Second Quarter................................................ 115/16 5 /16
Third Quarter................................................. 121/16 4 /16
Fourth Quarter................................................ 10 5/8 6 1/2
Fiscal year ending October 31, 1997
First Quarter................................................. 1523/32 9 /16
Second Quarter................................................ 17 11 5/8
Third Quarter................................................. 2311/16 15 /16
Fourth Quarter................................................ 441/16 20 1/2
</TABLE>
On January 5, 1998, the reported last sale price for the Common Stock on
the Nasdaq National Market was $27 1/8 per share. At January 5, 1998, the
Company had approximately 131 holders of record of the Common Stock and
approximately 13,000 beneficial holders of the Common Stock. The Company has
never paid cash dividends on the Common Stock. The Company presently intends to
retain any earnings for use in its business and does not anticipate paying any
cash dividends in the foreseeable future. Certain financial covenants set forth
in the Company's bank line of credit agreement prohibit the Company from paying
dividends.
On November 17, 1995, the Company commenced its initial public offering of
6,000,000 shares of Common Stock with an aggregate offering price of $36,000,000
(the "Offering"). The Company's Registration Statement on Form S-1 (File No.
33-97748) for the Offering became effective on November 16, 1995. The Offering
terminated upon the sale of all securities registered at the offering price.
Donaldson, Lufkin & Jenrette Securities Corporation, Cowen & Company and
Oppenheimer & Co., Inc. served as the managing underwriters for the Offering.
In connection with the issuance and distribution of the securities
registered, direct or indirect payments to others were made as follows: (i)
underwriting discounts and commissions of $2,520,000, and (ii) estimated other
expenses of $1,028,536. Estimated expenses for the Offering totaled $3,548,536.
The Company received net offering proceeds of $32,451,464, of which as of
October 31, 1997 an estimated $17,000,000 has been used for the purchase and
installation of machinery and equipment and an estimated $7,500,000 toward the
repayment of indebtedness. These uses of net offering proceeds were made in the
form of direct or indirect payments to others. Pending additional capital
expenditures, remaining net offering proceeds are presently held as temporary
investments in money market and mutual fund accounts, containing balances of
approximately $2,900,000 and $4,900,000 at the end of fiscal 1997, respectively.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below under the captions
"Consolidated Statement of Income Data" and "Consolidated Balance Sheet Data"
are derived from the consolidated financial statements of the Company and
subsidiaries, which financial statements have been audited by Arthur Andersen
LLP, independent public accountants, to the extent indicated in their reports
included elsewhere herein. On July 28, 1995, a wholly-owned subsidiary of the
Company merged with Apex Data, Inc., a Delaware
14
<PAGE> 15
corporation ("Apex"), which resulted in Apex becoming a wholly-owned subsidiary
of the Company. The merger was accounted for as a pooling of interests.
Accordingly, the consolidated financial statements have been restated to include
the financial statements of Apex from its inception in May 1992. On July 31,
1996, a wholly-owned subsidiary of the Company merged with RISQ Modular Systems,
Inc., a California corporation ("RISQ"), which resulted in RISQ becoming a
wholly-owned subsidiary of the Company. The merger was accounted for as a
pooling of interests. Given the immateriality of this acquisition to the
Company's consolidated financial position and results of operations, RISQ has
been included in the Company's consolidated results of operations as of the
beginning of fiscal 1996 (November 1, 1995) and amounts presented for periods
prior to fiscal 1996 have not been restated to include RISQ's historical results
of operations. See Note 2 to the Consolidated Financial Statements.
The selected consolidated financial data set forth below is qualified in
its entirety by, and should be read in conjunction with, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements.
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
FISCAL YEARS ENDED OCTOBER 31,
---------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
Net sales.................................. $694,675 $401,774 $274,592 $163,849 $80,810
Cost of sales.............................. 582,515 329,644 224,931 132,826 63,542
-------- -------- -------- -------- -------
Gross profit............................... 112,160 72,130 49,661 31,023 17,268
Operating expenses:
Research and development................ 8,496 5,933 5,283 5,891 2,224
Sales, general and administrative....... 37,163 28,544 23,952 15,192 9,629
-------- -------- -------- -------- -------
Total operating expenses........... 45,659 34,477 29,235 21,083 11,853
-------- -------- -------- -------- -------
Income from operations..................... 66,501 37,653 20,426 9,940 5,415
Other income (expense), net................ 2,364 2,238 (515) (143) 9
-------- -------- -------- -------- -------
Income before provision for income taxes... 68,865 39,891 19,911 9,797 5,424
Provision for income taxes................. 23,418 14,760 7,344 3,759 2,134
-------- -------- -------- -------- -------
Income before cumulative effect of change
in accounting principle................. 45,447 25,131 12,567 6,038 3,290
Cumulative effect of change in accounting
principle............................... -- -- -- 121 --
-------- -------- -------- -------- -------
Net income................................. $ 45,447 $ 25,131 $ 12,567 $ 6,159 $ 3,290
======== ======== ======== ======== =======
Net income per share(1).................... $ 1.04 $ 0.60 $ 0.36 $ 0.19 $ 0.11
======== ======== ======== ======== =======
Weighted average common and common
equivalent shares outstanding(2)........ 43,892 41,748 35,130 33,074 28,678
======== ======== ======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
AS OF OCTOBER 31,
-------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA (IN THOUSANDS):
Working capital.............................. $206,115 $ 74,324 $21,464 $12,185 $ 5,719
Total assets................................. 327,985 172,185 91,976 45,612 34,752
Capital lease obligations, net of current
portion................................... 234 1,241 1,599 632 142
Shareholders' equity......................... 230,320 86,619 26,234 13,665 5,598
</TABLE>
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<PAGE> 16
- ---------------
(1) The cumulative effect of the change in accounting principle did not
materially impact net income per share.
(2) See Note 2 to the Consolidated Financial Statements for an explanation of
the method used to determine the number of shares used in computing net
income per share.
ITEM 7. 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 first paragraph of the Gross Profit Section, the
first paragraph of the Research and Development Section, the first paragraph of
the Sales, General and Administrative Section, the Other Income (Expense), Net
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 7. 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
The Company 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 in July 1995. The Company further
expanded its product line to include embedded computer modules through the
acquisition of RISQ in July 1996.
The Company's net sales and gross profit have increased substantially over
the last three fiscal years. Over the last three fiscal years, SMART's gross
margin has ranged from 16.1% to 18.1%. 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 which 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
years, a significant majority of the Company's net sales were derived from the
sales of its specialty memory modules, which typically have higher gross margin
than the Company's standard memory modules. In fiscal 1997, sales of standard
memory modules accounted for approximately one half of the Company's net sales.
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.
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<PAGE> 17
The Company expects that its gross margin will continue to vary based on
these and other factors, including changes in the selling prices for its
products, pricing by competitors and suppliers and the level of manufacturing
efficiencies achieved. Selling prices of certain of SMART's products have
declined in the past and SMART expects that some prices will continue to decline
in the future. Accordingly, SMART's ability to maintain or increase gross profit
and gross margin will be highly dependent upon its ability to increase unit
sales volumes of existing products and to introduce and sell new products in
quantities and with gross margin sufficient to compensate for the anticipated
declines in selling prices.
The Company primarily sells its products to OEMs and semiconductor
manufacturers in the computer, networking and telecommunications industries. The
Company's ten largest customers accounted for 86%, 71% and 68% of the Company's
net sales for fiscal 1997, fiscal 1996 and fiscal 1995, respectively. In 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. The Company has added new OEM customers and programs in
recent periods and its strategy is to increase its sales to both existing and
new OEM customers. In addition, the Company's strategy calls for further
expansion of its geographic operations, particularly in Europe. International
sales accounted for 18%, 8% and 14% of the Company's net sales in fiscal 1997,
fiscal 1996 and fiscal 1995, respectively.
In July 1995, the Company expanded its PC card communication products with
the acquisition of Apex. Apex designs and markets wireless and wireline
communication card products into both the computer reseller and OEM channels.
The Company acquired Apex in a stock for stock transaction that was accounted
for as a pooling-of-interests. Accordingly, the Company's historical results of
operations include Apex's historical results of operations, the impact of which
was immaterial to the Company's consolidated financial results.
In July 1996, the Company expanded its specialized technical capabilities
with the acquisition of RISQ. RISQ designs and manufactures embedded computer
modules and products in both standard and custom form factors for OEMs in the
telecommunications, networking, industrial control and image processing markets.
The Company acquired RISQ in a stock for stock transaction that was accounted
for as a pooling-of-interests. Given the immateriality of this acquisition to
the Company's consolidated financial position and results of operations, RISQ
has been included in the Company's consolidated results of operations as of the
beginning of fiscal 1996 (November 1, 1995) and amounts presented for periods
prior to fiscal 1996 have not been restated to include RISQ's historical results
of operations.
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<PAGE> 18
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of income
data of the Company expressed as a percentage of net sales:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
OCTOBER 31,
------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Net sales................................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 83.9 82.0 81.9
------ ------ ------
Gross profit................................................ 16.1 18.0 18.1
Operating expenses:
Research and development............................... 1.2 1.5 1.9
Sales, general and administrative...................... 5.3 7.1 8.7
------ ------ ------
Total operating expenses.......................... 6.6 8.6 10.6
------ ------ ------
Income from operations...................................... 9.6 9.4 7.4
Other income (expense), net................................. .3 .6 (.2)
------ ------ ------
Income before provision for income taxes.................... 9.9 9.9 7.3
Provision for income taxes.................................. 3.4 3.7 2.7
------ ------ ------
Net income.................................................. 6.5% 6.3% 4.6%
====== ====== ======
</TABLE>
Net Sales
Fiscal Year 1997 vs. 1996. 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 increased 72.9% to $694.7
million in fiscal 1997 from $401.8 million in fiscal 1996, reflecting an overall
increase in demand for the Company's products from new customers and certain
existing customers. In addition, increases in sales of products manufactured on
a turnkey basis as compared to products manufactured on a consignment basis
further contributed to the increase in net sales as compared to the same period
of fiscal 1996.
Fiscal Year 1996 vs. 1995. Net sales increased 46.3% to $401.8 million in
fiscal 1996 from $274.6 million in fiscal 1995. The increase was primarily due
to an increase in sales of specialty memory products and, to a lesser extent due
to an increase in sales of standard memory products to both existing and new
customers.
Gross Profit
Fiscal Year 1997 vs. 1996. 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 increased 55.5% to $112.2 million in
fiscal 1997 from $72.1 million in fiscal 1996. Gross margin decreased to 16.1%
in fiscal 1997 from 18.0% in fiscal 1996. The decrease in gross margin was due
in large part to an increase in the proportion of products manufactured on a
turnkey basis versus those products manufactured on a consignment basis as
compared to fiscal 1996. Further contributing to the decline in gross margin in
fiscal 1997 was an increase in the proportion of the Company's net sales derived
from its lower margin standard memory products as compared to fiscal 1996. The
Company currently anticipates that a substantial majority of the Company's
memory products will continue to be manufactured on a turnkey basis in the near
term.
Fiscal Year 1996 vs. 1995. Gross profit increased 45.2% to $72.1 million in
fiscal 1996 from $49.7 million in fiscal 1995. Gross margin decreased to 18.0%
in fiscal 1996 from 18.1% in fiscal 1995. The decrease in gross margin was
principally due to an increase in the proportion of sales of memory products
manufactured on a turnkey basis compared to products manufactured on a
consignment basis. The decrease was partially offset by an increase in the
percentage of net sales derived from higher margin specialty memory products as
compared to standard memory products in fiscal 1996 over fiscal 1995.
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<PAGE> 19
Research and Development
Fiscal Year 1997 vs. 1996. 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 increased 43.2% to $8.5 million in fiscal 1997 from
$5.9 million in fiscal 1996. As a percentage of net sales, research and
development expenses were 1.2% and 1.5% in fiscal 1997 and fiscal 1996,
respectively. The Company expects that its research and development expenses
will increase in absolute dollars in future periods to the extent the Company
expands its research and development efforts.
Fiscal Year 1996 vs. 1995. Research and development expenses increased
12.3% to $5.9 million in fiscal 1996 from $5.3 million in fiscal 1995. As a
percentage of net sales, research and development expenses decreased to 1.5% in
fiscal 1996 from 1.9% in fiscal 1995 primarily due to a change in the Company's
bonus structure which rewards the development efforts of certain key management
employees and was partially offset by an overall increase in non-compensation
based research and development expenses.
Sales, General and Administrative
Fiscal Year 1997 vs. 1996. 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 increased 30.1% to $37.2 million in fiscal 1997 from $28.5 million in
fiscal 1996. Sales, general and administrative expenses totaled 5.3% and 7.1% of
net sales in fiscal 1997 and fiscal 1996, respectively. The decrease in sales,
general and administrative expenses as a percentage of net sales was principally
due to the growth in net sales generated by certain OEM customers, which sales
generally require lower incremental levels of selling and marketing expenses.
The Company expects that its sales, general and administrative expenses will
increase in absolute dollars in future periods to the extent the Company expands
its staffing, information systems and other systems and personnel in connection
with the expansion of the Company's infrastructure.
Fiscal Year 1996 vs. 1995. Sales, general and administrative expenses
increased 19.2% to $28.5 million during fiscal 1996 from $24.0 million in fiscal
1995. As a percentage of net sales, sales, general and administrative expenses
decreased to 7.1% for fiscal 1996 from 8.7% in fiscal 1995, due primarily to the
elimination of significant operating costs related to Apex's operations, which
were integrated into the Company's operations during the final quarter of fiscal
1995, and to a lesser extent, a change in the Company's bonus structure for
certain key employees.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income, less
interest expense. Interest expense is attributable to the Company's utilization
of its lines of credit and interest paid on certain lease obligations. In fiscal
1996, the Company repaid nearly all outstanding balances on its then existing
lines of credit. Interest income from the proceeds of the Company's initial
public offering completed during November 1995, as well as cash generated from
operations has resulted in significant increases in other income during fiscal
1997 and fiscal 1996 as compared to fiscal 1995. The Company expects interest
income to increase in absolute dollars in the near term due to the proceeds
generated from the Company's secondary public offering completed in September
1997.
Provision for Income Taxes
Provisions for income taxes were $23.4 million, $14.8 million and $7.3
million in fiscal 1997, fiscal 1996 and fiscal 1995, respectively. The Company's
effective tax rates for these periods were 34.0%, 37.0% and 36.9%, respectively.
The decrease in the Company's consolidated effective tax rate for fiscal 1997
was principally due to an increase in the amount of income contributed to the
Company from its Puerto Rican and international operations compared to fiscal
1996. At October 31, 1997, the Company had a net operating loss carryforward of
approximately $1.8 million for federal income tax purposes and $1.0 million for
state income
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tax purposes arising from the acquisition of Apex. Utilization of this net
operating loss carryforward is subject to certain annual limitations. See Note 8
to the Consolidated Financial Statements.
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 accounts
receivable. The Company generated cash from operations totaling $15.9 million,
$27.0 million and $11.0 million in fiscal 1997, fiscal 1996 and fiscal 1995,
respectively. The decrease in cash provided by operations in fiscal 1997 as
compared to fiscal 1996 is primarily due to increases in accounts receivable and
certain prepaid expenses related to the Company's international operations, and
partially offset by an increase in net income and an increase in accounts
payable. 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 amounts borrowed
under its existing line of credit and utilization of existing cash balances. The
Company expects to fund any future liquidity requirements from a combination of
available cash balances and certain short-term borrowings under its existing
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 May 30, 1998. 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 October 31, 1997, the Company was in compliance
with all covenants related to the Credit Line. The Credit Line is unsecured and
no borrowings were outstanding under the Credit Line as of October 31, 1997.
Capital expenditures totaled $17.1 million, $9.0 million and $5.4 million
in fiscal 1997, fiscal 1996 and fiscal 1995, respectively. These expenditures
were primarily for manufacturing and test equipment and the expansion of the
Company's manufacturing facilities. SMART anticipates spending an additional
$30.0 million to $35.0 million during fiscal 1998 for the continued growth and
expansion of the Company's manufacturing facilities and related equipment.
SMART has entered into certain capital lease arrangements. The outstanding
principal on these obligations was $1.2 million and $2.7 million at October 31,
1997 and October 31, 1996, respectively. See Note 4 to the Consolidated
Financial Statements.
From time to time, the Company evaluates acquisitions of businesses,
products or technologies that complement its business. Currently, the Company
has no present understandings, commitments or agreements with respect to any
material acquisitions of other businesses, products or technologies. Any such
transactions, if consummated, may use a portion of the Company's working capital
or require the issuance of debt or equity.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's business, financial condition and results of operations can
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,
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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 under
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.
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. See "Item 1.
Business -- Customers, Sales and Marketing."
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 has adversely impacted net sales. Because a substantial portion of the
Company's net sales are attributable to the resale of semiconductor memory
devices, continued price declines 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 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
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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 Micron Electronics, Inc. (a subsidiary of
Micron Technology, Inc.) and 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 may have the ability
to manufacture competitive products at lower costs than the Company as a result
of their higher levels of integration. 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. See "Item 1.
Business -- Competition."
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 loss of a principal customer or the reduction in orders from a
customer due to excess product inventory accumulation by such customer, adverse
changes in the mix of products sold by the Company and the inability to procure
required components. Other factors that may affect the Company's results of
operations in the future 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, delays in the introduction of
new products and enhancements to existing products, and manufacturing
inefficiencies associated with the start up of new product introductions. In
addition, the Company's operating results may 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
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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 has 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 net sales. Because a substantial portion of the Company's
turnkey sales are attributable to the resale of semiconductor devices, a
continued decline in the prices of these components would have a material
adverse effect on the Company's net sales. 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 PC 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 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.
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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.
See "Item 1. Business -- Design, Manufacturing and Test."
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 intends to purchase a new management information system to
replace its existing management information system. The implementation of such a
new system will impact almost all phases of the Company's operations (e.g.,
planning, manufacturing, finance and accounting). Implementation of a new
management information system and transition from the current system to a 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 a 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 a 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.
The Company anticipates that future demand for its products will require
expansion of its current operations and the addition of new production lines in
the future. Specifically, in December 1997, the
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Company relocated its manufacturing operations in Puerto Rico from a 23,000
square foot facility in Arecibo, Puerto Rico into an 83,000 square foot facility
in Aguada, Puerto Rico. The Company's expansion will result in higher operating
expenses. There can be no assurance that the Company can successfully implement
the transition from its old facility to the new facility or that the new
facility's production lines will be efficient or that they will result in an
increase in output. Any delay or unexpected difficulties arising from the
transition 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 in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, 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's existing management information system is not Year
2000 compliant. The Company intends to purchase a new management information
system to replace its existing management information system. The implementation
of such a new system will impact almost all phases of the Company's operations
(e.g., planning, manufacturing, finance and accounting). Implementation of a new
management information system and transition from the current system to a new
system will require substantial financial resources, time and personnel. There
can be no assurance that such a system will be implemented by the year 2000, or
that the Company will not experience problems, delays or unanticipated
additional costs in implementing the new 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. In addition, there can be no assurance
that the Company's customers and suppliers have, or will have management
information systems 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 sales could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Item 1. Business -- Research and Development."
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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.
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 will 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.
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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. While there is currently no material pending intellectual
property litigation involving the Company, 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 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. Any 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 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. The Company has entered
into license agreements in the past regarding certain alleged infringement
claims asserted by third parties. 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
such 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. See "Item 1.
Business -- Intellectual Property."
Risks Associated with Acquisitions
As part of its business strategy, the Company expects to make acquisitions
of, or 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
27
<PAGE> 28
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements and the report of the independent
auditors appear on pages F-1 through F-23 of this report.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not Applicable.
28
<PAGE> 29
PART III
Certain information required by Part III is omitted from this Annual Report
on Form 10-K because the Registrant will file a definitive proxy statement for
its Annual Meeting of Shareholders currently scheduled for March 16, 1998 (the
"Proxy Statement") with the Securities and Exchange Commission within one
hundred twenty (120) days after the end of its fiscal year pursuant to
Regulation 14A, and certain information included in the Proxy Statement is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to the
information in the Registrant's Proxy Statement under the headings "Election of
Directors" and "Other Information -- Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information in the Registrant's Proxy Statement under the headings "Other
Information -- Executive Compensation," "Other Information -- Option Grants in
Last Fiscal Year," and "Other Information -- Aggregate Option Exercises in Last
Fiscal Year and Fiscal Year End Option Values."
ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
information in the Registrant's Proxy Statement under the headings "Information
Concerning Solicitation and Voting -- Record Date and Shares Outstanding" and
"Other Information -- Security Ownership of Certain Beneficial Owners and
Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information in the Registrant's Proxy Statement under the headings "Other
Information -- Compensation Committee Interlocks and Insider Participation" and
"Other Information -- Certain Transactions."
29
<PAGE> 30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements. The following Consolidated Financial Statements of
SMART Modular Technologies, Inc. are filed as part of this report:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants...................................... F-2
Consolidated Balance Sheets as of October 31, 1997 and 1996................... F-3
Consolidated Statements of Income for the Years Ended October 31, 1997, 1996
and 1995.................................................................... F-4
Consolidated Statements of Shareholders' Equity for the Years Ended October
31, 1997, 1996 and 1995..................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended October 31, 1997,
1996 and 1995............................................................... F-6
Notes to Consolidated Financial Statements.................................... F-7
</TABLE>
2. Financial Statement Schedules. The following financial statement
schedules of SMART Modular Technologies, Inc. for the years ended October 31,
1997, 1996 and 1995 are filed as part of this report and should be read in
conjunction with the Consolidated Financial Statements of SMART Modular
Technologies, Inc.:
<TABLE>
<CAPTION>
SCHEDULE PAGE
------------------------------------------------------------------------------ ----
<S> <C>
Report of Independent Public Accountants on Schedule.......................... F-21
Valuation and Qualifying Accounts............................................. F-22
</TABLE>
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or Notes thereto.
3. Exhibits. The following exhibits are filed as part of this report:
<TABLE>
<C> <S>
2.1(1) Agreement and Plan of Reorganization among the Registrant, Apex Data, Inc. and
SMART Acquisition, Inc. dated April 24, 1995
3.1(1) 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.
</TABLE>
30
<PAGE> 31
<TABLE>
<C> <S>
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.
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.
</TABLE>
31
<PAGE> 32
<TABLE>
<C> <S>
10.32(5) Subfeature Note between the Registrant and Wells Fargo Bank, National Association
dated May 29, 1997.
10.33 Lease Contract between the Registrant and The Puerto Rico Industrial Development
Company dated October 9, 1997.
10.34 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.
16.1(1) Letter Regarding Change in Certifying Accountant.
16.2(1) Letter Regarding Change in Certifying Accountant.
16.3(1) Letter Regarding Change in Certifying Accountant.
16.4(1) Letter Regarding Change in Certifying Accountant.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Certified Public Accountants.
24.1 Power of Attorney (included on page 33).
27.1 Financial Data Schedule for the Fiscal Year Ended October 31, 1997.
</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
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.
* 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.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of fiscal
1997.
(c) Exhibits.
See Item 14(a)(3) above.
(d) Financial Statement Schedules.
See Item 14(a)(2) above.
32
<PAGE> 33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
SMART MODULAR TECHNOLOGIES, INC.
By: /s/ AJAY SHAH
------------------------------------
Ajay Shah
President, Chief Executive Officer
and
Chairman of the Board of Directors
Dated: January 29, 1998
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Ajay Shah and David B. Mullin and each of
them singly, as true and lawful attorneys-in-fact and agents with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities to sign any or all amendments to this report on Form
10-K, and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission granting unto
said attorneys-in-fact and agents the full power and authority to do and perform
each and every act and thing requisite and necessary to be done in and about the
foregoing, as full to all intents and purposes as he or she might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or his substitute, may lawfully do or cause to be done by
virtue hereof. Witness our hands on the date set forth below.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------------- ----------------------------------- -----------------
<C> <C> <S>
/s/ AJAY SHAH President, Chief January 29, 1998
- ------------------------------------------------- Executive Officer and
Ajay Shah Chairman of the Board of Directors
(Principal Executive Officer)
/s/ MUKESH PATEL Vice President and January 29, 1998
- ------------------------------------------------- General Manager
Mukesh Patel Memory/Processor
Product Line
and Director
/s/ DAVID B. MULLIN Vice President, January 29, 1998
- ------------------------------------------------- Finance and
David B. Mullin Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ ERIK ANDERSEN Director January 29, 1998
- -------------------------------------------------
Erik Andersen
/s/ TOR R. BRAHAM Director January 29, 1998
- -------------------------------------------------
Tor R. Braham
</TABLE>
33
<PAGE> 34
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS............................................. F-2
CONSOLIDATED BALANCE SHEETS.......................................................... F-3
CONSOLIDATED STATEMENTS OF INCOME.................................................... F-4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY...................................... F-5
CONSOLIDATED STATEMENTS OF CASH FLOWS................................................ F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS........................................... F-7
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE................................. F-21
SCHEDULE II -- Valuation and Qualifying Accounts..................................... F-22
SUPPLEMENTARY CONSOLIDATED FINANCIAL DATA............................................ F-23
</TABLE>
F-1
<PAGE> 35
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To SMART Modular Technologies:
We have audited the accompanying consolidated balance sheets of SMART
Modular Technologies, Inc. (a California Corporation) and subsidiaries as of
October 31, 1997 and 1996, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended October 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of SMART
Modular Technologies, Inc. and subsidiaries as of October 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the three years
in the period ended October 31, 1997 in conformity with generally accepted
accounting principles.
/s/ ARTHUR ANDERSEN LLP
--------------------------------------
ARTHUR ANDERSEN LLP
San Jose, California
November 19, 1997
F-2
<PAGE> 36
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
OCTOBER 31,
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Current Assets:
Cash and cash equivalents............................................ $111,331 $ 52,568
Short-term investments............................................... 38,672 8,494
Accounts receivable, net of allowance for doubtful accounts of $669
and $583, respectively............................................ 95,366 52,806
Related party notes receivable....................................... 8 36
Inventories.......................................................... 39,336 39,001
Deferred income taxes................................................ 5,325 3,848
Prepaid expenses and other........................................... 12,984 1,065
-------- --------
Total current assets......................................... 303,022 157,818
Property and equipment, net............................................ 24,604 13,434
Related party notes receivable, net of current portion................. -- 177
Other.................................................................. 359 756
-------- --------
Total assets................................................. $327,985 $172,185
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable..................................................... $ 73,833 $ 66,206
Accrued bonuses...................................................... 6,761 4,212
Other accrued expenses............................................... 9,001 6,886
Income taxes payable................................................. 7,312 6,190
-------- --------
Total current liabilities.................................... 96,907 83,494
Long-term Liabilities:
Capital lease obligations, net of current portion.................... 234 1,241
Deferred income taxes................................................ 524 831
-------- --------
Total liabilities............................................ 97,665 85,566
-------- --------
Shareholders' Equity:
Common stock, no par value -- Authorized -- 100,000,000 shares
Outstanding -- 42,334,260 and 37,716,326 shares, respectively..... 135,302 37,321
Shareholder notes receivable related to common stock issuances......... (179) (452)
Retained earnings...................................................... 95,197 49,750
-------- --------
Total shareholders' equity................................... 230,320 86,619
-------- --------
Total liabilities and shareholders' equity................... $327,985 $172,185
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 37
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED OCTOBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net sales.................................................. $694,675 $401,774 $274,592
Cost of sales.............................................. 582,515 329,644 224,931
-------- -------- --------
Gross profit............................................... 112,160 72,130 49,661
-------- -------- --------
Operating expenses:
Research and development................................. 8,496 5,933 5,283
Sales, general and administrative........................ 37,163 28,544 23,952
-------- -------- --------
Total operating expenses......................... 45,659 34,477 29,235
-------- -------- --------
Income from operations..................................... 66,501 37,653 20,426
Other income (expense):
Interest expense......................................... (225) (309) (704)
Interest income.......................................... 2,615 2,252 190
Other, net............................................... (26) 295 (1)
-------- -------- --------
Total other income (expense)..................... 2,364 2,238 (515)
Income before provision for income taxes................... 68,865 39,891 19,911
Provision for income taxes................................. 23,418 14,760 7,344
-------- -------- --------
Net income................................................. $ 45,447 $ 25,131 $ 12,567
======== ======== ========
Net income per share....................................... $ 1.04 $ 0.60 $ 0.36
======== ======== ========
Weighted average common and common equivalent shares
outstanding.............................................. 43,892 41,748 35,130
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 38
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK SHAREHOLDER TOTAL
--------------------- NOTES RETAINED SHAREHOLDERS'
SHARES AMOUNT RECEIVABLE EARNINGS EQUITY
---------- -------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, October 31, 1994................ 28,666,010 $ 2,020 $(301) $ 11,946 $ 13,665
Issuance of common stock pursuant to
exercise of stock options........... 540,000 2 -- -- 2
Issuance of common stock pursuant to
exercise of stock purchase rights in
exchange for notes receivable....... 100,000 200 (200) -- --
Net income............................. -- -- -- 12,567 12,567
---------- -------- ----- ------- --------
BALANCE, October 31, 1995................ 29,306,010 2,222 (501) 24,513 26,234
Issuance of common stock pursuant to
acquisition of pooled company....... 736,000 205 (5) 106 306
Issuance of common stock pursuant to
initial public offering............. 6,000,000 32,640 -- -- 32,640
Issuance of common stock pursuant to
exercise of stock options........... 1,627,276 772 -- -- 772
Issuance of common stock............... 47,040 240 -- -- 240
Disqualifying dispositions of stock
options............................. -- 1,242 -- -- 1,242
Repayment of shareholder note
receivable.......................... -- -- 54 -- 54
Net income............................. -- -- -- 25,131 25,131
---------- -------- ----- ------- --------
BALANCE, October 31, 1996................ 37,716,326 37,321 (452) 49,750 86,619
Issuance of common stock pursuant to
secondary public offering........... 2,821,000 86,391 -- -- 86,391
Issuance of common stock pursuant to
exercise of stock options........... 1,729,342 3,909 -- -- 3,909
Issuance of common stock............... 67,592 574 -- -- 574
Disqualifying dispositions of stock
options............................. -- 7,107 -- -- 7,107
Repayment of shareholder note
receivable.......................... -- -- 273 -- 273
Net income............................. -- -- -- 45,447 45,447
---------- -------- ----- ------- --------
BALANCE, October 31, 1997................ 42,334,260 $135,302 $(179) $ 95,197 $ 230,320
========== ======== ===== ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 39
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 31,
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 45,447 $ 25,131 $ 12,567
Adjustments to reconcile net income to net cash provided
by (used in) operating activities --
Depreciation and amortization......................... 5,058 2,182 867
Provision for doubtful accounts....................... 86 140 324
Reserve for inventory obsolescence.................... 1,068 2,135 1,359
Loss (gain) on disposition of equipment............... 24 31 (7)
Change in assets and liabilities --
Increase in accounts and notes receivable........... (42,618) (25,230) (8,912)
Increase in inventories............................. (1,403) (137) (24,107)
Increase in deferred income taxes, net.............. (1,888) (776) (1,729)
(Increase) decrease in prepaid expenses and other... (11,919) 77 (522)
Decrease (increase) in other assets................. 574 (712) (93)
Increase in accounts payable........................ 7,627 15,518 29,265
Increase in income taxes payable.................... 8,229 5,656 1,463
Increase in accrued liabilities..................... 5,568 3,015 478
-------- -------- --------
Net cash provided by operating activities........ 15,853 27,030 10,953
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments available-for-sale.............. (36,712) (8,494) --
Sales of investments available-for-sale.................. 6,534 -- --
Purchases of property and equipment...................... (17,103) (7,652) (2,297)
Proceeds from sales of equipment......................... 851 -- 109
-------- -------- --------
Net cash used in investing activities............ (46,430) (16,146) (2,188)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from lines of credit............................ 8,600 16,521 67,064
Payments on lines of credit.............................. (8,600) (20,087) (66,327)
Payments of capital lease obligations and long-term
debt.................................................. (1,534) (1,461) (1,410)
Proceeds from notes payable.............................. -- -- 495
Payments on notes payable................................ -- -- (595)
Proceeds from sale of common stock....................... 91,257 33,912 2
Expenses related to issuances of common stock............ (383) (260) --
-------- -------- --------
Net cash provided by (used in) financing
activities..................................... 89,340 28,625 (771)
-------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS.................. 58,763 39,509 7,994
CASH AND CASH EQUIVALENTS, beginning of year............... 52,568 13,059 5,065
-------- -------- --------
CASH AND CASH EQUIVALENTS, end of year..................... $111,331 $ 52,568 $ 13,059
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes............................... $ 15,189 $ 9,895 $ 7,854
======== ======== ========
Cash paid for interest................................... $ 225 $ 309 $ 453
======== ======== ========
NON CASH INVESTING AND FINANCING ACTIVITIES:
Property and equipment acquired under capital leases..... $ -- $ 1,322 $ 3,099
======== ======== ========
Tax benefits from employee stock transactions............ $ 7,107 $ 1,242 $ --
======== ======== ========
Issuance of common stock pursuant to acquisition of
pooled company........................................ $ -- $ 306 $ --
======== ======== ========
Issuance of common stock pursuant to notes receivable.... $ -- $ -- $ 200
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 40
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
SMART Modular Technologies, Inc. (the "Company") was incorporated in
California in August 1988. The Company designs, manufactures and markets memory
modules, Flash memory cards, high performance embedded computer modules and
communication card products primarily to the computer, networking and
telecommunications industries. In July 1996, the Company acquired RISQ Modular
Systems, Inc. ("RISQ") (See Note 2). RISQ designs and manufactures embedded
processor modules and products for OEMs in the telecommunications, networking,
industrial control and image processing markets.
On September 11, 1997, the Company completed a secondary public offering of
2,821,000 shares of common stock (including underwriters' over-allotment) at
$32 3/8 per share (as adjusted for the Company's stock split in December
1997 -- See Note 2). Total proceeds to the Company (net of underwriting
discounts and commissions) was approximately $86.4 million.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries after elimination of all intercompany accounts and
transactions.
Business Combinations
On July 31, 1996, a wholly-owned subsidiary of the Company merged with RISQ
Modular Systems, Inc., a California corporation ("RISQ"), which resulted in RISQ
becoming a wholly-owned subsidiary of the Company. The Company acquired RISQ by
issuing 736,000 shares of SMART common stock in exchange for 100% of the
outstanding securities of RISQ. The merger was accounted for as a pooling of
interests. Given the immateriality of this acquisition to the Company's
consolidated financial position and results of operations, RISQ has been
included in the Company's consolidated results of operations as of the beginning
of fiscal 1996 (November 1, 1995) and amounts presented for periods prior to
fiscal 1996 have not been restated to include RISQ's historical results of
operations. RISQ designs and manufactures embedded computer modules and products
in both standard and custom form factors for OEMs in the telecommunications,
networking, industrial control and image processing markets.
Stock Split
In December 1997, the Company consummated a stock split effected as a stock
dividend whereby each issued and outstanding share of the Company's common stock
was converted into two shares of common stock. All share and per share amounts
in the accompanying consolidated financial statements have been retroactively
adjusted to reflect the stock split.
Cash Equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
F-7
<PAGE> 41
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Investments in Debt and Equity Securities
The Company accounts for its investments in debt and equity securities
pursuant to the provisions of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." In accordance with SFAS No. 115, debt securities are classified as
held-to-maturity and recorded at amortized cost when the Company has the
positive intent and ability to hold the securities to maturity. Marketable debt
securities not classified as held-to-maturity are classified as available-
for-sale. Available-for-sale securities are carried at fair value, with
unrealized holding gains and losses reported as a separate component of
shareholders' equity, if significant.
All of the Company's investments are classified as available-for-sale
securities as summarized below (in thousands):
<TABLE>
<CAPTION>
AMORTIZED AGGREGATE UNREALIZED UNREALIZED
COST FAIR VALUE GAINS LOSSES
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
AS OF OCTOBER 31, 1997:
AVAILABLE-FOR-SALE SECURITIES:
Debt securities issued by the states of the United
States and political subdivisions of the
states........................................... $34,772 $ 34,764 $ 5 $(13)
Securities issued by private investment companies
and backed by debts issued by the United States
and states of United States government
agencies......................................... 3,900 3,900 -- --
------- ------- ---- ----
$38,672 $ 38,664 $ 5 $(13)
======= ======= ==== ====
AS OF OCTOBER 31, 1996:
AVAILABLE-FOR-SALE SECURITIES:
Debt securities issued by the states of the United
States and political subdivisions of the
states........................................... $ 4,594 $ 4,595 $ 3 $ (2)
Securities issued by private investment companies
and backed by debts issued by the United States
and states of United States government
agencies......................................... 3,900 3,900 -- --
------- ------- ---- ----
$ 8,494 $ 8,495 $ 3 $ (2)
======= ======= ==== ====
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the estimated useful life of five years. Assets
acquired under capital leases are recorded at the present value of the related
lease obligations and depreciated on a straight-line basis over five years.
Betterments, renewals and extraordinary repairs that extend the life of the
asset are capitalized; other repairs and maintenance are expensed. The cost and
accumulated depreciation applicable to assets retired are removed from the
accounts and any resulting gain or loss on disposition is recognized in income.
F-8
<PAGE> 42
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Property, plant and equipment consists of the following as of October 31,
(in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Computer and office equipment.................................... $ 4,019 $ 1,001
Production machinery and equipment............................... 28,960 16,583
Vehicles......................................................... 60 36
Construction in progress......................................... 306 3
------- -------
Total property and equipment........................... 33,345 17,623
Less: accumulated depreciation and amortization.................. (8,741) (4,189)
------- -------
Property and equipment, net................................. $24,604 $13,434
======= =======
</TABLE>
Included in property and equipment are assets acquired under capital lease
obligations with an original cost of approximately $4,732,000 and $5,024,000 as
of October 31, 1997 and 1996, respectively. Accumulated amortization on the
leased assets was approximately $2,178,000 and $1,651,000 as of October 31, 1997
and 1996, respectively.
Foreign Currency Translation
The functional currency of the Company's subsidiaries is the United States
dollar. Accordingly, all translation gains and losses resulting from
transactions denominated in currencies other than United States dollars are
included in net income. To date the resulting gains and losses have not been
material.
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
Net income per share has been computed using the weighted average number of
shares of common stock, common equivalent shares from convertible preferred
stock using the if converted method at date of issuance and common equivalent
shares from stock options outstanding using the treasury stock method. Pursuant
to certain Securities and Exchange Commission Staff Accounting Bulletins, common
and common equivalent shares issued during the twelve-month period prior to the
Company's initial public offering have been included in the calculation as if
they were outstanding for all periods presented (even if antidilutive using the
treasury stock method and assuming an initial public offering price of $7.50 per
share).
F-9
<PAGE> 43
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In March 1997, the Financial Accounting Standards Board issued Statement
No. 128 ("SFAS No. 128"), "Earnings Per Share," which the Company will be
required to adopt on a retroactive basis in the first quarter of fiscal 1998.
The pro forma effect of SFAS No. 128 is shown in the following table for the
years ended October 31, (shares in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
AS REPORTED:
Net income per share................................ $ 1.04 $ 0.60 $ 0.36
Weighted average common and common equivalent shares
outstanding...................................... 43,892 41,748 35,130
PRO FORMA:
Basic net income per share.......................... $ 1.17 $ 0.69 $ 0.44
Weighted average common shares outstanding.......... 38,894 36,460 28,986
Diluted net income per share........................ $ 1.04 $ 0.60 $ 0.36
Weighted average common and common equivalent shares
outstanding...................................... 43,892 41,748 35,130
</TABLE>
Risks and Uncertainties
Financial instruments which potentially subject the Company to a
concentration of credit risk principally consist of accounts receivable. As of
October 31, 1997, approximately 83% of accounts receivable were concentrated
with four customers. As of October 31, 1996, approximately 70% of accounts
receivable were concentrated with six customers. The Company generally does not
require collateral on accounts receivable as the majority of the Company's
customers are large, well established companies.
The Company is dependent on certain suppliers, including limited and sole
source suppliers, to provide key components used in the Company's products.
Although there are a limited number of manufacturers of such key components,
management believes that other suppliers could provide similar components on
comparable terms. A change in suppliers, however, could cause a delay in
manufacturing and a possible loss of net sales, which would affect operating
results adversely.
A substantial majority of the Company's net sales are 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 in bringing a new product to market could
adversely affect the Company's operating results.
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 as of October 31, (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Raw materials.................................... $22,692 $21,553
Work-in-process.................................. 5,266 9,267
Finished goods................................... 11,378 8,181
------- -------
Total....................................... $39,336 $39,001
======= =======
</TABLE>
Effect of Recent Accounting Pronouncements
In March 1995, the Financial Accounting Standards Board issued SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of."
This statement requires long-lived assets to be evaluated for impairment
whenever events or changes in circumstances indicate that the carrying amount of
F-10
<PAGE> 44
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
an asset may not be recoverable. The Company adopted SFAS No. 121 on November 1,
1996 and its provisions did not have a material effect on the Company's
consolidated results of operations in the year of adoption.
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." The Company adopted the
disclosure provisions of SFAS No. 123 on November 1, 1996 and accordingly, its
provisions will not have an impact on the Company's consolidated results of
operations since the intrinsic value-based method prescribed by APB Opinion No.
25, and also allowed by SFAS No. 123, will continue to be used. See Note 7 to
the Consolidated Financial Statements.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
display of comprehensive income and its individual components. The statement
requires the disclosure of all changes in equity of an enterprise that result
from transactions and other economic events of the period other than
transactions with owners ("comprehensive income"). The Company is required to
adopt the provisions of SFAS No. 130 in the first quarter of fiscal 1999. At
that time, reclassification of financial statements for all periods presented
will be required. The Company does not expect the adoption of SFAS No. 130 to
have a material effect on the Company's consolidated financial statements.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," which
establishes annual and interim reporting standards for an enterprise's business
segments and related disclosures about its products, services, geographic areas
of operations and major customers. The Company is required to adopt the
provisions of SFAS No. 131 beginning with its annual report on Form 10-K for the
fiscal year ended October 31, 1999 and for all subsequent interim periods. The
Company does not expect the adoption of SFAS No. 131 to have a material effect
on the Company's consolidated financial statements.
3. LINES OF CREDIT
In June 1997, the Company entered into an unsecured revolving bank line of
credit agreement which expires in May 1998. Borrowings under this agreement are
limited to $20.0 million and bear interest at either the bank's prime rate
(8.50% at October 31, 1997) or a spread over LIBOR (5.65% at October 31, 1997),
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 October 31,
1997, no borrowings were outstanding under this agreement.
At October 31, 1996, the Company had two revolving line of credit
agreements that expired according to their terms in May 1997. Borrowings under
these agreements were limited to $7.5 million and $12.5 million, respectively,
and had respective interest rates at prime and at 2.6% above the rate for 30-day
commercial paper. Both agreements were secured by substantially all of the
Company's assets and required that the Company maintain specified levels of
tangible net worth and comply with certain other covenants. No borrowings were
outstanding under these agreements as of October 31, 1996.
F-11
<PAGE> 45
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. CAPITAL LEASE OBLIGATIONS
Minimum future lease payments under capital leases as of October 31, 1997
are summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING OCTOBER 31,
------------------------------------------------------------
<S> <C>
1998........................................................ $1,030
1999........................................................ 183
------
Total minimum lease payments........................... 1,213
Less: Amount representing interest (8% to 13%).............. (55)
------
Present value of lease payments............................. 1,158
Less: Current portion....................................... (924)
------
Long-term portion........................................... $ 234
======
</TABLE>
5. COMMITMENTS
The Company leases its current facilities and certain equipment under
noncancelable operating leases that expire at various dates through fiscal 2007.
Under the terms of the facilities leases, the Company is responsible for
utilities, maintenance, insurance and property taxes. As of October 31, 1997,
the future minimum lease payments are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDING OCTOBER 31,
------------------------------------------------------------
<S> <C>
1998........................................................ $ 997
1999........................................................ 1,122
2000........................................................ 1,119
2001........................................................ 1,179
2002........................................................ 1,190
Thereafter.................................................. 1,910
------
$7,517
======
</TABLE>
Rental expense was approximately $1,417,000, $1,025,000 and $539,000 for
the years ended October 31, 1997, 1996 and 1995, respectively.
6. PROFIT SHARING AND 401(k) PLANS
The Company has a profit sharing plan (the "Plan") which generally covers
all employees of the Company who are over 21 years of age and have worked for
the Company for at least one year. Annual contributions to the Plan are
discretionary, as determined by the Board of Directors. Contributions vest at a
rate of 20% per year beginning with an individual's third year with the Company.
There were no contributions to the Plan for the fiscal years ended October 31,
1997 and 1996. Contribution to the Plan for the fiscal year ended October 31,
1995 was approximately $100,000.
Effective November 1, 1993, the Company established a 401(k) Plan. The
401(k) Plan covers all employees of the Company who are over 21 years of age and
have worked for the Company for at least 90 days. Annual Company contributions
are discretionary, as determined by the Board of Directors and are based on the
Company's annual performance. Contributions vest at a rate of 20% per year
beginning with an individual's second year with the Company. Employer
contributions to the 401(k) Plan for the years ended October 31, 1997, 1996 and
1995 were approximately $86,000, $50,000 and $25,000, respectively.
F-12
<PAGE> 46
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY
Preferred Stock
The Board of Directors has the authority to issue up to 15,000,000 shares
of preferred stock in one or more series and to fix the number of shares of any
series and to determine or alter the rights, preferences, privileges,
restrictions and designation granted to or imposed upon any wholly unissued
series of preferred stock, without any further vote or action by the
shareholders.
Stock Plans
The Company has four stock plans, the 1989 Incentive Stock Plan, (the "1989
Stock Plan"), the 1995 Stock Plan (the "1995 Stock Plan"), the 1995 Director
Option Plan (the "Director Plan") and the Employee Stock Purchase Plan (the
"Purchase Plan"). The Company accounts for these plans under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Pursuant to the provisions of APB
No. 25, no compensation cost has been recognized by the Company related to
option grants issued under any of its stock plans. Under SFAS No. 123,
"Accounting for Stock-Based Compensation," the Company is required to calculate
compensation cost related to option grants issued to employees subsequent to
October 31, 1995 and present the pro forma effect of this expense on net income
and net income per share. Accordingly, since no options were granted under the
1989 Stock Plan subsequent to October 31, 1995, the Company is not required to
disclose the pro forma effect of compensation expense related to option grants
issued under the 1989 Stock Plan.
Had compensation cost been charged to the Company pursuant to the
provisions of SFAS No. 123 for option grants issued under its remaining plans,
the Company's net income and net income per share would have been adjusted to
the following pro forma amounts for the years ended October 31, (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Net Income:
As reported............................................ $45,447 $25,131
Pro forma.............................................. $44,351 $24,614
Net Income Per Share:
As reported............................................ $ 1.04 $ 0.60
Pro forma.............................................. $ 1.01 $ 0.59
</TABLE>
Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to November 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
1989 Incentive Stock Plan
Under the 1989 Stock Plan, the Board of Directors may grant incentive stock
options to employees and nonstatutory stock options and stock purchase rights to
employees, directors and consultants. Stock purchase rights are rights, other
than stock options, to purchase common stock pursuant to the 1989 Stock Plan.
The exercise price for an incentive stock option cannot be less than the fair
market value on the date of grant. The exercise price per share of nonstatutory
stock options granted under the 1989 Stock Plan cannot be less than 85% of the
fair market value on the date of grant. As of October 31, 1997, a total of
13,540,000 shares of common stock have been authorized by the Company's Board of
Directors and shareholders for grant under the 1989 Stock Plan.
F-13
<PAGE> 47
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Under the 1989 Stock Plan, in the event of the termination of a purchaser's
continuous status as an employee or consultant, the Company has the right to
repurchase, at the original purchase price, any unvested stock granted under a
stock purchase right.
The 1989 Stock Plan grants the Board of Directors the discretion to
determine when the stock purchase rights and options granted thereunder shall
become exercisable. The majority of the options vest at the rate of 1/36th per
month. In addition, under the 1989 Stock Plan, all unvested stock options are
exercisable at any time in whole or in part provided that the optionee executes
a purchase agreement that grants the Company repurchase rights similar to those
described above. In October 1995, the Board of Directors suspended the issuance
of further grants under the 1989 Stock Plan.
Stock option and purchase right activity under the 1989 Stock Plan is as
follows:
<TABLE>
<CAPTION>
STOCK OPTIONS AND PURCHASE
RIGHTS OUTSTANDING
SHARES ---------------------------
AVAILABLE NUMBER PRICE
FOR GRANT OF SHARES PER SHARE
---------- ---------- ------------
<S> <C> <C> <C>
BALANCE, October 31, 1994............................ 2,189,968 4,810,032 $.004-$1.88
Authorized......................................... 3,540,000 -- --
Granted............................................ (3,044,380) 3,044,380 $1.50-$4.00
Exercised / Canceled/ Forfeited.................... 9,766 (651,132) $.004-$2.00
---------- ---------- ------------
BALANCE, October 31, 1995............................ 2,695,354 7,203,280 $.008-$4.00
Exercised / Canceled/ Forfeited.................... 65,294 (1,692,570) $.008-$3.50
---------- ---------- ------------
BALANCE, October 31, 1996............................ 2,760,648 5,510,710 $0.01-$4.00
Exercised / Canceled/ Forfeited.................... 62,138 (1,520,186) $0.01-$4.00
---------- ---------- ------------
BALANCE, October 31, 1997............................ 2,822,786 3,990,524 $0.01-$4.00
========= ========= ===========
</TABLE>
As of October 31, 1997, 3,719,682 shares underlying the outstanding options
and purchase rights were vested.
1995 Stock Plan
On October 3, 1995, the Company's Board of Directors adopted and its
shareholders approved the 1995 Stock Plan to be effective as of the date of the
Company's initial public offering (November 17, 1995). The 1995 Stock Plan
provides for the granting to employees (including officers and employee
directors) of incentive stock options and for the granting to employees
(including officers and employee directors) and consultants of nonstatutory
stock options and stock purchase rights ("SPRs"). Unless terminated sooner, the
1995 Stock Plan will terminate automatically in October 2005. A total of
6,000,000 shares of common stock are reserved for issuance under the 1995 Stock
Plan.
The exercise price of all nonstatutory stock options and SPRs granted under
the 1995 Stock Plan will be determined by the 1995 Stock Plan administrator.
With respect to any participant who owns stock possessing more than 10% of the
voting power of all classes of the Company's outstanding capital stock (a "10%
Shareholder"), the exercise price of any incentive stock option granted must
equal at least 110% of the fair market value on the date of grant. The exercise
price of incentive stock options for all other employees will be no less than
100% of the fair market value per share on the date of grant. The maximum term
of an option granted under the 1995 Stock Option Plan will not exceed ten years
from the date of grant (five years in the case of an incentive stock option
granted to a 10% Shareholder).
F-14
<PAGE> 48
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock option activity under the 1995 Stock Plan is as follows:
<TABLE>
<CAPTION>
STOCK OPTIONS OUTSTANDING
------------------------------------------------
SHARES WEIGHTED AVG.
AVAILABLE NUMBER PRICE EXERCISE
FOR GRANT OF SHARES PER SHARE PRICE
---------- --------- ---------------- -------------
<S> <C> <C> <C> <C>
BALANCE, October 31, 1995........ -- -- -- --
Authorized..................... 6,000,000 -- -- --
Granted........................ (1,285,200) 1,285,200 $5.125 - $ 7.688 $ 7.4766
Exercised...................... -- -- -- --
Canceled/Forfeited............. 52,044 (52,044) $7.625 - $ 7.625 $ 7.6250
---------- --------- -------------- ---------
BALANCE, October 31, 1996........ 4,766,844 1,233,156 $5.125 - $ 7.688 $ 7.4699
Granted........................ (1,206,440) 1,206,440 $9.688 - $ 20.50 $ 14.370
Exercised...................... -- (271,294) $5.125 - $17.125 $ 7.7609
Canceled/Forfeited............. 161,502 (161,502) $7.50 - $17.125 $ 8.7410
---------- --------- -------------- ---------
BALANCE, October 31, 1997........ 3,721,906 2,006,800 $5.125 - $20.50 $ 11.5028
========== ========= ============== =========
</TABLE>
The following table summarizes information about stock options outstanding
under the 1995 Stock Plan as of October 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- -----------------------------
WEIGHTED AVG. WEIGHTED AVG. WEIGHTED AVG.
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ---------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$ 5.00 - $10.00 1,186,710 8.7 $ 8.09 247,682 $ 7.68
$10.01 - $20.00 738,890 9.1 $ 15.99 52,697 $ 16.72
$20.50 81,200 9.9 $ 20.50 -- --
--------- -------
2,006,800 8.9 $ 11.50 300,379 $ 9.27
========= =======
</TABLE>
The per share weighted average fair value of options granted under the 1995
Stock Plan in fiscal 1997 and fiscal 1996 is $9.67 and $5.27, respectively. The
fair value of each option granted is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions used for
grants in fiscal 1997 and fiscal 1996, respectively: average risk-free interest
rates of 6.20% and 6.04%; expected dividend yield of 0.0% in both fiscal years;
expected lives of 5 years in both fiscal years; and expected volatility of 78.0%
and 83.5%.
1995 Director Option Plan
Non-employee directors are entitled to participate in the Director Plan.
The Director Plan has a term of ten years, unless terminated sooner by the Board
of Directors. A total of 200,000 shares of common stock are reserved for
issuance under the Director Plan.
The Director Plan provides that each non-employee director who first
becomes a non-employee director on or after the date of the Company's initial
public offering (November 17, 1995) will be automatically granted an option to
purchase 24,000 shares of common stock (the "First Option") on the date on which
the person first becomes a non-employee director, unless immediately prior to
becoming a non-employee director, such person was a director of the Company.
Beginning November 1, 1996, each non-employee director will be automatically
granted an option to purchase 7,200 shares (a "Subsequent Option") on November 1
of each year provided they are then a non-employee director and, provided
further, that on such date he or she has served on the Board of Directors for at
least the preceding six months. Each First Option and each Subsequent Option
shall have a term of ten years and the shares subject to the option shall vest
as to 1/36th of the shares at the end of each month after the date of grant,
provided that the optionee continues to serve as a director on
F-15
<PAGE> 49
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
such dates. The exercise prices of the First Option and each Subsequent Option
shall be 100% of the fair market value per share of the common stock on the date
of grant of the option.
Stock option activity under the 1995 Director Plan is as follows:
<TABLE>
<CAPTION>
STOCK OPTIONS OUTSTANDING
-----------------------------------------
SHARES WEIGHTED AVG.
AVAILABLE NUMBER PRICE EXERCISE
FOR GRANT OF SHARES PER SHARE PRICE
--------- --------- --------- -------------
<S> <C> <C> <C> <C>
BALANCE, October 31, 1995............ -- -- -- --
Authorized......................... 200,000 -- -- --
Granted............................ -- -- -- --
------- ------ -------- --------
BALANCE, October 31, 1996............ 200,000 -- -- --
Granted............................ (14,400) 14,400 $ 10.5625 $ 10.5625
Exercised.......................... -- -- -- --
Canceled/Forfeited................. -- -- -- --
------- ------ -------- --------
BALANCE, October 31, 1997............ 185,600 14,400 $ 10.5625 $ 10.5625
======= ====== ======== ========
</TABLE>
The following table summarizes information about stock options outstanding
under the Director Plan as of October 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- -----------------------------
WEIGHTED AVG. WEIGHTED AVG. WEIGHTED AVG.
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ---------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$10.5625 14,400 9.0 $ 10.5625 4,400 $ 10.5625
</TABLE>
The weighted average fair value of options granted under the Director Plan
in fiscal 1997 is $7.12 per share. There were no grants in fiscal 1996. The fair
value of each option granted is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions used for the
1997 grants: risk-free interest rate of 6.13%; expected dividend yield of 0.0%;
expected life of 5 years; and expected volatility of 78%.
Employee Stock Purchase Plan
On October 3, 1995, the Company's Board of Directors adopted and its
shareholders approved the Purchase Plan to be effective as of the date of the
Company's initial public offering (November 17, 1995). A total of 1,000,000
shares of common stock are reserved for issuance under the Purchase Plan. The
Purchase Plan permits eligible employees of the Company to purchase common stock
through payroll deductions of up to 15% of their compensation (excluding
payments for overtime, shift premium, incentive compensation, incentive
payments, bonuses and other compensation), up to a maximum of $21,250 for all
purchase periods ending within any calendar year.
The price of common stock purchased under the Purchase Plan will be 85% of
the lower of the fair market value of the common stock on the first or last day
of each six-month purchase period. Employees may end their participation in the
Purchase Plan at any time during an offering period, upon which time, any
payroll deductions not used to purchase Company stock will be refunded.
Participation ends automatically upon termination of employment with the
Company.
Employees are eligible to participate if they are customarily employed by
the Company or any designated subsidiary for at least 20 hours per week and for
more than five months in any calendar year. The Purchase Plan will terminate in
October 2005. For the year ended October 31, 1997, a total of 67,592 shares of
the Company's common stock were issued under the Purchase Plan at an approximate
average of $8.50 per share. For the year ended October 31, 1996, a total of
47,040 shares of the Company's common stock were issued
F-16
<PAGE> 50
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
under the Purchase Plan at $5.10 per share. The per share weighted average fair
value of shares sold in fiscal 1997 and fiscal 1996 was $3.41 and $2.12,
respectively. At October 31, 1997, 885,368 shares remained available for sale
under the Purchase Plan.
8. INCOME TAXES
Effective November 1, 1993, the Company adopted the provisions of SFAS No.
109 "Accounting for Income Taxes." SFAS No. 109 provides for an asset and
liability approach to accounting for income taxes under which deferred income
taxes are provided based upon enacted tax laws and rates applicable to the
periods in which taxes become payable.
Pre-tax income from continuing operations for the years ended October 31
was taxed in the following jurisdictions (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Domestic.......................................... $64,839 $39,991 $19,911
Foreign........................................... 4,026 (100) --
------- ------- -------
$68,865 $39,891 $19,911
======= ======= =======
</TABLE>
The provision for income taxes consisted of the following components as of
October 31, (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Current:
Federal......................................... $19,122 $14,178 $ 7,251
State........................................... 6,184 3,598 1,882
------- ------- -------
Total current........................... 25,306 17,776 9,133
------- ------- -------
Deferred (prepaid):
Federal......................................... (1,600) (2,526) (1,368)
State........................................... (288) (490) (421)
------- ------- -------
Total deferred (prepaid), net........... (1,888) (3,016) (1,789)
------- ------- -------
Total provision for income taxes........ $23,418 $14,760 $ 7,344
======= ======= =======
</TABLE>
The provision for income taxes differs from the amount computed by applying
the statutory Federal income tax rates as follows as of October 31, (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Provision computed at Federal statutory rate....... $24,103 $13,962 $6,971
State income taxes, net of Federal benefit......... 2,204 2,513 1,203
Foreign taxes provided for at rates other than U.S.
statutory rate................................... (3,374) -- --
Tax credits........................................ (1,239) (1,795) (646)
Tax exempt interest income......................... (482) (798) --
FSC benefit........................................ (550) (598) --
Other.............................................. 2,756 1,476 (184)
------- ------- ------
Total provision for income taxes......... $23,418 $14,760 $7,344
======= ======= ======
</TABLE>
F-17
<PAGE> 51
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The major components of the deferred tax asset and liability are as follows
as of October 31, (in thousands):
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Inventory reserves........................................... $1,721 $1,565
Bad debt reserves............................................ 234 239
Accrued vacation............................................. 342 404
Warranty reserves............................................ 912 308
State taxes.................................................. 1,024 653
Net operating loss carryforward.............................. 679 679
Other temporary differences.................................. 413 --
------ ------
Total deferred tax assets.......................... $5,325 $3,848
====== ======
Deferred tax liabilities -- depreciation..................... $ (524) $ (831)
------ ------
Total deferred tax liabilities..................... $ (524) $ (831)
====== ======
</TABLE>
Net operating loss and tax credit carryforwards, all of which resulted from
the acquisition of Apex Data, Inc., a Delaware corporation ("Apex"), expire at
various dates through 2010. In accordance with certain provisions of the
Internal Revenue Code, a change in ownership of greater than 50% within a three
year period results in an annual limitation of the Company's ability to utilize
its net operating loss carryforwards from tax periods prior to the ownership
change. Accordingly, utilization of net operating loss carryforwards of
approximately $1,770,000 for Federal income tax purposes and $996,000 for state
income tax purposes are subject to this annual limitation. Realization is
dependent on generating sufficient taxable income prior to the expiration of the
loss carryforwards. Although realization is not assured, management believes it
is more likely than not that all the deferred tax asset will be realized. The
amount of the deferred tax asset considered realizable, however, could be
reduced in the near term if estimates of future taxable income during the
carryforward period are reduced.
9. RELATED PARTY TRANSACTIONS
Research and Development Funding
In July 1994, the Company paid $30,000 for a warrant to purchase 2,000,000
shares of Series A preferred stock of a company in which certain shareholders of
the Company and members of its Board of Directors had concurrently purchased a
combined 42.8% interest in the affiliate's common stock. The Company has the
right to exercise the warrant until January 29, 2000 at $0.05 per warrant share.
The Company also entered into a license and supply agreement with the affiliate,
whereby the affiliate agreed to supply the Company with 100% of the Company's
requirements for certain of the affiliate's product, and the Company agreed to
purchase 100% of such requirements from the affiliate. In addition, the
affiliate granted to the Company certain license and trademark rights, with
respect to the use and modification of the affiliate's product. In exchange, the
Company agreed to provide research and development funding to the affiliate in
an aggregate amount of $750,000. Prior to fiscal 1996, all agreed upon funding
had been paid in full to the affiliate. The license portion of the agreement has
no expiration date. All other provisions of the agreement shall continue in
effect for a period of 15 years.
In January 1996, the Company and the affiliate entered into an agreement
whereby the Company paid an additional $80,000 for a warrant to purchase
2,000,000 shares of Series B preferred stock of the affiliate. The Company has
the right to exercise the warrant for a period of up to 48 months after the date
of issuance at $0.15 per warrant share. The Company and the affiliate also
entered into a license and supply agreement similar to that described above but
covering different intellectual property. In exchange, the Company provided
research and development funding to the affiliate totaling $500,000. The license
portion of the
F-18
<PAGE> 52
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
agreement has no expiration date. All other provisions of the agreement will
continue in effect for a period of 15 years. Concurrently with the Company's
purchase of the warrant, certain shareholders of the Company and members of its
Board of Directors purchased additional common stock of the affiliate, which
increased their interest to 50.0% of the affiliate.
In April 1996, certain shareholders of the Company and members of its Board
of Directors purchased additional common stock of the affiliate from other
shareholders of the affiliate. Currently, certain shareholders of the Company
and members of its Board of Directors have a 50.4% interest in the affiliate.
During fiscal 1997, the Company paid approximately $235,500 to the
affiliate for its products. As of October 31, 1997, the affiliate owed the
Company approximately $7,600 on a note bearing interest at 10% per annum and
payable in full by April 1998.
Note Receivable from Shareholder
On November 15, 1993, a former officer of the Company borrowed $146,250
from the Company. The debt arose from the issuance and sale of shares of the
common stock of Apex to the officer prior to the acquisition of Apex. The loan,
which is unsecured, bears interest at a rate of 6.5% per annum, and is payable
in annual interest-only installments through November 15, 1998, when the
principal balance is due in full. As of October 31, 1997, the officer owed the
Company approximately $71,500 under this loan.
Stock Purchase Right
On June 30, 1995, pursuant to a stock purchase right granted under the 1989
Stock Plan, the Company sold 100,000 shares of common stock to a director for
$200,000. In consideration, the director executed a full recourse promissory
note secured by the 100,000 shares of common stock for a like amount. The note
bears interest at 6.27% compounded semiannually and is due in full on June 30,
1998. As of October 31, 1997, approximately $107,200 was outstanding under the
note. Portions of this stock is subject to repurchase by the Company, at the
original purchase price per share, upon the director's cessation of service
prior to vesting of such shares. The shares vest as to 1/36th of the shares at
the end of each month after the date of purchase, provided that the director
continues to serve as a director on such dates.
Stock Option Grant
On August 31, 1995, pursuant to the 1989 Stock Plan, the Company granted a
nonstatutory stock option exercisable for 60,000 shares of common stock to one
of the Company's directors. The stock option exercise price is $3.50 per share
and vests at the rate of 1/36th of the shares on the first day of each calendar
month.
10. EXPORT SALES, SIGNIFICANT CUSTOMERS AND GEOGRAPHIC DATA:
The Company operates in a single industry segment. The Company markets its
products in the United States (which includes Puerto Rico) and in foreign
countries through its sales personnel, independent sales representatives and
distributors. The Company's geographic sales as a percent of net sales are as
follows for the years ended October 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
United States....................................... 82% 92% 86%
International....................................... 18 8 14
--- --- ---
Total..................................... 100% 100% 100%
=== === ===
</TABLE>
F-19
<PAGE> 53
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A relatively small number of customers have accounted for a significant
percentage of the Company's net sales. Sales to major customers as a percentage
of net sales are as follows for the years ended October 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Compaq Computer Corporation............................. 53% * *
Cisco Systems, Inc...................................... 12% 19% 18%
Hewlett-Packard Company................................. 11% 15% 10%
IBM Corporation......................................... * 12% 15%
</TABLE>
- ---------------
* Less than 10%
The Company's operations by geographic area for each of the two years in
the period ended October 31, 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
ADJUSTMENTS
UNITED UNITED AND
STATES KINGDOM ELIMINATIONS CONSOLIDATED
-------- ------- ------------ ------------
<S> <C> <C> <C> <C>
1997
Revenues:
Customers........................ $595,942 $98,733 $ -- $694,675
Intercompany..................... 19,262 -- (19,262) --
-------- ------- -------- --------
$615,204 $98,733 $(19,262) $694,675
======== ======= ======== ========
Income from operations................ $ 61,101 $ 5,398 $ 2 $ 66,501
======== ======= ======== ========
Total identifiable assets............. $269,121 $58,941 $ (77) $327,985
======== ======= ======== ========
1996
Revenues:
Customers........................ $397,237 $ 4,537 $ -- $401,774
Intercompany..................... 7,694 -- (7,694) --
-------- ------- -------- --------
$404,931 $ 4,537 $ (7,694) $401,774
======== ======= ======== ========
Income (loss) from operations....... $ 37,945 $ (279) $ (13) $ 37,653
======== ======= ======== ========
Total identifiable assets... $165,310 $ 6,936 $ (61) $172,185
======== ======= ======== ========
</TABLE>
Intercompany sales and transfers are accounted for based on established
intercompany sales prices. The United Kingdom subsidiary was not material to the
Company's fiscal 1995 consolidated results of operations.
F-20
<PAGE> 54
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements of SMART Modular Technologies, Inc. and
subsidiaries included in this Form 10-K and have issued our report thereon dated
November 19, 1997. Our audits were made for the purpose of forming an opinion on
the basic consolidated financial statements taken as a whole. The schedule
listed under Item 14 is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic consolidated financial statements and, in our opinion, fairly states
in all material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
--------------------------------------
ARTHUR ANDERSEN LLP
San Jose, California
November 19, 1997
F-21
<PAGE> 55
SCHEDULE II
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF YEAR EXPENSES DEDUCTIONS OF YEAR
- ------------------------------------------------------- ----------- ----------- ---------- --------
<S> <C> <C> <C> <C>
Year ended October 31, 1995
Allowance for doubtful accounts...................... $ 119 $ 343 $ (19) $443
Allowance for future returns......................... $ 68 $ -- $ -- $ 68
Year ended October 31, 1996
Allowance for doubtful accounts...................... $ 443 $ 349 $ (209) $583
Allowance for future returns......................... $ 68 $ 75 $ -- $143
Year ended October 31, 1997
Allowance for doubtful accounts...................... $ 583 $ 207 $ (121) $669
Allowance for future returns......................... $ 143 $ -- $ -- $143
</TABLE>
F-22
<PAGE> 56
SMART MODULAR TECHNOLOGIES, INC. AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATED FINANCIAL DATA
QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31, 1997
-----------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Sales..................................... $131,612 $143,652 $201,923 $217,488
Gross Profit.................................. 22,631 24,141 30,876 34,512
Net Income.................................... 8,710 9,468 12,452 14,817
Net Income Per Share.......................... $ 0.21 $ 0.22 $ 0.28 $ 0.33
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31, 1996
-----------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Sales..................................... $ 90,317 $104,116 $101,048 $106,293
Gross Profit.................................. 16,538 17,889 18,320 19,383
Net Income.................................... 5,445 5,958 6,621 7,107
Net Income Per Share.......................... $ 0.13 $ 0.14 $ 0.16 $ 0.17
</TABLE>
F-23
<PAGE> 57
SMART MODULAR TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED OCTOBER 31, 1997
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(1) 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.
</TABLE>
<PAGE> 58
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
------- -----------------------------------------------------------------------------
<C> <S>
*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.
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 Lease Contract between the Registrant and The Puerto Rico Industrial
Development Company dated October 9, 1997.
10.34 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.
16.1(1) Letter Regarding Change in Certifying Accountant.
16.2(1) Letter Regarding Change in Certifying Accountant.
16.3(1) Letter Regarding Change in Certifying Accountant.
</TABLE>
<PAGE> 59
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
------- -----------------------------------------------------------------------------
<C> <S>
16.4(1) Letter Regarding Change in Certifying Accountant.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Independent Certified Public Accountants.
24.1 Power of Attorney (included on page 33).
27.1 Financial Data Schedule for the Fiscal Year Ended October 31, 1997.
</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
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.
* 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.
<PAGE> 1
PUERTO RICO INDUSTRIAL DEVELOPMENT COMPANY
PO BOX 362350
SAN JUAN, PUERTO RICO 00936-2350
LEASE CONTRACT
PROJECTS NO.: T-0870-0-68 and extensions and Lot No. L-253-2-77-11-0
LOCATION: AGUADA, PUERTO RICO
THIS AGREEMENT ENTERED into on October 9, 1997 by: AS "LANDLORD", THE
PUERTO RICO INDUSTRIAL DEVELOPMENT COMPANY, AND AS "TENANT", SMART MODULAR
TECHNOLOGIES (P.R.), INC.
WITNESSETH
WHEREAS, LANDLORD is the owner of certain land-site and building,
identified in the Epigraph, hereinafter referred to as the Premises.
WHEREAS, LANDLORD has agreed to lease to TENANT, and TENANT has agreed
to lease from LANDLORD the Premises. NOW THEREFORE, in consideration of the
foregoing premises, the parties herein agree on this Lease subject to the
following:
TERMS AND CONDITIONS
ONE: LANDLORD hereby demises and lets unto TENANT, and TENANT hereby
leases from LANDLORD the premises which are fully described in SCHEDULE "A"
hereto annexed and made a part hereof. The Premises are subject to the
encumbrances, liens and/or restrictions, if any, that may appear from said
Schedule "A". Furthermore, the air rights of the Premises, are excepted and
reserved to LANDLORD. The Building consists of approximately 83,018.13 square
feet and the lot to be used for parking consists of approximately 11,615.92
square meters, with existing improvements.
TWO: Premises shall be used and occupied exclusively in the
manufacture of MEMORY MODULES, EMBEDDED COMPUTER MODULES, COMMUNICATIONS
PRODUCTS AND/OR SUCH OTHER ELECTRONICS PRODUCTS AS THE TENANT MAY DECIDE TO
MANUFACTURE IN PUERTO RICO.
THREE: TENANT shall hold the Premises for a period of TEN (10) years
commencing the first day of the month following the obtention of the
corresponding ARPE permits, but not later than DECEMBER 31, 1997.
FOUR: TENANT shall pay to LANDLORD an annual rental as follows:
$2.20 PER SQ. FT. MONTHLY FOR THE FIRST FIVE (5) YEARS
$2.75 PER SQ. FT. MONTHLY FOR THE SECOND FIVE (5) YEARS
During the first year TENANT will pay rent on the basis of 60,000 sq.
ft. Thereafter, TENANT will pay rent for said 60,000 sq. ft. and any space in
excess of 60,000 sq. ft. actually utilized, nevertheless TENANT shall start
paying rent for the entire space of approximately 83,018.13 sq. ft., not later
than three (3) years from the date of this lease contract. TENANT shall notify
LANDLORD thirty (30) days prior to the end of each quarter, the space that it
is presently occupying, so that the rent for the following months can be
appropriately adjusted.
Parking Lot Rent - $1,000.00 monthly throughout the term of the Lease.
The monthly installments for rent specified herein, shall be paid in
advance on the first day of each month at LANDLORD'S office, or at any other
place that LANDLORD may notify. In the event that the date of commencement does
not fall on the first of the month, TENANT further agrees to pay the first
partial monthly installments, prior to, or on the date of commencement.
<PAGE> 2
2
FIVE: TENANT shall deposit in certified check, simultaneously with the
execution of this Lease, the amount of $15,840.
This deposit shall guarantee the compliance by TENANT of its obligations,
under this Contract, particularly, but not limited to, the payment of rent,
the compliance of the environmental clauses herein included and the return of
the Premises in proper condition at the termination of this Lease. On said
termination, if TENANT is not in default of any of the terms and conditions of
this Contract, LANDLORD will return to TENANT the sum of money, if any, held
pursuant to this provision, after LANDLORD's Environmental Office certifies
that there are no environmental deficiencies as a result of TENANT's
manufacturing operation on the demised Premises.
SIX: TENANT agrees to have on the date of commencement of the term of
this Lease a capitalization of $5.7 million. Likewise TENANT agrees to install
within TWENTY FOUR (24) months from the same date, manufacturing machinery and
equipment with a value of at least $15 million. In other words, TENANT shall
increase its present investment of $5.7 millions so that its total investment
in machinery and equipment shall be $15 million. It is understood that TENANT
may require a period of up to twelve (12) additional months and LANDLORD will
grant the extension, if so requested.
This shall not include the cost of transportation and installation
thereof, nor its ordinary depreciation after installation; and within
TWENTY FOUR (24) months from the date of commencement of the term, increase
its employment from 125 to 525. It is understood that TENANT may require a
period of up to TWELVE (12) additional months and LANDLORD will grant the
extension, if so requested.
The aforementioned levels of capitalization, machinery and equipment and
employment herein required shall be maintained throughout the term of this
Lease or any extension thereof.
SEVEN: All notices, demands, approvals, consents and/or communications
herein required or permitted shall be in writing. If by mail should be
certified and to the following addresses: To LANDLORD: P.O. BOX 362350, SAN
JUAN, PUERTO RICO 00936-2350. To TENANT: MR. DAVID B. MULLIN, SMART MODULAR
TECHNOLOGIES, INC., 4305 CUSHING PARKWAY, FREMONT, CALIFORNIA 94538.
EIGHT: NET LEASE -- This Lease shall be interpreted as a net lease; it
being the exclusive responsibility of TENANT to pay for all operating expenses,
utilities, maintenance, expenses, insurance, taxes or any; other costs,
expenses or charges of any nature not specifically assumed by LANDLORD
hereunder.
NINE: WARRANTY AS TO USE -- LANDLORD does hereby warrant that at the time
of the commencement of the term of this Lease, the Premises may be used by
TENANT for the manufacturing purposes herein intended which are deemed
consistent with the design and construction in accordance with the
corresponding plans and specifications.
TEN: ALTERATIONS -- TENANT shall make no alterations, additions or
improvements to the Premises without the prior consent of LANDLORD and all such
alterations, additions or improvements made by or for
<PAGE> 3
3
TENANT, shall be at TENANT'S own cost and expenses and shall, when made, be the
property of LANDLORD without additional consideration and shall remain upon and
be surrendered with the Premises as a part thereof at the expiration or
earlier termination of this Lease, subject to any right of LANDLORD to require
removal or to remove as provided for hereinafter.
In the event TENANT asks for LANDLORD'S consent for any alteration;
LANDLORD may at its option, require from TENANT to submit plans and
specifications for said alteration. Before commencing any such work, said plans
and specifications, if required, shall be filed with and approved by all
governmental agencies having jurisdiction thereof, and the consent of any
mortgagee having any interest in or lien upon this Lease shall be procured by
TENANT and delivered to LANDLORD if required by the term of the mortgage.
Before commencing any such work, TENANT shall at TENANT'S own cost and
expense, deliver to LANDLORD a General Accident Liability Policy more
particularly described in Article THIRTY (30) hereof, but said policy shall
recite and refer to such work, and in addition thereto, if the estimated cost
of such work is more than FIVE THOUSAND DOLLARS ($5,000.00), TENANT shall, at
TENANT'S own cost and expense, deliver to LANDLORD a surety bond, or a
performance bond from a company acceptable to LANDLORD, or a similar bond or
other security satisfactory to LANDLORD, in an amount equal to the estimated
cost of such work, guaranteeing the completion of such work within a reasonable
time, due regard being had to conditions, free and clear of materialmen liens,
mechanics liens or any other kind of lien, encumbrances, chattel mortgages and
conditional bills of sale and in accordance with said plans and specifications
submitted to and approved by LANDLORD. At LANDLORD'S option TENANT shall
provide a blanket written guarantee in an amount sufficient to satisfy LANDLORD
as to all alterations, changes, additions and improvements to the Premises in
lieu of separate guarantee for each such project.
TENANT shall pay the increased premium, if any, charged by the insurance
companies carrying insurance policies on said building, to cover the additional
risk during the course of such work.
ELEVEN: POWER SUBSTATION - If required by TENANT'S operations, TENANT
shall, at its own cost and expense, construct and/or install a power substation
and connect it to the PUERTO RICO ELECTRICAL POWER AUTHORITY (PREPA)
distribution lines, for voltages up to 13.2 KV; and to PREPA transmission lines
for voltages of 38 KV, all in conformity to PREPA's requirements. Such
construction shall, in no event, be undertaken by TENANT until after LANDLORD
has approved the location thereof, as well as the routing of the power line
extension.
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TWELVE: Repairs and Maintenance - TENANT shall, at its own cost and
expense, put, keep and maintain in thorough repair and good order and safe
condition the building and improvements standing upon the Premises at the
commencement of the term hereon or thereafter erected upon the premises, or
forming part of the Premises, and their full equipment and appurtenances, the
side walks areas, sidewalk hoists, railings, gutters, curbs and the like in
from of the adjacent to the Premises, and each and every part thereof, both
inside and outside, extraordinary and ordinary, and shall repair the whole and
each and every part thereof in order to keep the same at all times during the
term hereof in through repair and good order and safe conditions, whenever the
necessity or desirability therefor may occur, and whether or not the same shall
occur, in whole or in part, by wear, tear, obsolescence or defects, and shall
use all reasonable precautions to prevent waste, damage or injury, except as
provided hereinafter.
LANDLORD and not TENANT, shall be responsible for and shall promptly
correct any defects in the building on the Premises which are due to faulty
design, or to errors of construction not apparent at the time the Premises were
inspected by TENANT for purposes of occupancy by TENANT; this shall not be
interpreted to relieve TENANT of any responsibility or liability herein
otherwise provided, including among others, for structural failure due to the
fault or negligence of TENANT.
TENANT shall also at TENANT'S own cost and expense, maintain the
landsite in thoroughly clean condition; free from solid waste (which includes
liquid and gaseous as defined by the Resource Conservation and Recovery Act),
and the Regulation on Hazardous and Non-Hazardous Waste of the Environmental
Quality Board, as amended, rubbish, garbage and other obstructions.
Specifically, TENANT shall not use said landsite, nor permit it to be used, as a
deposit or as dump for raw materials, waste materials, hazardous, toxic or
non-toxic substances, or substances of whichever nature. TENANT shall neither
make any excavation for the purpose of storing, putting away and/or concealing
raw materials or waste materials of any kind. Underground storage of hazardous
and/or toxic substances is specifically prohibited.
TENANT shall not do or cause to be done, nor permit on the Premises
anything deemed extra hazardous, nor shall it store in the Premises flamable or
toxic products of any class or kind without taking the proper precautions and
complying with applicable federal and Commonwealth laws and regulations.
<PAGE> 5
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In case TENANT needs to store in the landsite raw materials of a
hazardous and/or toxic nature or hazardous and/or toxic wastes, TENANT shall
notify LANDLORD and secure its prior authorization. LANDLORD shall be furnished
with a copy of any permit issued for such storage.
Although it is not intended that TENANT shall be responsible for any
decrease in value of the Premises due to the mere passing of time, or for
ordinary wear and tear of surfaces and other structural members of the
building, nevertheless TENANT shall: (i) replace, with like kind and quality,
doors, windows; electrical, sanitary and plumbing, fixtures; building equipment
and/or other facilities or fixtures in the Premises which through TENANT's use,
fault or negligence, become too worn out to repair during the life of this
Lease, (ii) paint the property inside and outside as required.
In addition to the foregoing, TENANT shall indemnify and safe harmless
LANDLORD from and against any and all cost, expenses, claims, losses, damages,
or penalties, including counsel fees, because of or due to TENANT's failure to
comply with the foregoing, and TENANT shall not call upon LANDLORD for any
disbursement or outlay of money whatsoever, and hereby expressly releases and
discharges LANDLORD of and from any liability or responsibility whatsoever in
connection therewith.
THIRTEEN: Roof Care - TENANT, without the prior consent of LANDLORD,
shall not: (i) erect or cause to be erected on the roof any bill board, aerial
sign, or structure of any kind, (ii) place any fixture, equipment or any other
load over the roof, (iii) drill any hole on the roof for whichever purpose,
(iv) use the roof for storage nor (v) correct any leaks; it shall be the
responsibility of Landlord to correct leaks in a diligent manner and to respond
to communications regarding leaks on a timely basis, especially those that
TENANT has communicated to LANDLORD adversely effect its operations, it being
understood that a response within 48 hours to evaluate the situation and
determine a mutually satisfactory course of action in order to diligently
resolve the problem shall be deemed a timely response.
FOURTEEN: Floor Loads - TENANT hereby acknowledges that it has been
informed by LANDLORD that the maximum floor load of the Premises herein demised
is 150 pounds per sq. ft. Therefore, TENANT hereby agrees that in the event the
load of the machinery and equipment to be installed thereat exceeds such
maximum load, it shall, at its own cost and expense, carry out any improvements
to the floor of the Premises which may be necessary to support such additional
load; it being further agreed and understood that construction and/or
installation of such improvements shall not be commenced until after LANDLORD'S
approval of the plans to be prepared therefor by TENANT and
<PAGE> 6
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approval of the plans to be prepared therefor by TENANT and thereafter, after
completion of construction and/or installation of said facilities, they shall
be deemed covered by and subject to the applicable provisions of this Contract;
it being further specifically agreed and understood that upon termination of
this Lease, such facilities shall be removed by TENANT, at its own cost and
expense, or in the alternative, and upon request by LANDLORD, they shall remain
as part of the Premises with no right whatsoever on the part of TENANT to be
reimbursed and/or compensated therefor.
FIFTEEN: Fixtures - TENANT shall not affix to the ceiling, nor to its
supporting joists or columns, nor to any of its walls, any air conditioning
unit, nor any other fixture, without the prior consent of LANDLORD.
SIXTEEN: Environmental Protection and Compliance - TENANT agrees, as a
condition hereof, that it will not discharge its solid, liquid or gaseous
industrial and/or sanitary effluent or discharges, either into the sewer system
and/or into any other place until after required authorizations therefor has
been obtained from the Puerto Rico Aqueduct and Sewer Authority, and/or the
Department of Health of Puerto Rico and/or Environmental Quality Board, and/or
any other governmental agency having jurisdiction thereof and TENANT further
agrees and undertakes to pre-treat any such effluent, prior to discharge thereof
as required by the said Authority, Department and/or governmental agency with
jurisdiction, and/or to install any equipment or system required, and to fully
abide by and comply with any and all requisites imposed thereby, and upon
request by LANDLORD to submit evidence of such compliance; it being agreed that
non-compliance thereof by TENANT for a period of ninety (90) days after notice,
shall be deemed an additional event of default under the provisions hereof.
Provided, that no construction and/or installation shall be made until LANDLORD
has approved of it.
TENANT shall also, at TENANT's own cost and expense, construct and
maintain Premises, processes and/or operating procedures in compliance with the
terms, conditions and commitments specified in any Environmental Impact
Statement, Environmental Assessment or any other analogous document produced by
the Commonwealth of Puerto Rico, Economic Development Administration/LANDLORD
as lead agency/or by any other governmental agency in connection with the
approval or operation of the project.
TENANT shall also serve LANDLORD with a copy of any lawsuit, notice of
violation, order to show cause or any other regulatory or legal action against
TENANT in any environmental-related case or issue.
<PAGE> 7
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TENANT shall also serve LANDLORD with a copy of any permit granted to
TENANT for air emissions, water discharge, solid waste generation, storage,
treatment and/or disposal, and for any hazardous and/or toxic waste raw
materials or by-products used or generated, stored, treated and/or disposed or
any other endorsement, authorization or permit required to be obtained by
TENANT.
TENANT shall also serve LANDLORD with a copy of any filing or notification
to be filed by TENANT with any regulatory agency or any environmentally related
case or issue, especially in any situation involving underground or surface
water pollution, hazardous and/or toxic waste spillage and ground contamination.
The notification to LANDLORD shall take place not later than the actual filing
of the pertinent documents with the regulatory agency.
SEVENTEEN: Improper Use - TENANT, during the term of this Lease and of any
renewal or extension thereof, agrees not to use or keep or allow the leased
Premises or any portion thereof to be used or occupied for any unlawful purpose
or in violation of this Lease or of any certificate of occupancy or certificate
of compliance covering or affecting the use of the Premises or any portion
thereof, and will not suffer any act to be done or any condition to exist on the
Premises or any portion thereof, or any article to be brought thereon, which may
be dangerous, unless safeguarded as required by law, or which may in law,
constitute a nuisance, public or private, or which may made void or voidable any
insurance then in force on the leased Premises.
EIGHTEEN: Government Regulations - TENANT agrees and undertakes to abide by
and comply with any and all rules, regulations and requirements of the Planning
Board of Puerto Rico, the Department of Health, the Environmental Quality Board,
the Environmental Protection Agency (EPA), where applicable and/or of any other
governmental agency, having jurisdiction thereon applicable to TENANT'S
operations at the Premises and/or products to be manufactured thereat, and if
requested by LANDLORD, TENANT shall submit evidence of such compliance; it being
agreed and understood that noncompliance with any and all such rules,
regulations and requisites shall be deemed an additional event of default under
the provisions of this Contract, unless remedied within thirty (30) days after
receipt of notice thereof.
Any and all improvements to the Premises required by any governmental
agency, having jurisdiction thereon so as to carry TENANT'S operations in
accordance with the regulations and requisites thereof, shall be at TENANT'S own
cost and expense, except for any improvements that may be required as a result
of any violation by LANDLORD that may exist at the effective date hereof other
than violations caused by TENANT or TENANT'S agents.
<PAGE> 8
8
TENANT further agrees and undertakes to install in the Premises, at its own
costs and expense, such devices as may be necessary to prevent any hazard, which
may be caused or created by its operations from affecting the environmental
integrity of the landsite or causing any nuisance to adjacent TENANTS and/or the
community in general; it being agreed and understood that creating or causing
any such nuisance, shall be deemed an additional event of default under the
provisions of this Contract.
TENANT further agrees and undertakes to abide by and comply with any and
all rules, regulations and requisites of the Fire Department relative to the
use and storage of raw materials, finished products and/or inflammable
materials, and/or of any other governmental agency, having jurisdiction thereon
applicable to TENANT'S operations at the Premises, and if requested by
LANDLORD, TENANT shall submit evidence of such compliance; it being agreed and
understood that noncompliance by TENANT with any of the aforementioned rules,
regulations and requisites shall be deemed, in each of such cases, an
additional event of default under the provisions of this Contract, unless
remedied within thirty (30) days after receipt of notice thereof.
If as a consequence of the foregoing dispositions, TENANT need to make
alterations to the Premises, the same shall be done subject to the dispositions
of Article TEN hereof.
NINETEEN: Use Permit - TENANT agrees to abide and comply with any and all
conditions and requisites included in the Use Permit which may be issued by
the Puerto Rico Permits and Regulations Administration (ARPE), and if requested
by LANDLORD, shall submit evidence of such compliance; it being agreed and
understood that noncompliance by TENANT with any and all such conditions and
requisites and/or the cancellation of the said Use Permit shall, in each of
such cases, be deemed an additional event of default under the provisions of
this Contract.
TWENTY: Inspection - TENANT shall permit LANDLORD or LANDLORD'S agents to
enter the Premises at all reasonable time for the purpose of inspecting the
same, or of making repairs that TENANT has neglected or refused to make as
required by the terms, covenants and conditions of this Lease, and also for the
purpose of showing the Premises to persons wishing to purchase the same, and
during the year next preceding the expiration of this Lease, shall permit
inspection thereof by or on behalf of prospective TENANTS. If, at a reasonable
time, admission to the Premises for the purposes aforesaid cannot be obtained,
or if at any time an entry shall be deemed necessary for the inspection or
protection of the property, or for making any repairs, whether for the benefit
of TENANT or LANDLORD, LANDLORD'S agents or representatives may enter the
Premises by force, or otherwise, without rendering LANDLORD,
<PAGE> 9
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or LANDLORD'S agents or representatives liable to any claim or cause of action
or damage by reason thereof, and accomplish such purpose.
The provisions contained in this Article are not to be construed as an
increase of LANDLORD'S obligations under this Lease; it being expressly agreed
that the right and authority hereby reserved does not impose, nor does LANDLORD
assume, by reason thereof, any responsibility or liability whatsoever for the
repair, care or supervision of the Premises, or any building, equipment or
appurtenance on the Premises.
TWENTY ONE: LANDLORD'S entry for repairs and alterations - LANDLORD
reserves the right to make such repairs, changes, alterations, additions or
improvements in or to any portion of the building and the fixtures and
equipment which are reputed part thereof as it may deem necessary or desirable
and for the purpose of making the same, to use the street entrances, halls,
stairs and elevators of the building provided that there be no unnecessary
obstruction of TENANT'S right of entry to and peaceful enjoyment of the
Premises, and TENANT shall make no claim for rent abatement compensation or
damages against LANDLORD by reason of any inconvenience or annoyance arising
therefrom.
TWENTY TWO: LANDLORD excused in certain instances - If, by reason of
inability to obtain and utilized labor, materials or supplies, or by reason of
circumstances directly or indirectly the result of any state of war, or of
emergency duly proclaimed by the corresponding governmental authority, or by
reason of any laws, rules, orders, regulations or requirements of any
governmental now or hereafter in force or by reason of strikes or riots, or by
reason of accidents, in damage to or the making of repairs, replacements
or improvements to the building or any of the equipment thereof, or by reason of
any other cause reasonable beyond the control of LANDLORD, LANDLORD shall be
unable to perform or shall be delayed in the performance of any covenant to
supply any service, such non-performance or delay in performance shall not be
ground to any claim against LANDLORD for damages or constitute a total or
partial eviction, constructive or otherwise. It being agreed and understood
that the time for completion of any such construction, shall be extended for a
period of time equal to the number of days of any such delay.
TWENTY THREE: Quiet Enjoyment - TENANT on paying the full rent and
keeping and performing the conditions and covenants herein contained, shall and
may peaceably and quietly enjoy the Premises for the term aforesaid,
subject, however, to the terms of this Lease and to the mortgages hereinafter
mentioned.
TWENTY FOUR: Leasehold Improvements - If leasehold improvements made by
or for the benefit of TENANT in the Premises at his request or other personal
property to TENANT are assessable or taxable and a tax
<PAGE> 10
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liability is imposed to TENANT or LANDLORD, it is understood that it shall be
the sole responsibility of TENANT to pay such taxes and in no event shall such
taxes be the liability of or be transferable to LANDLORD. In the event that by
operation of law, such taxes became a liability of LANDLORD, TENANT shall pay
such taxes as they become due and payable and shall promptly reimburse LANDLORD
for any payments or expenses incurred or disbursed by LANDLORD by reasons of
any such assessment. Said amount shall be due and payable, as additional rent,
with the next installment of rent. In the event that TENANT fails to make this
payment when due, it shall be subject to the dispositions of Article THIRTY
SEVEN hereof.
TWENTY FIVE: Stoppage of Options - It is understood by the parties
hereto that this Lease is made by LANDLORD in furtherance of the
industrialization plans of the Commonwealth of Puerto Rico, and it is
accordingly understood that TENANT will use all reasonable efforts while this
Lease is in effect to maintain a manufacturing operation upon the Premises, but
nothing contained in this paragraph shall be deemed to require TENANT to
maintain such an operation otherwise than in accordance with sound principles of
business management, or (without limiting the generality of the foregoing) to
prevent TENANT from curtailing such operation or from shutting it down, whenever
and as often as TENANT may, in the exercise of sound business judgment, deem
such action advisable. However, TENANT shall give to LANDLORD notice of any
necessary or convenient curtailment and/or shut-down, at least seven (7) days
prior to the date fixed therefor except in cases of an emergency shut-down, in
which case such notice shall be given at the earliest possible time. No
curtailment of operations or shut-down in accordance with the provisions of this
paragraph shall constitute a default under the provisions of this Contract which
will enable LANDLORD to terminate it, unless such plants shall have been
shut-down for a period of six (6) consecutive months. A shut-down on account of
unforeseeable event or events which although foreseeable could not be prevented,
shall not constitute a breach of this agreement. Nothing in this paragraph
contained shall relieve TENANT from the payment of rent during the period of any
shut-down or curtailments of operations.
TWENTY SIX: Assignment and Subletting - TENANT shall not assign, this
Lease nor let or sublet the Premises or any part thereof except to its parent
company, to a wholly owned subsidiary, to an affiliate of TENANT, wholly owned
by TENANT'S parent company or to a corporation to be organized by TENANT. In any
of these cases, TENANT shall promptly notify LANDLORD of said assignment or
subletting, it being agreed and understood that no such assignment or subletting
shall: (i) reduce or, in any way, affect the obligations of TENANT under this
Lease, nor (ii)
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release TENANT from liability under this Lease.
TWENTY SEVEN: Successors in Interest - This Lease Contract and every
provision thereof, shall bind and inure to the benefit of the legal
representatives, successors and assigns on the parties. However, the term
"LANDLORD", as used in this Contract, so far as any covenants or obligations on
the part of LANDLORD under this Lease are concerned, shall be limited to mean
and include only the owner of lessor, at the time in question, of the Premises,
so that in the event hereafter of a transfer of the title to the Premises,
whether any such transfer be voluntary or by operation of law or otherwise, the
person, natural or juridicial, by whom any such transfer is made, shall be and
hereby is entirely freed and relieved of all personal liability as respects the
performance of the covenants and obligations of LANDLORD under this Lease from
and after the date of such transfer.
TWENTY EIGHT: No Representation by LANDLORD - LANDLORD, LANDLORD'S
agents or employees, or the agents, executives or employees of the Economic
Development Administration, have made no representations or promises with
respect to the Premises except as herein expressly set forth and no rights,
easements or licenses are acquired by TENANT by implication or otherwise except
as expressly set forth in the provisions of this Contract. The taking possession
of the Premises by TENANT, shall be conclusive evidence, as against TENANT, that
TENANT accepts same "AS IS" and that said Premises, particularly the building
which forms a part of the same, were in good and satisfactory conditions at the
time such possession was so taken.
TWENTY NINE: Damages - LANDLORD shall not be responsible for any latent
defect or change of conditions in the Premises resulting in damage to the same,
or the property or person therein, except to the extent of LANDLORD'S gross
negligence, and provided such claims or loss is not covered by insurances herein
required from TENANT. TENANT shall promptly notify LANDLORD of any damage to or
defects in the Premises, particularly in any part of the building's sanitary,
electrical, air conditioning or other systems located in our passing through the
Premises, and the damage or defective conditions, subject to the provisions of
Article TWENTY ONE (21) hereof, shall be remedied by LANDLORD with reasonable
diligence.
THIRTY: General Liability Insurance - TENANT shall indemnify, have
harmless and defend LANDLORD and agents, servants and employees of LANDLORD
against and from any and all liability, fines, suits, claims, demands, expenses,
including attorneys' fees, and actions of any kind or nature arising by reason
of injury to person or property including
<PAGE> 12
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the loss of use resulting thereof or, violation of law occurring in the
Premises occasioned in whole or in part by any negligent act or omission on the
part of TENANT or an employee (whether or not acting within the scope of his
employment), servant, agent, licensee, visitor, assignor or undertenant of
TENANT, or by any neglectful use or occupancy of the Premises or any breach,
violation or non-performance of any covenant in this Lease on the part of
TENANT to be observed or performed.
Pursuant to the foregoing, TENANT shall, maintain during the term of this
lease, at its own cost and expense, a Comprehensive General Liability Policy.
Said policy shall: (i) be for a combined single limit of no less than
$500,000.00 per accident, (ii) hold LANDLORD harmless against any and all
liability as hereinbefore stated, and (iii) the care, custody & control
exclusion shall be deleted from this coverage. LANDLORD may require additional
reasonable limits of public liability insurance and coverages, when changing
circumstances so require.
THIRTY ONE: Property Insurance - TENANT recognizes that the rent
provided for herein does not include any element to indemnify, repair, replace
or make whole TENANT, his employees, servants, agents, licensees, visitors,
assignees, or undertenant for any loss or damage to any property or injury to
any person in the Premises.
Accordingly, during the term of this Lease, TENANT shall keep the building
standing upon the Premises at the commencement of the term hereof or thereafter
erected upon the Premises, including all equipment appurtenant to the Premises
and all alterations, changes, additions and improvements, insured for the
benefit of LANDLORD and TENANT, as their respective interest may appear, in an
amount at least equal to the percentages stated below (as LANDLORD may from
time to time determine).
The basis of the Property Insurance shall be Replacement Cost and the
coverage an "All Risks" Property Insurance Policy. Coverages included in the
All Risks Form:
1. Fire - "Building & Contents Form"
(a) Building - 100% of insurable value exclusive of
foundations
(b) Contents - All equipment appurtenant to the Premises
(State value of Policy)
2. Additional Coverages under the Fire Policy
(a) Extended Coverage Endorsement - 100% of insurable value
exclusive of foundations
(b) Earthquake - 50% of insurable value including
foundations
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(c) Vandalism and Malicious Mischief Endorsement
(d) Improvements and Betterments - For all alterations, changes,
additions and improvements
3. Landsite and Flood whenever applicable and/or necessary
4. Boiler and Machinery (if any) - 100% of insurable value
5. Pollution Liability Policy - if necessary
THIRTY TWO: Multifactory Building Specific Dispositions - In the event
that the Premises constitute a section or sections of an industrial building
and landsite in which other operations are conducted by other TENANTS: (i) the
insurance coverage herein required, shall be acquired by LANDLORD for the whole
of the industrial building and TENANT shall reimburse LANDLORD for its
proportionate share in the total cost of said policies, (ii) if, because of
anything done, caused or permitted to be done, permitted or omitted by TENANT,
the premium rate for any kind of insurance affecting the Premises shall be
increased, TENANT shall pay to LANDLORD the additional amount which LANDLORD
may be thereby obligated to pay for such insurance, and if LANDLORD shall
demand that TENANT remedy the condition which cause the increase in the
insurance premiums rate, TENANT will remedy such conditions within five (5)
days after such demand, and (iii) the insurance policies required in the
preceding Articles THIRTY (30) & THIRTY ONE (31) shall be endorsed to include a
waiver of subrogation against TENANT. All amounts to be reimbursed by TENANT
under this Article, shall be due and payable, as additional rent, with the next
installment of rent. In the event that TENANT fails to make this payment, when
due, it shall be subject to the dispositions of Article THIRTY SEVEN (37)
hereof.
THIRTY THREE: Additional Dispositions about Insurance - All the Insurance
policies herein required from TENANT, shall be taken in form and substance
acceptable to LANDLORD with insurance companies duly authorized to do business
in Puerto Rico, having a "A" and a higher financial fatting according to
Best's Insurance Report; and shall include LANDLORD as additional insured.
TENANT shall instruct the corresponding insurer to deliver such policies or
certified copies of Certificates of Insurance, in lieu of, directly to
LANDLORD. LANDLORD reserves the right not to deliver possession of the Premises
to TENANT, unless, and until two (2) days after such original policies, or
certified copies or certificates have been deposited with LANDLORD.
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Furthermore, said policies, shall: (i) provide that they may not be
canceled by the insurer for nonpayment of premium or otherwise, until at least
thirty (30) days after services of notice by registered or certified mail of
the proposed cancellation upon LANDLORD, and (ii) be promptly renewed by TENANT
upon expiration and TENANT shall, within thirty (30) days after such renewal,
deliver to LANDLORD adequate evidence of the payment of premiums thereon. If
such premiums or any of them shall not be so paid, LANDLORD may procure the
same in the manner set forth for governmental agencies, and TENANT shall
reimburse LANDLORD any amount so paid. This reimbursement being due and payable
with the next installment of rent. In the event that TENANT fails to make this
payment when due, it shall be subject to the dispositions of Article THIRTY
SEVEN (37) hereof. It is expressly agreed and understood, that payment by
LANDLORD of any such premiums shall not be deemed to waive or release the
default in the payment thereof by TENANT nor the right of LANDLORD to take such
action as may be available hereunder as in the case of default in the payment
of rent.
Upon the commencement of the term hereof, TENANT shall pay to LANDLORD the
apportioned unearned premiums on all such policies of insurance then carried by
LANDLORD in respect of the Premises in the event TENANT continues with the
insurance policies placed in LANDLORD.
TENANT shall not violate nor permit to be violated any of the conditions
or provisions of any of said policies, and TENANT shall so perform and satisfy
the requirements of the companies writing such policies that at all times
companies of good standing and acceptable to LANDLORD shall be willing to write
and continue such insurance.
TENANT shall cooperate with LANDLORD in connection with the collection of
any insurance monies that may be due in the event of loss and shall execute and
deliver to LANDLORD such proofs of loss and other instruments that may be
required for the purpose of facilitating the recovery of any such insurance
monies, and in the event that TENANT shall fail or neglect so to cooperate or
to execute, acknowledge and deliver any such instrument, LANDLORD, in addition
to any other remedies, may as the agent or attorney-in-fact of TENANT, execute
and deliver any proof of loss or any other instruments as may seem desirable to
LANDLORD and any mortgagee for the collection of such insurance monies. This
shall not be interpreted as any waiver of the obligations of TENANT under
Articles THIRTY, THIRTY ONE, THIRTY TWO and THIRTY THREE hereof or exclusively
in favor of LANDLORD under Article THIRTY NINE hereof.
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THIRTY FOUR: Waivers - The receipt by LANDLORD of the rent, additional
rent, or any other sum or charges payable by TENANT with or without knowledge of
the breach of any covenant of this Contract, shall not be deemed a waiver of
such breach. No act or omission of LANDLORD or its agent during the term of this
Lease shall be deemed an acceptance of a surrender of the Premises and no
agreement to accept a surrender of the Premises shall be valid unless it be made
in writing and described by LANDLORD. This Contract contains all the agreements
and conditions made between the parties hereto with respect to the Premises and
it cannot be changed orally. Any additions to, or charges in this Lease must be
in writing, signed by the party to be charged.
Failure on the part of LANDLORD to act or complain of any action or
non-action on the part of TENANT shall not be deemed to be a waiver of any of
its respective rights hereunder nor constitute a waiver at any subsequent time
of the same provision. The consent or approval by LANDLORD to, or of any action
by the other requiring consent or approval, shall not be deemed to waive or
render unnecessary the consent or approval by LANDLORD of any subsequent
similar act.
THIRTY FIVE: Reinstatement - No receipt of monies by LANDLORD for TENANT
after the termination or cancellation hereof in any lawful manner shall
reinstate, continue or extend the term hereof, or affect any notice theretofore
given to TENANT, or operate as a waiver of the right of LANDLORD to enforce the
payment of rent, additional rent, or other charges then due or thereafter
falling due, or operate as a waiver of the right of LANDLORD to recover
possession of the Premises by proper suit, action, proceeding or remedy; it
being agreed that, after the service of notice to terminate or cancel this
Lease, and the expiration of the time therein specified, if the default has not
been cured in the meantime, or after the commencement of suit, action or
summary proceedings or of any other remedy, or after a final order, warrant of
judgment of the possession of the Premises, LANDLORD may demand, receive and
collect any monies then due, or thereafter becoming due, without in any manner
affecting such notice, proceeding, suit, action, order, warrant or judgment;
and any and all such monies so collected shall be deemed to be payments for the
use and occupation of the Premises, or at the election of LANDLORD, on account
of TENANT'S liability hereunder. Delivery or acceptance of the keys to the
Premises, or any similar act, by the LANDLORD, or its agents or employees,
during the term hereof, shall not be deemed to be a delivery or an acceptance
of a surrender of the Premises unless LANDLORD shall explicitly consent to it,
in the manner set forth hereinbefore.
<PAGE> 16
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THIRTY SIX: Subordination and Attornment - This Lease is and shall be
subject and subordinate to all liens, or mortgages which may now or hereafter
affect the Premises and to all renewals, modifications, consolidations,
replacements and extensions thereof and, although this subordination provision
shall be deemed for all purposes to be automatic and effective without any
further instrument on the part of TENANT, TENANT shall execute any further
instrument requested by LANDLORD to confirm such subordination.
TENANT further covenants and agrees that if by reason of a default upon
the part of LANDLORD of any mortgage affecting the Premises, the mortgage is
terminated or foreclosed by summary proceedings or otherwise, TENANT will
attorn to the mortgagee or the purchaser in foreclosure proceedings, as the
case may be, and will recognize such mortgage or purchaser, as the TENANT'S
landlord under this Lease. TENANT agrees to execute and deliver, at any time
and from time to time, upon the request of LANDLORD or of the mortgagee or the
purchaser in foreclosure proceedings, as the case may be, any reasonable
instrument which may be necessary or appropriate to evidence such attornment.
TENANT further waives the provision of any statute or rule of law now or
hereafter in effect which may give or purport to give TENANT any right of
election to terminate this lease or to surrender possession of the Premises
demised hereby in the event any such proceeding is brought by the holder of any
such mortgage, and TENANT'S obligations hereunder shall not be affected in any
way whatsoever by any such proceeding.
TENANT, covenants and agrees, upon demand of the holder of any mortgage
duly recorded or recordable in the corresponding Registry of the Property or of
any receiver duly appointed by the foreclose any such mortgage, to pay to the
holder of any such mortgage or to such receiver, as the case may be, all rent
becoming due under this Lease after such demand, provided such holder of any
such mortgage or any such receiver complies with the obligations of LANDLORD
under this Lease.
TENANT, upon request of LANDLORD or any holder of any mortgage or lien
affecting the Premises, shall from time to time, deliver or cause to be
delivered to LANDLORD or such lien holder or mortgagee, within ten (10)
working days from date of demand a certificate duly executed and acknowledged
in form for recording, without charges, certifying, if true, or to extent true,
that this Lease is valid and subsisting and in full force and effect and
LANDLORD is not in default under any of the terms of this Lease.
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THIRTY SEVEN: Late Payments and Payment by LANDLORD - In the event that
(i) TENANT makes late payment, or fails to make payments to LANDLORD, in whole
or in part, of the rent, or of the additional rent, or of any of the other
payments of money required to be paid by TENANT to LANDLORD, as stipulated in
this Lease, when and as due and payable; or if (ii) LANDLORD, without assuming
any obligation to do so, after any notice or grace period provided hereunder,
performs or causes to be performed, at the cost and expense of TENANT, any of
the acts or obligations agreed to be performed by TENANT, as stipulated in this
Lease, and TENANT fails to refund LANDLORD any amounts of money paid or incurred
by LANDLORD in performing of causing the performance of such acts or
obligations, when and as due and payable, TENANT undertakes and agrees to pay
LANDLORD as additional rent, interest on such lately paid or unpaid rents,
additional rent, and/or on such other payments of money required to be paid,
and/or on any such amounts of money required to be refunded, from and after the
date when payment thereof matured or became due and payable, until full payment,
at the rate of twelve (12%) per cent per annum, or if such 12% interest, is
unlawful, then and in such event, at the highest maximum prevailing rate of
interest on commercial unsecured loans as fixed by the Board of Regulatory Rates
of Interest and Financial Charges, created under Law #1, approved October 15,
1973 (10 LPRA 998), as amended, or by any successor statute or regulation
thereof.
THIRTY EIGHT: Abatement - If any substantial service or facility to be
provided by LANDLORD is unavailable for a period exceeding thirty (30) days and
LANDLORD has been notified of the same, should time unavailability of such
service render all or any portion of the Premises untenable, TENANT after the
aforesaid thirty (30) days, shall be entitled to an abatement of a portion of
the rent that shall reflect that portion of the Premises which is untenable,
provided the damage to the service or facility is not attributable to the act
or neglect of TENANT or the employees, servants, licensees, visitors, assigns
or undertenants of TENANT.
THIRTY NINE: Fire or other Casualty - If before or during the term of
this Lease, the Premises shall be damaged by fire or other casualty, LANDLORD
after written notice thereof is given by TENANT, shall repair the same with
reasonable dispatch after notice to it of the damage, due allowances being made
for any delay due to causes beyond the LANDLORD's reasonable control,
provided, however, that
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LANDLORD shall not be required to repair or replace any furniture, furnishings
or other personal property which TENANT may have placed or installed or which it
may be entitled or required to remove from the Premises. LANDLORD shall proceed
with due diligence to obtain the corresponding insurance adjustment of the loss
and TENANT shall fully cooperate with LANDLORD and assist in the adjustment of
the loss. Until such repairs are completed, and provided such damage or other
casualty is not attributable to the act or neglect of TENANT or the employees,
servants, licensees, visitors, assigns or undertenants of TENANT, the rent
required to be paid pursuant to Article FOUR hereof, shall be abated in
proportion to the part of the Premises which are untenable. If the building, be
so damaged that LANDLORD shall decide to demolish and/or to reconstruct the
building, in whole or in part, LANDLORD may terminate this Lease by notifying
TENANT within a reasonable time after such damage of LANDLORD'S election to
terminate this Lease, such termination to be effective immediately if the term
shall not have commenced or on a date to be specified in such notice if given
during the term. In the event of the giving of such notice during the term of
this Lease, the rent shall be apportioned and paid up to the time of such fire
or other casualty if the Premises are damaged, or up to the specified date of
termination if the Premises are not damaged and LANDLORD shall not be otherwise
liable to TENANT for the value of the unexpired term of this Lease.
FORTY: Default Provisions - If, during the term of this Lease, TENANT
shall: (i) apply for or consent in writing to, the appointment of a receiver,
trustee or liquidator of TENANT or of all or substantially all of its assets or
(ii) seek relief under the Bankruptcy Act, or admit in writing its inability to
pay its debts as they become due, or (iii) make a general assignment for the
benefit of this creditors, or (iv) file a petition case or an answer seeking
relief (other than a reorganization not involving the liabilities of TENANT) or
arrangement with creditors, or take advantage of any insolvency law, or (v)
file an answer admitting the material allegations of a case filed against it in
any bankruptcy, reorganization or insolvency proceeding or, if an order,
judgment or decree shall be entered by any court of competent jurisdiction on
the application of TENANT or creditor adjudicating TENANT a bankrupt or
insolvent, or approving a petition seeking reorganization of TENANT (other than
a reorganization not involving the liabilities of TENANT) or appointment of a
receiver, trustee or liquidator of TENANT, or of all or substantially all its
assets, and such order, judgment or decree, shall continue stayed and in effect
for any period of sixty
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(60) consecutive days, the term of this Lease and all right, title and interest
of TENANT hereunder shall expire as fully and completely as if that day were
the date herein specifically fixed for the expiration of the term, and TENANT
will then, quit and surrender the Premises to LANDLORD, but TENANT shall remain
liable as hereinafter provided.
If, during the term of this Lease: (i) TENANT shall default in
fulfilling any of the covenants of this Lease (other than the covenants for the
payment of rent or additional rent), or of any other standing contract with
LANDLORD or (ii) if, during the term of this Lease TENANT shall abandon,
vacate, or remove from the Premises the major portion of the goods, wares,
equipment, or furnishings usually kept on said premises, of (iii) this Lease,
without the prior consent of LANDLORD, shall be encumbered, assigned or
transferred in any manner in whole or in part or shall, by operation of law,
pass to or devolve upon any third party, except as herein provided, or (iv) if
TENANT is in violation of laws, rules and regulations regarding minimum wages
of its employees, or of any other law, rules and regulations applicable to his
operations, but which have not been specifically mentioned in this Lease,
LANDLORD may give to TENANT notice of any such default or the happening of any
event referred to above and if at the expiration of thirty (30) days after the
service of such a notice the default or event upon which said notice was based
shall continue to exist, or in the case of a default which cannot with due
diligence be cured within a period of thirty (30) days, if TENANT fails to
proceed promptly after the service of such notice and with all due diligence to
cure the same and thereafter to prosecute the curing of such default with all
due diligence (it being intended that in connection with a default not
susceptible of being cured with due diligence within thirty (30) days that the
time of TENANT within which to cure the same shall be extended for such period
as may be necessary to complete the same with all due diligence), LANDLORD may
give to TENANT a notice of expiration of the term of this Lease as of the date
of the service of such second notice, and upon the giving of said notice of
expiration the term of this Lease and all right, title and interest of TENANT
hereunder shall expire as full and completely as if that day were the date
herein specifically fixed for the expiration of the term, and TENANT or any
party holding under his will then quit and surrender the Premises to LANDLORD,
but TENANT shall remain liable as hereinafter provided.
If, (i) TENANT shall default in the payment of the rent, the additional
rent, or of any other payment as required under this Lease and such default
shall continue for ten (10) working days after notice thereof by LANDLORD, of
(ii) if the default of the payment of
<PAGE> 20
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the rent, continued for thirty (30) days from the date any such payment became
due and payable (AUTOMATIC DEFAULT TERMINATIONS), or (iii) if this Lease shall
terminate as in Paragraph one and two of this Article provided, this Lease
shall terminate and TENANT will then quit and surrender the Premises to
LANDLORD, but TENANT shall remain liable as hereinafter provided, LANDLORD or
LANDLORD's agents and servants may immediately or at any time thereafter
re-enter the Premises and remove all persons and all or any property therefrom,
whether by summary dispossess proceedings or by any suitable action or
proceeding at law, or with the license and permission of TENANT, which
shall under this Contract be deemed given upon expiration of the strict thirty
(30) days notice period of subdivision of paragraph Two of this Article,
without LANDLORD being liable to indictment, prosecution or damages therefor
and repossess and enjoy the Premises with all additions, alterations and
improvements.
If TENANT shall fail to take possession of the Premises within ten (10)
days after the commencement of the term of this Lease, of if TENANT shall
vacate and abandon the Premises, LANDLORD shall have the right, at LANDLORD'S
option, to terminate this Lease and the term hereof, as well as all the right,
title and interest of TENANT hereunder, by giving TENANT five (5) days notice
in writing of such intention, and upon the expiration of the time fixed in such
latter notice, if such default be not cured prior thereto, this lease and the
term hereof, as well as all the right, title and interest of TENANT hereunder,
shall wholly cease and expire in the same manner and with the same force and
effect (except as to TENANT'S liability) as if the date fixed by such latter
notice were the expiration of the term herein originally granted; and TENANT
shall immediately quit and surrender to LANDLORD the Premises and each and
every part thereof and LANDLORD may enter into or repossess the Premises,
either by force, summary proceedings or otherwise. The right granted to
LANDLORD in this Article or any other Article of this Lease to terminate this
Lease, shall apply to any extension or renewal of the term hereby granted, and
the exercise of any such right by LANDLORD during the term hereby granted,
shall terminate any extension or renewal of the term hereby granted and any
right on the part of TENANT thereto.
Upon the termination of this Lease by reason of any of the foregoing
event, or in the event of the termination of this Lease by summary dispossess
proceedings or under any provisions of law, now or at any time hereafter, in
force by reason of, or based upon, or arising out of a default under or breach
of this Lease on the part of TENANT, or upon LANDLORD recovering possession of
the Premises in the manner or
<PAGE> 21
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in any of the circumstances herein-before mentioned, or in any other manner or
circumstances whatsoever, whether with or without legal proceedings, by reason
of, or based upon, or arising out of a default under or breach of this Lease on
the part of TENANT, LANDLORD, at its option, but without assuming any obligation
to do so in any case, may at any time, and from time to time, re-let the
Premises or any part or parts thereof for the account of TENANT or otherwise on
such terms as LANDLORD may elect, including the granting of concessions, and
receive and collect the rents therefor, applying the same at a rental not higher
than the one stipulated in this Contract, first to the payment of such
reasonable expenses as LANDLORD may have incurred in recovering possession of
the Premises, including reasonable legal expenses, and for putting the same into
good order or condition or preparing or altering the same for re-rental, and
expenses, commissions and charges paid, assumed, or incurred by LANDLORD in and
about the re-letting of the Premises or any portion thereof and then to the
fulfillment of the covenants of TENANT hereunder. Any such re-letting herein
provided for, may be for the remainder of the term of this Lease or for a longer
or shorter period or at a higher or lower rental. In any such case, whether or
not, the Premises or any part thereof be re-let, TENANT shall pay to LANDLORD
the rent required to be paid by TENANT up to the time of such termination of
this Lease, and/or the full rent provided for in the agreement for any holdover
of such period after termination and up to the surrender or recovery of
possession of the Premises by LANDLORD, as the case may be, and thereafter
TENANT covenants and agrees, to pay to LANDLORD until the end of the term of
this Lease as originally demised the equivalent of any deficiency amount of all
the rent reserved herein, less the net avails of reletting, if any, as specified
hereinabove in this Article and the same shall be due and payable by TENANT to
LANDLORD as provided herein, that is to say, TENANT shall pay to LANDLORD the
amount of any deficiency then existing.
FORTY ONE: LANDLORD'S Remedies - In the event TENANT shall default in
the performance of any of the terms, covenants or provisions herein contained,
LANDLORD may, but without the obligation to do so, perform the same for the
account of TENANT and any amount paid or expense incurred by LANDLORD in the
performance of the same shall be repaid by TENANT on demand. In the event of a
breach or threatened breach by TENANT or any subtenant or other person holding
or claiming under TENANT of any of the covenants, conditions or provisions
hereof, LANDLORD shall have the right of injunction to restrain the same, and
the right to invoke any remedy allowed by law or in equity as if
<PAGE> 22
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specific remedies, indemnity or reimbursement were not herein provided for. The
rights and remedies given to LANDLORD in this Lease are distinct, separate and
cumulative, and no one of them, whether or not exercised by LANDLORD, shall be
deemed to be a waiver, or an exclusion of any of the others.
FORTY TWO: Notice of Default - Anything in this Lease to the contrary
notwithstanding, it is specifically agreed that there shall be no enforceable
default against LANDLORD under any provisions of this Lease, unless notice of
such default be given by TENANT to LANDLORD in which TENANT shall specify the
default or omission complained of, and LANDLORD shall have thirty (30) days
after receipt of such notice in which to remedy such default, or if said default
or omission shall be of such a nature that the same cannot be cured within said
period, then the same shall not be an enforceable default if LANDLORD shall have
commenced taking the necessary steps to cure or remedy said default within the
said thirty (30) days and diligently proceeds with the correction thereof.
FORTY THREE: Capitalization - For the purpose of this Contract,
specifically of Article SIX, Capitalization includes the total of owner's equity
sources (preferred stock, common stock and surplus accounts) plus long-term
debts, it being agreed and understood that the amortization of any such debt
shall in no way diminish the amount originally determined as capitalization.
FORTY FOUR: Disclosure of Information - TENANT agrees to furnish to
LANDLORD within ninety (90) days after the expiration of each fiscal year of
TENANT, an annual statement certified by an independent Certified Public
Accountant showing as of the end of each such fiscal year: (i) TENANT'S paid-in
capital, (ii) long-term debts and capitalization as required by Articles SIX and
FORTY THREE hereof, (iii) investment in machinery and its capacity to provide
employment, (iv) taxes (including Social Security taxes) paid, and (v) any other
information as required by this Lease.
In the event such statement is not filed with LANDLORD as herein
provided, LANDLORD may obtain such information from TENANT at TENANT'S expense,
and for such purpose TENANT shall make available to LANDLORD'S designated
representatives, its books of accounts and other necessary data and facilities,
all of which shall be provided and made available at TENANT'S principal office
in Puerto Rico.
<PAGE> 23
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FORTY FIVE: Renewal - At the end of the term of the contract, renewal of
the lease shall be subject to negotiations between the parties, which shall not
exceed a six months period. In the event negotiations for a new lease has taken
place and the six month period has elapsed without any agreement, this lease
shall be deemed terminated.
FORTY SIX: Partial Invalidity and Applicable Law - If any term or
provisions of this Lease or the application thereof to any person or
circumstances shall, to any extent, be invalid or unenforceable, the remainder
of this Lease and the application of such term or provision to persons or
circumstances other than those as to which it is held invalid or unenforceable,
shall not be affected thereby, and each term and provision of this Lease shall
be valid and be enforceable to the fullest extent permitted by law. This
Contract is entered into and shall be interpreted in accordance with the laws
of the Commonwealth of Puerto Rico.
FORTY SEVEN: Lease Termination and Holding Over - Upon the expiration or
termination of this Lease:
(i) TENANT shall inform LANDLORD in writing of TENANT'S activities
affecting each or any environmental area of concern during the period of
TENANT'S operation, including a description from an environmental standpoint of
the physical conditions of the premises and landsite. TENANT shall also inform
to LANDLORD in writing of any environmental regulatory violations, compliance
plans, permits, closure plans, clean-up actions or any other regulatory
procedures related to the operation. In the event that the information reveals
TENANT'S noncompliance of any of the above, or in the event that a physical
inspection of the Premises and adjacent areas by LANDLORD, or any other source
of information reveal the possibility of contamination, in that event, TENANT
shall, at LANDLORD'S request submit a plan of action with the appropriate
financial provisions to execute it. LANDLORD shall hold TENANT responsible for
any and all environmental damage, or any damage to third parties as a result of
any environmental damage, or any remedial action (including monitoring) to be
performed at landsite or otherwise as a result of TENANT'S operations after
termination of Lease and until such a time as complete remediation or
fulfillment of TENANT'S obligations is effected. In case TENANT fails to comply
with the foregoing provisions, LANDLORD may elect to effect them at TENANT'S
expense and responsibility.
(ii) TENANT shall remove all hazardous and toxic substances belonging to
TENANT or to a third party. TENANT shall also
<PAGE> 24
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remove all other property of TENANT and that of any third party and failing so
to do, TENANT hereby appoints LANDLORD its agent so that LANDLORD may cause all
of the said property to be removed at the expense and risk of TENANT. TENANT
covenants and agrees to give full and timely observance and compliance to this
covenant to remove all its property and surrender the Premises broom clean.
TENANT hereby agrees to pay all reasonable necessary cost and expenses thereby
incurred by LANDLORD. IF, as the sole result of the removal of TENANT'S
property any portion of the Additional Premises or of the building of which
they are a part, are damaged, TENANT shall pay to LANDLORD the reasonable cost
of repairing such damages unless due to the gross negligence of LANDLORD, its
agents, servants, employees and contractors. TENANT'S obligation to observe or
perform this covenant shall survive the expiration or other termination of the
term of this Lease.
FORTY EIGHT: Change of Address - TENANT shall promptly notify LANDLORD
of any change in the addresses other than those required from it in Article
SEVEN hereof.
FORTY NINE: TENANT will indemnify LANDLORD for any and all liability,
loss, damages, expenses, penalties and/or fines, and any additional expenses
including any attorney fees LANDLORD may suffer as a result of claims,
lawsuits, demands, administrative orders, costs, resolutions or judgements
against it arising out of negligence and/or failure of TENANT or those acting
under TENANT to conform to the statutes, ordinances, or other regulations or
requirements of any governmental authority, be it Federal, of the Commonwealth
of Puerto Rico, its instrumentalities or public corporations, in connection
with the performance of this Lease.
<PAGE> 25
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FIFTY: Notwithstanding, Paragraph 28, TENANT hereby accepts the Premises
in their present condition, subject to (1) the removal and disposal by the
current tenant of the freezer and/or coolers, (2) a favorable Phase I
environmental report to be undertaken at LANDLORD's expense, and (3) as set
forth in Article Twelve, any defects which are due to faulty design or errors
of construction not apparent at the time TENANT takes possession of the
Premises.
FIFTY ONE: TENANT shall, at is own cost and expense, construct and/or
install all necessary equipment required to connect the building's electrical
system to the Puerto Rico Electrical Power Authority's electrical distribution
lines, such connection to be made in compliance with the requirement of PREPA.
Paragraph Eleven, notwithstanding, it is clarified that the prior tenant
has left a 330 KVA electrical substation on the Premises which is fully
approved by LANDLORD and which is delivered and accepted by TENANT in its
actual condition as part of the Premises.
FIFTY TWO: Anything contained in this Contract to the contrary
notwithstanding, if required by TENANT, it shall be at TENANT's own cost and
expense the construction and/or installation of a sprinkler system; it being
agreed and understood that such construction shall be in accordance with the
provisions hereof.
FIFTY THREE: TENANT shall, at its own cost and expense, install a fire
protection system and shall obtain the endorsement and approval from said Fire
Department for such installation. TENANT must also provide security measures to
prevent or reduce fire hazard due to the storage of inflammable materials and
products.
FIFTY FOUR: TENANT hereby acknowledges that in the industrial park there
are other industries; therefore TENANT hereby specifically agrees and
undertakes to take such steps and install such equipment as may be necessary to
prevent that any hazard and/or noise which may be created by its operations
may in any way or manner unduly affect the operations of the other industries
and therefore TENANT hereby releases and saves LANDLORD harmless from any and
all claims or demands arising therefrom or in connection therewith.
FIFTY FIVE: TENANT must comply with the rules and regulations of
pre-treatment established by the Puerto Rico Aqueduct and Sewer Authority, the
Environmental Quality Protection Agency related to the effluent industrial
discharge in the sanitary sewer system and their final disposition. Also, any
improvement necessary to provide pre-treatment facilities for the above
mentioned effluents shall be at TENANT's own cost and expense and in
coordination and with the approval of LANDLORD's Engineering and Maintenance
Departments.
FIFTY SIX: TENANT shall procure and obtain a permit for the operation of
a solid waste emission source from the Environmental Quality Board and
authorization for the Office of Solid Waste and/or from the Municipality of
Aguada for the final disposition of wastes.
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FIFTY SEVEN: TENANT, at its own cost and expense, shall implement the
necessary measures and install the control equipment to maintain the
atmospheric air quality levels in compliance with the environmental laws and
regulations of the Environmental Quality Board and the Environmental Protection
Agency, as promulgated by any succeeding law or regulations.
FIFTY EIGHT: It is hereby agreed and understood that TENANT shall take the
necessary steps to comply with the regulations and law requirements of the
PUERTO RICO OCCUPATIONAL SAFETY AND HEALTH OFFICE (PROSHO).
FIFTY NINE: TENANT certifies and guarantees that at the date of
subscribing this Contract it has submitted the Corporate Tax Returns Forms
during the last five (5) years and does not have any tax debt pending with the
Commonwealth of Puerto Rico or is complying with the terms of a payment plan
duly approved. TENANT also certifies and guarantees that at the date of
execution of this contract it has paid unemployment insurance compensation,
temporary disability insurance, and the driver's social security (as
applicable); or is complying with a payment plan duly approved.
TENANT acknowledges that this is an essential condition of the Contract
and if the above certification is incorrect in any of its parts, LANDLORD may
cancel this contract.
SIXTY: LANDLORD reserves the right to audit the leased premises from time
to time during the term of this contract, as LANDLORD may deem necessary, in
order to assess all aspects of the environmental condition of said premises and
TENANT's compliance with all environmental legislation and regulations, under
Commonwealth and federal law, TENANT hereby agrees to provide access to all
areas and structures of the premises for these purposes, upon LANDLORD's
request, and to also provide access to all books, records, documents and
instruments which LANDLORD may deem necessary in order to fully audit the
premises as herein stated.
SIXTY ONE: TENANT shall furnish to LANDLORD, in addition to any other
information, documents or instruments that may be required in this contract:
a) Prompt written notice of the occurrence of any event that by law or
regulation would require any oral, telephonic or written notice or
communication to the US Environmental Protection Agency and/or to the
Puerto Rico Environmental Quality Board, or any successor agency, and
copies of all orders, notices or other communications and reports
received, made or given in connection with any such event, and any
enforcement action taken against TENANT or against any property owned,
occupied or used by TENANT;
b) Quarterly certifications subscribed by an authorized representative
designated by TENANT, as to the environmental condition of the leased
premises, containing the information required by LANDLORD, which is
specified in the form included as Schedule "B" of this contract, or
any subsequent modification thereto;
c) Any other information and documents relating to TENANT's compliance
with environmental legislation and regulations under federal and
commonwealth laws.
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SIXTY-TWO: TENANT hereby acknowledge having been informed by the
LANDLORD that Project No. T-0870-0-68 extensions and Lot No. L-253-277-11 are
currently leased to Dade Diagnostics of P.R. Inc. and that LANDLORD is exerting
its best efforts to terminate and/or rescind the existing lease contract to
recover possession of said premises. As soon as the mentioned projects are
vacated and are ready for occupancy by TENANT, LANDLORD shall so notify TENANT
by certified mail, return receipt requested.
SIXTY-THREE: LANDLORD shall provide infrastructure funds in the amount
of up to $600,000 to cover a part of the investment to be made by TENANT to
reconstruct and refurnish LANDLORD's property (Premises). These funds will be
disbursed to TENANT in two (2) payments as follows: $400,000.00 in 1997 and
$200,000.00 by JANUARY 31, 1998. The initial incentive of $400,000.00 shall be
disbursed by LANDLORD to TENANT within fifteen (15) business days after
TENANT's written request that it is to be accompanied by adequate invoices and
evidence of payment; and upon inspection and approval by LANDLORD of the
completed work. The parties hereby acknowledge that the funds LANDLORD is
willing to provide to TENANT, are conditioned on TENANT's investment within the
first five (5) years after the commencement of the Lease Term in improvements
to the Premises. (Even though not restricted to the items set forth in
Paragraph 64 PRIDCO must approve improvements) of an amount that matches the
amount to be reimbursed by LANDLORD. Should TENANT (i) not invest in
improvements to the Premises an amount that matches the amount reimbursed by
LANDLORD and (ii) terminate the Lease prior to five years, then TENANT shall
reimburse to LANDLORD the short fall multiplied by a fraction, the numerator of
which shall be the months remaining in order to achieve the five year term and
the denominator of which shall be sixty.
SIXTY-FOUR: LANDLORD recognizes that the following items qualify for
the infrastructure funds provided:
a) General Demolition and Architectural Work
-----------------------------------------
10" ft. high cyclone fencing
8 Refinish ga. Polished concrete flooring
Window type A Toilet accessories
Window type B Door type A
Window type C Door type B
Floor to be leveled Door type C (10'-0" high)
Door type D
Paint (interior)
Paint (exterior)
Door type C (8'-8" high)
New toilet equipment (including plumbing)
New ramp
b) HVAC System
-----------
New roof top air conditioners: 6 @ 25 tons; 1 split @ 40 tons
New ductwork galvanized sheet metal
Ductwork insulation - rigid fiberglass board
New control system, humidity and energy management of A/C
Diffusers, registers, fire dampers, volume & control campers
Electric reheat coils (5 units)
<PAGE> 28
28
c) Fire Protection System
----------------------
Sprinkler system grid relocation & sprinkler heads replacement
Fire hose cabinets with fire extinguisher
Fire system testing and compliance with insurer recommendations
d) Electrical Work
---------------
o General
4160V-120/208V Transformer 500 KVA
120/208V & 227/480V Feeders (from SWBOS)
Panel boards
Breaker for 500 KVA Transformer
AHU Starters
AHU Disconnect switches
400 KW Emergency Generator
300 KVA Transformer 480-208/120
600A Auto-Transfer switch
o Fire Alarm System
Total: $600,000.00
The foregoing items have been estimated by TENANT at $851,420.00 but
the infrastructure funds to be provided shall be limited to $600,000.00 or the
actual amount invested by TENANT, whichever is lower.
SIXTY-FIVE: Subject to the execution of the present lease, LANDLORD
shall release TENANT from any and all obligations under the previous lease
(Arecibo lease), nevertheless, TENANT must comply with the payment of all rent
through the termination date of the Arecibo's lease and with the delivery of
the property as agreed in the Arecibo's lease contract, including but not
limited to the compliance with environmental laws and regulations.
The foregoing notwithstanding, LANDLORD has inspected the Arecibo
leased facilities and agrees to accept them in their present condition so that
TENANT will not have to remove any improvements made to said leased facilities.
SIXTY-SIX: TENANT shall comply with all Government of Puerto Rico and
Federal laws and regulations.
SIXTY-SEVEN: TENANT shall have the option of terminating the Lease by
giving LANDLORD six months prior written notice. To the extent such prior
notice does not comply with the six months, then TENANT shall pay rent for the
remaining period so that LANDLORD receives the equivalent of at least six
months rent from the notification date. Upon the payment of the rent and
compliance by TENANT with all the other terms and conditions under this Lease,
then TENANT shall be released from any further obligations under this Lease.
<PAGE> 29
29
SIXTY-EIGHT: TENANT agrees to submit to LANDLORD within thirty (30) days
from the date of execution of this Contract: (a) evidence of its registration
in the Department of State of the Commonwealth of Puerto Rico and the name and
address of its resident agent; and (b) a certificate of a resolution of its
Board of Directors either authorizing or ratifying the execution of this
Contract.
IN WITNESS WHEREOF, LANDLORD and TENANT have respectively signed upon
proper authority this Lease, this 9 day of October 1997.
PUERTO RICO INDUSTRIAL DEVELOPMENT COMPANY
SSP: 66-0292871
BY: [SIG]
----------------------------------------
SMART MODULAR TECHNOLOGIES (P.R.), INC.
SSP: 77-039-4145
BY: [SIG[
----------------------------------------
<PAGE> 30
SCHEDULE "A"
DESCRIPTION OF BUILDING T-0870-0-68
LOCATED AT AGUADA, PUERTO RICO
- --------------------------------------------------------------------------------
This is a pitched roof type building consisting of reinforced concrete
foundations, steel columns and steel girders supporting 30 feet long steel
joists, which in turn support 22 gauge standard galvanized steel deck, covered
by 1" fiberglass insulation and a 3 plies built-up roofing. Roof ventilators
are provided.
The structure consists of a main 240'-11" x 90'-6" out to out dimensions
with an area of 21,803.26 sq. ft. of manufacturing space, lean to 60'-6" x
10'-6" for an area of 635.25 sq. ft. This amounts to a total area of 22,438.51
sq. ft. of covered floor space.
The floor consists of a 3 1/2" thick reinforced concrete slab with a
monolithic cement finish floor slab designed for a load capacity of 150 pounds
per square feet.
Exterior walls are of concrete blocks plastered and painted on both sides.
Interior walls at the lean-to are plastered and painted together with a
6'-1" sprayed-on glazed finish wainscot.
Ceiling is rubbed and painted throughout the building.
Windows are Miami aluminum louvers throughout the building.
Interior doors are made of plywood and exterior are industrial type metal
ones.
Clearance in the manufacturing area from finish floor to lowest part of
beams at the side eaves is 12'-4" and 13'-4" at the highest point.
DESCRIPTION OF BUILDING T-0870-1-73
LOCATED AT AGUADA, PUERTO RICO
- --------------------------------------------------------------------------------
This is a pitched roof type building consisting of reinforced concrete
foundations, steel columns and steel girders supporting 30 feet long steel
joists, which in turn support 22 gauge galvanized steel deck, covered by 1"
fiberglass insulation and a 3 plies built-up roofing. Roof ventilators are
provided.
The structure consists of a divided main floor consisting of TWO (2)
units.
UNIT #1 - consists of a manufacturing area 152'-2" x 181'-0" out to out
dimensions with an area of 25,540 sq. ft. and a lean-to 30'-0" x 13'-2" for an
area of 394.80 sq. ft. This gives a total area of 25,935.76 sq. ft. of covered
floor space.
UNIT #2 - consists of a manufacturing area 91'-3" x 241'-0" out to out
dimensions for an area of 21,991.25 sq. ft. and two loading platform for an
area of 1,598.82 sq. ft. This amounts an area of 23,590.07 sq. ft.
Adding both partial areas give a total area of 49,525.83 sq. ft. of
covered floor space for this project. In this project the sanitary facilities
are interior ones, so no change in gross area be considered.
<PAGE> 31
31
The floor consists of a 4" thick reinforce concrete slab with a
monolithic cement finish; floor slab designed for a load capacity of 150 pounds
per square foot.
Exterior walls are of concrete blocks plastered and painted on both
sides. A 6'-1" high sprayed-on glazed finish is provided as wainscot.
Windows are Miami aluminum louvers throughout the building.
Interior doors are made of plywood and exterior are industrial type
metal ones.
Clearance in the Unit #1 manufacturing area from finish floor to lowest
part beams at the side eaves is 12'-1" and 14'-4" at the highest below the
girders at mid span.
Clearance in the Unit #2 manufacturing area form finish floor to lowest
part of beams at the side eaves is 20'-0" and 21'-2" the highest below the
girders at mid span.
DESCRIPTION OF BUILDING T-0870-2-87
LOCATED AT AGUADA, PUERTO RICO
- --------------------------------------------------------------------------------
This is a pitched roof type building consisting of reinforced
foundations, structural steel columns and steel framing supporting 30'-0" steel
joists, which in turn support gauge 22 galvanized steel deck, covered by 2"
fiberglass insulation and a 3 plies built-up roofing. Roof ventilators are
provided.
The structure consists of corridor, office, file, gown and tab assembly
areas for a total area of 11,053.79 sq. ft. covered space & other support
facilities. (See Exhibit A)
The floor consists of 5" thick reinforced concrete slab with monolithic
cement finish and vinyl tile. Floor is designed for a live load of 150 pounds
per square foot.
Exterior walls are of concrete blocks plastered both sides, interior
face finish with gypsum board painted on both sides.
Ceiling is steel deck unpainted, gypsum board painted and cleanable tile
hung ceiling.
Windows opening consist of fixed aluminum louvers.
Interior and exterior doors are industrial metal type.
Clearance in the Tab assembly room from finish floor to lowest part of
beam at the side eaves is 21'-4".
<PAGE> 32
32
DESCRIPTION OF PARCEL OF LAND, LOT NO. 3 & 5, LOCATED AT AGUADA INDUSTRIAL
PARK, SITE FOR PROJECT NO. T-0870-0-68 & EXT.
- --------------------------------------------------------------------------------
GENERAL:
Parcel of land, Lot No. 3 & 5, located at Aguada Industrial Park, Aguada,
P.R.
It bounds: by the North, with Lot No. 7 of the same industrial area; by
the South, with Lot No. 1 of the same industrial area; by the East, with land
property of Comunidad Agricola Bianchi; and by the West, with Street "A" of the
same industrial park.
It has an approximate surface area of 16,242.00 square meters, equivalent
to 4.13 cuerdas.
It is affected by the following rights of ways:
1. A 3.00 meter wide strip in favor of PRASA running along the Northern
& Eastern boundaries.
2. A 3.00 meter storm sewer wide strip running along the Eastern
boundary.
DESCRIPTION OF PARCEL OF LAND, LOT NO. 11, LOCATED AT AGUADA INDUSTRIAL PARK
- --------------------------------------------------------------------------------
GENERAL:
Parcel of land, Lot No. 11, located at Aguada Industrial Park, Aguada, P.R.
It bounds: by the North, with land owned by Comunidad Agricola Bianchi; by
the South, with Lot No. 10 and with access street of the same industrial area;
by the East, with land owned by Comunidad Agricola Bianchi; and by the West,
with land owned by Residencial de Colores, Inc.
It has an approximate surface area of 11,615.92 square meters, equivalent
to 2.95 cuerdas.
It is not affected by any right of way.
<PAGE> 33
33
SCHEDULE "B"
COMPLIANCE REPORT WITH
ENVIRONMENTAL REQUIREMENTS
In the period of ____________ to ____________
I. PERMITS
PERMITS NUMBER EXPIRATION RENEWAL DATE
DATE (IF APPLY)
II. COMPLIANCE ACTIONS
REFERENCE/CASE NUMBER DATE RESPONSE OF
DATE OF
III. CERTIFICATION
I certify, under penalty of law, that this document was prepared under my
supervicion and direction; and that was based in my investigation by the persons
directly responsible of gathering the information, that the information here
submitted is, according to my best judgment, certain, complete and precise.
<PAGE> 1
SECOND AMENDMENT TO THE
KRYPTON ISOLATION, INC.
WARRANT TO PURCHASE 2,000,000 SHARES
OF SERIES A PREFERRED STOCK
This SECOND AMENDMENT TO THE KRYPTON ISOLATION, INC. WARRANT TO PURCHASE
2,000,000 SHARES OF SERIES A PREFERRED STOCK (this "Amendment") is made as of
January 21, 1998, by and between Krypton Isolation, Inc., a California
corporation (the "Company"), and SMART Modular Technologies, Inc., a California
corporation ("SMART Modular"). This Agreement amends that certain KRYPTON
ISOLATION, INC. WARRANT TO PURCHASE 2,000,000 SHARES OF SERIES A PREFERRED STOCK
dated as of July 27, 1994 by and between the Company and SMART Modular (the
"Series A Warrant").
RECITALS
WHEREAS, SMART Modular is entitled to purchase 2,000,000 shares of
Series A Preferred Stock of the Company (the "Shares") pursuant to the Series A
Warrant;
WHEREAS, the Company and SMART Modular desire to extend the time period
whereby SMART Modular may exercise its right to purchase the Shares;
NOW, THEREFORE, INTENDING TO BE LEGALLY BOUND, and pursuant to
consideration duly provided by both parties, the Company and SMART Modular
hereby agree as follows:
1. Amendment. Section 1(a) of the Series A Warrant is hereby deleted in its
entirety and replaced with the following:
"(a) January 29, 2000,"
2. Consideration. SMART Modular hereby delivers and the Company hereby
acknowledges receipt of a check in the amount of one thousand dollars ($1,000)
made payable to the Company in consideration of this Amendment.
3. Governing Law. This Amendment shall be governed in all respects by the laws
of the State of California as such laws are applied to the agreements between
California residents entered into and performed entirely within California.
4. Entire Agreement. This Agreement constitutes the full and entire
understanding and agreement between the parties with regard to the subject
hereof.
5. Counterparts. This Amendment may be executed in any number of counterparts,
each of which shall be enforceable against the parties actually executing such
counterparts, and all of which together shall constitute one instrument.
IN WITNESS WHEREOF, the parties have duly executed this SECOND AMENDMENT
TO THE KRYPTON ISOLATION, INC. WARRANT TO PURCHASE 2,000,000 SHARES OF SERIES A
PREFERRED STOCK as of the date first written above.
KRYPTON ISOLATION, INC. SMART MODULAR TECHNOLOGIES, INC.
By: ____________________________ By: ____________________________
Name: __________________________ Name: __________________________
<PAGE> 2
Title: _________________________ Title: _________________________
<PAGE> 1
EXHIBIT 21.1
LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
NAME JURISDICTION
- --------------------------------------------------------------------------- ---------------
<S> <C>
Apex Data, Inc............................................................. Delaware
SMART Modular Technologies (Europe) Limited................................ United Kingdom
SMART Modular Technologies (UK) Ltd........................................ United Kingdom
SMART Modular Technologies FSC, Inc........................................ Barbados
SMART Modular Technologies (India) Pvt. Ltd................................ India
SMART Modular Technologies (PR), Inc....................................... California
SMART Modular Technologies (Australia) Pty. Ltd............................ Australia
RISQ Modular Systems, Inc.................................................. California
SMART Modular Technologies (Deutschland) GmbH.............................. Germany
SMART Modular Technologies (Puerto Rico), Inc.............................. Cayman Islands
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our reports included in this Form 10-K into the Company's previously filed
Registration Statement (File No. 33-99822) on Form S-8.
/s/ ARTHUR ANDERSEN LLP
--------------------------------------
ARTHUR ANDERSEN LLP
San Jose, California
January 29, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME
CONTAINED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED
OCTOBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> OCT-31-1997 OCT-31-1996 OCT-31-1995
<PERIOD-START> NOV-01-1996 NOV-01-1995 NOV-01-1994
<PERIOD-END> OCT-31-1997 OCT-31-1996 OCT-31-1995
<CASH> 111,331 52,568 0
<SECURITIES> 38,672 8,494 0
<RECEIVABLES> 95,366 52,806 0
<ALLOWANCES> 669 583 0
<INVENTORY> 39,336 39,001 0
<CURRENT-ASSETS> 303,022 157,818 0
<PP&E> 33,345 17,623 0
<DEPRECIATION> 8,741 4,189 0
<TOTAL-ASSETS> 327,958 172,185 0
<CURRENT-LIABILITIES> 96,907 83,494 0
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 135,302 37,321 0
<OTHER-SE> 95,018 49,298 0
<TOTAL-LIABILITY-AND-EQUITY> 327,985 172,185 0
<SALES> 694,675 401,774 274,592
<TOTAL-REVENUES> 694,675 401,774 274,592
<CGS> 582,515 329,644 224,931
<TOTAL-COSTS> 582,515 329,644 224,931
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 225 309 704
<INCOME-PRETAX> 68,865 39,891 19,911
<INCOME-TAX> 23,418 14,760 7,344
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 45,447 25,131 12,567
<EPS-PRIMARY> 1.04 0.60 0.36
<EPS-DILUTED> 0 0 0
</TABLE>
