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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1998
[ ] 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 000-23097
INTERNATIONAL MANUFACTURING SERVICES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0393609
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification Number)
2222 Qume Drive, San Jose, California 95131
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 953-1000
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 [ ]
As of October 31, 1998, 16,110,977 shares of the Registrant's Class A Common
Stock, $.001 par value, and 2,509,425 shares of the Registrant's Class B Common
Stock, $.001 par value, were issued and outstanding.
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INTERNATIONAL MANUFACTURING SERVICES, INC.
INDEX TO FORM 10Q
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at October 31, 1998 and April 30,
1998
Condensed Consolidated Statements of Operations for the three and six
months ended October 31, 1998 and 1997
Condensed Consolidated Statements of Cash Flows for the six months ended
October 31, 1998 and 1997
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
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INTERNATIONAL MANUFACTURING SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
UNAUDITED
<TABLE>
<CAPTION>
October 31, April 30,
1998 1998
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,330 $ 3,939
Accounts receivable, net 56,950 45,289
Inventories 40,756 41,378
Other current assets 2,292 2,563
--------- ---------
Total current assets 110,328 93,169
Property and equipment, net 33,994 29,026
Other assets 3,644 4,442
--------- ---------
Total assets $ 147,966 $ 126,637
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 58,012 $ 42,621
Accrued liabilities 12,394 10,713
Bank borrowings 8,000 6,000
Current portion of long term debts 89 86
--------- ---------
Total current liabilities 78,495 59,420
Long term debt 12,522 12,559
Deferred tax liabilities 2,254 1,964
Stockholders' equity:
Preferred Stock -- --
Common Stock 18 18
Additional paid-in capital 66,112 65,253
Distributions in excess of net book value (20,608) (20,608)
Retained earnings 9,173 8,031
--------- ---------
Total stockholders' equity 54,695 52,694
--------- ---------
Total liabilities and stockholders' equity $ 147,966 $ 126,637
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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INTERNATIONAL MANUFACTURING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31, October 31, October 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenues:
Affiliates $ 27,055 $ 33,995 $ 59,063 $ 64,228
Other 46,279 41,371 132,329 75,873
Logistics Services 15,246 -- 27,302 --
-------- -------- -------- --------
Total revenues 88,580 75,366 218,694 140,101
Cost of revenues 85,747 67,960 207,078 126,356
-------- -------- -------- --------
Gross profit 2,833 7,406 11,616 13,745
-------- -------- -------- --------
Selling, general & administrative expenses 4,965 3,201 8,923 5,867
-------- -------- -------- --------
Total operating expenses 4,965 3,201 8,923 5,867
-------- -------- -------- --------
Operating income (loss) (2,132) 4,205 2,693 7,878
Interest expense, net 705 1,247 1,365 2,502
-------- -------- -------- --------
Income (loss) before income taxes (2,837) 2,958 1,328 5,376
Provision (benefit) for income taxes (397) 421 186 758
-------- -------- -------- --------
Net income (loss) (2,440) 2,537 1,142 4,618
Dividends on convertible preferred stock -- 222 -- 472
-------- -------- -------- --------
Net income (loss) available for common stockholders $ (2,440) $ 2,315 $ 1,142 $ 4,146
======== ======== ======== ========
Basic net income (loss) per share $ (0.13) $ 0.28 $ 0.06 $ 0.53
======== ======== ======== ========
Diluted net income (loss) per share $ (0.13) $ 0.16 $ 0.06 $ 0.29
======== ======== ======== ========
Shares used to compute basic net income (loss) per share 18,602 8,415 18,582 7,868
======== ======== ======== ========
Shares used to compute diluted net income (loss) per share 18,602 16,149 20,589 15,894
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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INTERNATIONAL MANUFACTURING SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
October 31, October 31,
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,142 $ 4,618
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 4,789 4,142
Deferred Income Taxes 290 --
Changes in assets and liabilities:
Accounts receivable (11,130) (13,485)
Accounts receivable from Maxtor and (531) (4,846)
affiliates
Inventories 622 (22,342)
Other current assets 271 (405)
Other assets 553 227
Accounts payable 15,484 18,082
Accounts payable to Maxtor (93) (144)
Accrued liabilities 1,837 5,207
Income taxes payable (156) 764
-------- --------
Net cash provided by (used in) operating activities 13,078 (8,182)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment, net (9,512) (6,484)
-------- --------
Net cash used in investing activities (9,512) (6,484)
-------- --------
Cash flows from financing activities:
Borrowings (repayments) under line of 2,000 500
credit
Principal payments on debt and capital lease
obligations (34) (20,040)
Payment of dividends -- (500)
Proceeds from issuance of common stock 859 52,513
-------- --------
Net cash provided by financing activities 2,825 32,473
-------- --------
Net change in cash and cash equivalents 6,391 17,807
Cash and cash equivalents at beginning of period 3,939 2,828
-------- --------
Cash and cash equivalents at end of period $ 10,330 $ 20,635
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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INTERNATIONAL MANUFACTURING SERVICES, INC.
UNAUDITED NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of the Company and all of its subsidiaries. All intercompany accounts
and transactions have been eliminated in consolidation.
In the opinion of management, the condensed consolidated financial
statements include all adjustments (consisting only of normal recurring items)
necessary to present fairly the financial position and results of operations for
each interim period shown. Interim results are not necessarily indicative of
results for a full year.
The condensed consolidated financial statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission (SEC) applicable to interim financial information. Certain
information and footnote disclosure included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted in
these interim statements pursuant to such SEC rules and regulations. The
information included in this Form 10-Q should be read in conjunction with the
consolidated financial statements and notes thereto, for the year ended April
30, 1998, included in the Company's 1998 annual report on Form 10-K.
In the six months ending October 31, 1998, the Company recognized
logistics revenue from one customer, which resulted from the purchase of
products from the customer's designated supplier. These products are tested,
configured, packaged and distributed to the end user or retailer. In addition,
the Company's logistics services consist of order management and call center
support to the end user or retailer.
2. INVENTORIES
Inventories consisted of (in thousands):
<TABLE>
<CAPTION>
October 31, April 30,
1998 1998
------- -------
<S> <C> <C>
Raw materials $34,577 $36,268
Work-in-process 4,489 3,666
Finished Goods 1,690 1,444
------- -------
Total $40,756 $41,378
======= =======
</TABLE>
3. INCOME TAXES
The effective tax rate for the six months ended October 31, 1998 was
approximately 14.00%. This rate is based on the Company's estimation of the
expected geographical mix of its fiscal 1999 income.
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4. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is based on the weighted average
number of shares of common stock outstanding during the period. Diluted net
income (loss) per share includes potential common shares from convertible
preferred stock outstanding and from options outstanding using the treasury
stock method except if their effect is anti-dilutive. All net income (loss) per
share amounts for prior periods have been restated to conform to the
requirements of SFAS 128.
SFAS No. 128 requires a reconciliation of the numerators and
denominators of the basic and diluted per share computations as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31, October 31, October 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) available for common stockholders $ (2,440) $ 2,315 $ 1,142 $ 4,146
Add back dividends on convertible preferred stock -- 222 -- 472
-------- -------- -------- --------
Net income (loss) for diluted earnings per share calculation $ (2,440) $ 2,537 $ 1,142 $ 4,618
======== ======== ======== ========
Denominator:
Weighted average common shares outstanding
during the period 18,602 8,415 18,582 7,868
Effect of dilutive securities:
Convertible preferred stock -- 5,407 -- 5,705
Stock Options -- 2,327 2,007 2,321
-------- -------- -------- --------
Average shares outstanding - assuming dilution 18,602 16,149 20,589 15,894
======== ======== ======== ========
Basic earnings per share $ (0.13) $ 0.28 $ 0.06 $ 0.53
======== ======== ======== ========
Diluted earnings per share $ (0.13) $ 0.16 $ 0.06 $ 0.29
======== ======== ======== ========
</TABLE>
All options were excluded from the computation of diluted net loss per share for
the three months ended October 31, 1998. Options to purchase 1,750,000 and
1,246,000 shares of common stock were outstanding as at October 31, 1998 and
1997, respectively, but were not included in the computations of diluted EPS
because these options had an exercise price greater than the average market
price of the common shares outstanding during the six months ended October 31,
1998 and 1997.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). FAS 133 establishes a new
model for accounting for derivatives and hedging activities and supersedes and
amends a number of existing accounting standards. SFAS 133 requires that all
derivatives be recognized in the balance sheet at their fair market value, and
the corresponding derivative gains and losses be either reported in the
statement of operations or as a deferred item depending on the type of hedge
relationship that exists with respect to such derivative. Adopting the
provisions of SFAS 133 are not expected to have a material effect on the
Company's consolidated financial statements, which will be effective for the
Company's fiscal year ending April 30, 2001.
6. SUBSEQUENT EVENTS
On November 2, 1998 the Company announced that it had entered into a
definitive merger agreement with Celestica Inc. ("Celestica") and Celestica Asia
Inc., a wholly owned subsidiary of Celestica ("Merger Sub"). Pursuant to the
merger agreement, at the effective time of the merger the Company will be merged
with and into Merger Sub, with
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Merger Sub becoming the surviving corporation (the "Merger"). In addition, at
the effective time of the Merger each outstanding share of Class A and Class B
common stock of the Company will be converted into the right to receive 0.4 of a
subordinate voting share of Celestica (the "Exchange Ratio") or, at the election
of the stockholder, $7.00 in cash subject to pro-ration.
Similarly, at the effective date of the Merger each option to purchase
Class A common stock of the Company will convert into an option to purchase 0.40
of a subordinate voting share of Celestica at an adjusted exercise price or, for
vested options with an exercise price of less than $7.00 per share, the holders
of such options will have the choice of receiving a cash payment equal to the
product of (a) the number of shares of Class A common stock subject to option at
the time of the merger times (b) the excess of $7.00 over the exercise price per
share. Unless an optionee elects to receive cash in the merger, Celestica will
assume each option to purchase Class A common stock of the Company in accordance
with the terms of the stock option plan under which the option was issued, but
converted as described above to an option to purchase subordinate voting shares
of Celestica.
In addition, each option to purchase Class A common stock of the Company
that has an exercise price that is $7.00 or more will be repriced to $17.50 per
subordinate voting share of Celestica (after taking into account the change in
the number of options based on the Exchange Ratio) if approved by The Toronto
Stock Exchange and the Montreal Stock Exchange (or, if not, $18.31 per
subordinate voting share of Celestica, the closing price of such shares on the
New York Stock Exchange on the last trading day before the announcement of the
merger agreement). If Celestica is not permitted by applicable law or stock
exchange rules to assume options to purchase Class A common stock of the
Company, Celestica shall issue new subordinate voting shares and/or options to
purchase subordinate voting shares to provide the comparable economic value to
each holder of options to purchase Class A common stock of the Company.
The total transaction value, including consideration for shares, stock
options and assumption of debt, is approximately $160.0 million. As a result of
the Merger, the Company will become a wholly owned subsidiary of Celestica. The
merger agreement was approved by the Board of Directors of both Celestica and
the Company and is subject to approval by stockholders of the Company. Subject
to satisfaction of the conditions to closing in the merger agreement, the
transaction is scheduled to close at the end of calendar 1998.
The Company's line of credit with Union Bank of California, N.A. and The
First National Bank of Boston, N.A. requires it to comply with certain financial
covenants, including a covenant requesting the Company to maintain a minimum
level of profitability. For the quarter ended October 31, 1998, the Company was
in violation of this profitability covenant and has obtained a waiver of this
covenant from its lenders.
On November 17,1998 Syquest Technology Inc. ("Syquest"), one of the
Company's customers, filed a petition for protection under Chapter 11 of the
U.S. Bankruptcy Code. The Company has written off asset balances aggregating
$2.6 million that it was holding for Syquest in the quarter ended October 31,
1998.
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ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This quarterly report on Form 10-Q contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements include expectations, beliefs, intentions or strategies regarding
future operating results, future expenditures, future cash requirements, and
future industry conditions and involve risks and uncertainties. The Company's
actual results could differ materially from those projected in such
forward-looking statements as a result of certain factors, including those set
forth under "Factors That May Affect Future Operating Results" below and
elsewhere in this report on Form 10-Q. A more detailed discussion of risks faced
by the Company is set forth in the Company's Registration Statement on Form S-1
(SEC File No. 333-34557) filed with the SEC in connection with the Company's
initial public offering, in the Company's Annual Report on Form 10-K for the
fiscal year ended April 30, 1998, and in Celestica's Registration Statement on
Form F-4 filed on November 13, 1998 with the SEC in connection with the
Company's proposed merger with Celestica. This analysis should be read in
conjunction with the Company's Management Discussion & Analysis of Financial
Condition and Results of Operations for the fiscal year ended April 30, 1998
included in the Company's Annual Report on Form 10-K filed with the SEC.
OVERVIEW
International Manufacturing Services, Inc. provides product design,
prototyping, printed circuit board assembly, final system assembly, materials
procurement, inventory management, testing, packaging, distribution and depot
repair services to original equipment manufacturers in the electronics industry.
The Company's Hong Kong operations, which commenced business in 1983,
were acquired in 1990 by Maxtor Corporation ("Maxtor"), a manufacturer of hard
disk drives, along with other manufacturing operations and assets. International
Manufacturing Services, Inc. was formed in November 1994 as a wholly-owned
subsidiary of Maxtor. In June 1996 the Company was recapitalized as an
independent company.
To accomplish such recapitalization, the Company redeemed approximately
76.5% of Maxtor's share ownership with a combination of $25.0 million cash,
$20.0 million principal senior subordinated notes (the "Maxtor Notes") and a
warrant for 300,000 shares of Class A common stock. The Company raised the cash
portion of the redemption price by issuing to a group of investors a combination
of common stock, preferred stock and junior subordinated notes. The redemption
and share transactions are hereafter referred to as the "Recapitalization". For
accounting purposes, the redemption of Maxtor's share ownership was treated as a
recapitalization and, accordingly, no change in the accounting basis of the
Company's assets was made. After the closing of the Company's initial public
offering in October 1997, the Company repaid the Maxtor Notes, and the warrant
was automatically terminated in accordance with its terms.
Prior to fiscal 1996, substantially all the Company's revenues were
derived from sales to Maxtor. In connection with the Recapitalization, Maxtor
agreed to purchase from the Company certain quarterly minimum quantities of
products through June 1999, provided that the Company continues to be
competitive on the basis of price and quality. Over the last two fiscal years,
the Company has evolved from being a captive EMS provider to Maxtor to an
independent EMS provider serving many customers. These customers collectively
represented approximately 73.0% of total revenues for the six months ended
October 31, 1998. The Company typically enters into manufacturing contracts with
each of its customers, but has no long-term volume purchase commitments from any
customer other than Maxtor. The Company remains dependent upon a relatively
small number of customers for a significant percentage of its revenues. For
fiscal 1996, 1997, 1998 and the six months ended October 31, 1998, Maxtor
accounted for approximately 83.1%, 48.6%, 41.5% and 27.0% of total revenues, and
Nortel Networks, Inc. (formerly Bay Networks, Inc.) ("Nortel Networks")
accounted for approximately 1.6%, 31.3%, 36.5% and 23.5% of total revenues. For
the six months ended October 31, 1998 of the total revenues derived from sales
to Nortel Networks, 46.8% consisted of manufacturing revenues and 53.2%
consisted of logistics service revenue.
During fiscal 1997, the Company took significant steps to expand its
manufacturing operations and to broaden the range of the manufacturing services
it provides to its customers. As part of its strategy to locate operations in
low cost regions, the Company transferred its Hong Kong manufacturing operations
to China while retaining its component procurement and regional administrative
functions in Hong Kong. In connection with this relocation, the Company
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recorded a charge of $3.0 million associated with employee severance and excess
facilities costs. The Company also expanded its manufacturing facilities in
Thailand over the last two years from 41,000 square feet to 220,000 square feet.
Moreover, in July 1998, the Company signed an agreement to lease a 112,000
square foot facility in Monterrey, Mexico, which is being constructed over the
next several months.
In order to broaden the range of services the Company offers, in January
1997 the Company acquired the assets of Pentagon Systems, a design and prototype
production company, for $4.4 million cash, 450,000 shares of Class A common
stock and assumed certain liabilities. The Company recorded goodwill of $3.4
million in connection with the acquisition, which is being amortized over seven
years on a straight line basis. In May 1997, the Company commenced manufacturing
operations in San Jose, California. In March 1998, the Company relocated its
United States operations to a new 80,000 square foot facility combining the
Company's full systems manufacturing operations with its design and prototype
production activities. Recently, the Company was qualified by and received
orders from three companies, including two from significant telecommunications
companies for backplane assembly. Although, backplane business has historically
represented an insignificant percentage of the Company's total revenues, the
Company believes it is strategically important over the longer term, as it
broadens the Company's service offerings and allows the Company to differentiate
itself from certain of its competitors. In May 1998, the Company began providing
full distribution services for the Netgear division of Nortel Networks from both
its Hong Kong and San Jose facilities. The revenue from such services had been
reported as logistics services revenue in the accompanying condensed
consolidated statements.
The Company has chosen to locate its manufacturing facilities in certain
countries in Asia to improve operational efficiencies and to take advantage of
generally lower income tax rates and the availability of tax incentives extended
to encourage foreign investment. The Company has operating subsidiaries located
in foreign countries, some of which enjoy multiple year tax holidays. As a
result, the Company estimates its effective tax rate for fiscal 1999 to be
approximately 14.0%. The Company does not expect to receive any tax benefits
associated with conducting business in Mexico and, if the Company's Mexican
operations become profitable, the Company would likely experience a higher
worldwide effective tax rate.
The Company's total revenues and overall gross margins may fluctuate
significantly from period to period depending upon the mix of revenues derived
from turnkey and consignment manufacturing. Gross margins may also be impacted
by the mix of sales to customers in each industry segment. The extent to which
revenues are generated on a turnkey or consignment basis has a significant
effect on the level of the Company's total revenue and gross margins. For
revenues generated on a turnkey basis, the Company generally procures all
materials used to manufacture the customer's product, which results in higher
revenue per unit. For revenues generated on a consignment basis, the customer
procures the materials and provides them to the Company at no charge. As a
result, revenues from turnkey manufacturing tend to be higher and gross margins
tend to be lower than revenues and margins generated from consignment
manufacturing. The Company's agreement with Maxtor permits Maxtor to consign
component parts to the Company from time to time. The Company believes that
Maxtor and other customers consider various factors in choosing to allocate
procurement responsibility to the Company, including their relationships with
key component suppliers and their ability to obtain components at lower prices
than are obtainable by the Company. Furthermore, gross margins on revenues
generated from sales to companies in the computer peripherals industry tend to
be lower than gross margins on revenues generated from sales to companies in the
data communications and telecommunications industries whose products are often
more complex. The Company's percentage of sales to customers in the computer
peripherals industry in fiscal 1998, and the six months ended October 31, 1998
was approximately 46.0% and 58.6% of total revenues, respectively. Because none
of the Company's customers, including Maxtor, is committed over the long term to
any particular manufacturing basis, the Company is unable to predict the mix of
revenues derived from turnkey and consignment manufacturing for any future
period.
In October 1997, the Company completed its initial public offering,
pursuant to which the Company issued 5,000,000 shares of its Class A Common
Stock to the public at a price of $11.50 per share and received cash of
approximately $52.4 million, net of underwriting discounts and commissions and
estimated expenses (the "IPO").
The Company is currently in the process of updating its information
systems to be Year 2000 compliant and, in this regard, has expended
approximately $ 2.2 million as of October 31, 1998, of which $1.9 million was
capitalized for hardware and software, and $0.3 million was expensed for
consulting and training. The Company expects its information systems to be Year
2000 compliant by the end of fiscal 1999 and expects to spend an additional $2.0
to $3.0
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million on the project. To date the Company has not completed an assessment for
any third party Year 2000 issues with its customers and vendors but intends to
do so over the next few months. Once this assessment is completed, the Company
does not anticipate any disruption in manufacturing services provided to its
customers resulting from third party Year 2000 issues which would result in any
material adverse effect to the results of its operations: however, no assurance
can be given that such disruption will not result from any third party Year 2000
issues.
RECENT DEVELOPMENTS
On November 2, 1998 the Company announced that it had entered into a
definitive merger agreement with Celestica and Merger Sub, a wholly owned
subsidiary of Celestica. Pursuant to the merger agreement, at the effective time
of the merger the Company will be merged with and into Merger Sub, with Merger
Sub becoming the surviving corporation. In addition, at the effective time of
the Merger each outstanding share of Class A and Class B common stock of the
Company will be converted into the right to receive 0.4 of a subordinate voting
share of Celestica or, at the election of the stockholder, $7.00 in cash.
Similarly, each option to purchase Class A common stock of the Company
will convert into an option to purchase 0.40 of a subordinate voting share of
Celestica at an adjusted exercise price or, for vested options with an exercise
price of less than $7.00 per share, the holders of such options will have the
choice of receiving a cash payment equal to the product of (a) the number of
shares of Class A common stock subject to option at the time of the merger times
(b) the excess of $7.00 over the exercise price per share. Unless an optionee
elects to receive cash in the merger, Celestica will assume each option to
purchase Class A common stock of the Company in accordance with the terms of the
stock option plan under which the option was issued, but converted as described
above to an option to purchase subordinate voting shares of Celestica.
In addition, each option to purchase Class A common stock of the Company
that has an exercise price that is $7.00 or more will be repriced to $17.50 per
subordinate voting share of Celestica (after taking into account the change in
the number of options based on the Exchange Ratio if approved by The Toronto
Stock Exchange and the Montreal Stock Exchange (or, if not, $18.31 per
subordinate voting share of Celestica, the closing price of such shares on the
New York Stock Exchange on the last trading day before the announcement of the
merger agreement). If Celestica is not permitted by applicable law or stock
exchange rules to assume option to purchase Class A common stock of the Company,
Celestica shall issue new subordinate voting shares and/or options to purchase
subordinate voting shares to provide the comparable economic value to each
holder of options to purchase Class A common stock of the Company.
The total transaction value, including consideration for shares, stock
options and assumption of debt, is approximately $160.0 million. As a result of
the Merger, the Company will become a wholly owned subsidiary of Celestica. The
merger agreement was approved by the Board of Directors of Celestica and the
Company and is subject to approval by stockholders of the Company. Subject to
satisfaction of the conditions to closing in the merger agreement, the
transaction is scheduled to close at the end of calendar 1998.
The Company's line of credit with Union Bank of California, N.A. and The
First National Bank of Boston, N.A. requires it to comply with certain financial
covenants, including a covenant requesting the Company to maintain a minimum
level of profitability. For the quarter ended October 31, 1998, the Company was
in violation of this profitability covenant and has obtained a waiver of this
covenant from its lenders.
On November 17,1998 Syquest, one of the Company's customers, filed a
petition for protection under Chapter 11 of the U.S. Bankruptcy Code. The
Company has written off asset balances aggregating $2.6 million that it was
holding for Syquest in the quarter ended October 31, 1998.
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total revenues.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31, October 31, October 31,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenues:
Affiliates 30.5% 45.1% 27.0% 45.8%
Other 52.3 54.9 60.5 54.2
Logistics Services 17.2 -- 12.5 --
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues 96.8 90.2 94.7 90.2
----- ----- ----- -----
Gross profit 3.2 9.8 5.3 9.8
----- ----- ----- -----
Selling, general & administrative expenses 5.6 4.2 4.1 4.2
----- ----- ----- -----
Total operating expenses 5.6 4.2 4.1 4.2
Operating income (loss) (2.4) 5.6 1.2 5.6
Interest expense, net 0.8 1.7 0.6 1.8
----- ----- ----- -----
Income (loss) before income taxes (3.2) 3.9 0.6 3.8
Provision (benefit) for income taxes (0.4) 0.5 0.1 0.5
----- ----- ----- -----
Net income (loss) (2.8) 3.4 0.5 3.3
===== ===== ===== =====
</TABLE>
Total Revenues
Total revenues increased 17.5% from $75.4 million for the three months
ended October 31, 1997 to $88.6 million for the three months ended October 31,
1998. Total revenues increased 56.1% from $140.1 million for the six months
ended October 31,1997 to $218.7 million for the six months ended October 31,
1998. This increase in total revenues for the three and six month periods was
primarily due to an increase in sales volume from existing and new customers and
the addition of $15.2 million of revenue derived from the provision of logistics
services to Netgear (a division of Nortel Networks). Logistics services revenue
consists of sales to customers of product that is purchased from a supplier
(often designated by such customer), and then is tested, configured and packaged
for distribution to the end user or retailer. In addition, the Company's
logistics services consists of order management and call center support to the
end user or retailer on behalf of a customer.
The Company's largest customers during the three months ended October
31, 1998 were Maxtor, Nortel Networks and Matrox Graphics, Inc., with sales
accounting for approximately 30.5%, 29.5%, and 17.8% of total revenues,
respectively. The Company's largest customers during the six months ended
October 31, 1998 were Maxtor, Nortel Networks and Diamond Multimedia Systems,
Inc. ("Diamond"), with sales accounting for approximately 27.0%, 23.5% and 20.4%
of total revenues, respectively. The Company currently expects future orders
from Maxtor, Matrox and Diamond to grow from the levels obtained in the three
months ended October 31, 1998 however, due to demand volatility for some of
these customers' products, particularly those in the computer peripherals
industry, there can be no assurance that continued levels of volumes and
associated revenues will continue in the foreseeable future.
Gross Profit
Gross profit for the three months ended October 31, 1998 decreased to
$2.8 million from $7.4 million for the three months ended October 31, 1997.
Gross margin (gross profit as a percentage of total revenues) decreased to 3.2%
from 9.8% for the same periods. Gross profit for the six months ended October
31, 1998 decreased to $11.6 million from $13.7 million for the six months ended
October 31, 1997. Gross margin for the same periods decreased to 5.3% from 9.8%.
Gross profit and gross margin for the three month and six month periods ended
October 31, 1998 were
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<PAGE> 13
negatively impacted by the reserve of $1.6 million primarily for inventory
balances held for Syquest, which filed a petition under Chapter 11 of the U.S.
Bankruptcy Code on November 17, 1998. In addition, 58.0% of total sales in the
three and six months ended October 31, 1998 were to customers in the computer
peripherals industry. These sales tend to generate lower gross margins. Also, in
the six months ended October 31, 1998 $27.0 million in revenues were derived
from logistics services which generate lower gross margins. Finally, the
downturn in the Asian economic condition in recent months has resulted in
significant excess capacity in many Asia-based contract manufacturers and
increased pricing pressures in that region. Furthermore, reduced orders from two
of the Company's customers during the three months ended October 31, 1998
resulted in the Company experiencing additional excess capacity. Such excess
capacity has resulted in a further negative impact on gross margins.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 55.1% from $3.2
million for the three months ended October 31, 1997 to $5.0 million for the
three months ended October 31, 1998. Selling, general and administrative
expenses increased 52.1% from $5.9 million for the six months ended October 31,
1997 to $8.9 million for the six months ended October 31, 1998. These increases
in absolute dollars for the three months ended October 31, 1998 and the six
months ended October 31, 1998 were primarily the result of an increase in the
Company's bad debt reserve by $1.3 million to cover accounts receivable balances
owed to the Company by Syquest which filed a petition under Chapter 11 of the
U.S. Bankruptcy Code on November 17, 1998, and to a lesser extent, increased
administrative expenses in Hong Kong and the United States related to expanding
operations and the implementation of a new enterprise resource planning system.
Net Interest Expense
Net interest expense decreased from $1.2 million in the three months
ended October 31, 1997 to $0.7 million in the three months ended October 31,
1998 and decreased from $2.5 million in the six months ended October 31, 1997 to
$1.3 million for the six months ended October 31, 1998. These decreases in net
interest expense during the three and six months ended October 31, 1998 were
primarily due to the repayment of the Maxtor Notes upon completion of the
Company's initial public offering in October 1997, and a reduction in financing
related interest expense, offset in part by increased bank borrowings.
Provision for Income Taxes
The Company's income tax provision for the three and six months ended
October 31, 1998 and the three and six months ended October 31, 1997 was
computed using an effective tax rate of 14.0%. This rate is based upon the
Company's estimation of its geographic distribution of income for fiscal years
1998 and 1999. This rate is lower than the United States Federal statutory rate
of 35.0% due primarily to the fact that income generated by the Company's
foreign operations is subject to lower or no foreign income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Prior to June 1996, the Company was a wholly-owned subsidiary of Maxtor
and funded its operations through cash provided by operations and intercompany
financing provided by Maxtor. Since the Recapitalization, the Company has funded
its working capital needs and capital expenditures through proceeds of the
initial public offering, borrowings under its credit facility and cash provided
by operations. At October 31, 1998, the Company's principal sources of liquidity
consisted of its cash and cash equivalents provided by operations and available
borrowings under the Company's credit facilities.
During the six months ended October 31, 1998, cash generated by
operating activities was $13.1 million. During the six months ended October 31,
1997 $8.2 million of cash was consumed by operating activities. Cash generated
from operations in the six months ended October 31, 1998 was primarily
attributable to increases in accounts payable and decreases in inventory, offset
in part by increased levels of accounts receivable.
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<PAGE> 14
Cash used in investing activities for the six months ended October 31,
1998 and the six months ended October 31, 1997 was $9.5 million and $6.5 million
respectively. The investing activity in both periods was related primarily to
the purchase of equipment and leasehold improvements associated with expanding
the Company's operations in Thailand, China and the United States.
During the six months ended October 31, 1998, the Company generated $2.8
million from financing activities. This includes $0.8 million of net proceeds
from the issuance of Class A common stock under the Company's various employee
stock benefit plans during the period and $2.0 million in additional borrowings
from its line of credit. During the six months ended October 31, 1997, the
Company generated $32.5 million from financing activities. This included $52.5
million of net proceeds from the issuance of Class A common stock in its IPO
offset in part by a repayment of $20 million of subordinated debt owed to
Maxtor.
At March 31, 1998, the Company established a new committed line of
credit with Union Bank of California, N.A. and The First National Bank of
Boston, N.A., that, subject to certain limitations, provides up to $30.0 million
of borrowing capacity to fund working capital and capital expenditures. In July
1998, the Company increased the availability under the line from $30 million to
$40 million. Availability under this line is restricted to a percentage of
qualified accounts receivable. The level of qualified accounts receivable at
October 31, 1998 was sufficient to allow full usage of the line. This line is
secured by a pledge of the stock of certain indirect subsidiaries of the
Company. This line of credit expires March 31, 2000. At October 31, 1998,
borrowings under the line of credit were $8.0 million, compared to $6.0 million
at April 30, 1998. At October 31, 1998 the effective interest rate under the
line of credit was approximately 6.5%.
The line of credit requires the Company to comply with certain financial
conditions, including minimum level of profitability and tangible net worth,
minimum financial ratios including a current assets to current liabilities
ratio, earnings before interest expense and income tax to interest expense
ratios, and a maximum ratio of funded debt to earnings before interest expense,
income taxes, depreciation and amortization expenses. The line of credit also
imposes certain restrictions, including limits on amounts attributable to
capital leases, performance bonds, permitted investments, dividends, employee
loans, prepayments of other indebtedness, and capital expenditures. For the
quarter ended October 31, 1998, the Company was in compliance with all such
financial covenants and restrictions except for the covenant which requires that
the Company maintain a minimum level of profitability. The Company has obtained
a waiver from its lender group of the financial covenant requiring profitable
operations for the quarter ended October 31, 1998.
The Company's future liquidity and cash requirements will depend upon
many factors, including the level of its operations, the degree and pace of
expansion or acquisition of facilities and adoption of new manufacturing
technology, and the mix of revenues derived from consignment and turnkey
operations. The Company anticipates that its planned purchases of capital
equipment for fiscal 1999 will aggregate approximately $25.0 million, of which
approximately $9.5 million have been made as of October 31, 1998. The Company
believes that funds available under its line of credit and any cash generated
from operations will be sufficient to fund its currently anticipated working
capital, capital expenditure and debt service requirements for fiscal 1999.
Nonetheless, in the event that the Company experiences significant continued
growth, the Company may need to finance such growth and any corresponding
working capital needs, with additional public and private offerings of debt or
equity securities. There can be no assurance as to the availability of such
financing or, if available, the terms thereof.
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<PAGE> 15
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
In addition to the other information in this report on Form 10-Q and to
the information contained on the Company's and Celestica's recent filings with
the SEC, the following are important factors that should be carefully considered
in evaluating the Company and its business.
Risks Related to the Merger
Various risks related to the Merger with Celestica could have a material
adverse effect on the Company's business and results of operations. Among other
things, the Merger will not achieve its anticipated benefits unless Celestica
can successfully integrate the Company's operations into its business in a
timely manner. Expansion causes strain on Celestica's infrastructure, including
its managerial, technical, financial and other resources. Celestica may
experience certain inefficiencies as it integrates the Company and other new
operations into its business and manages geographically dispersed operations. We
cannot assure you that Celestica will be able to manage its expansion
effectively, and a failure to do so could materially and adversely affect
Celestica and the Company. Furthermore the Company cannot assure you that its
customers would continue to utilize the Company's services at levels consistent
with their current or historical utilization, or that customers will not defer
their decision to use the Company's services as they evaluate the Merger.
However, Celestica and the Company could be materially adversely affected if
facilities acquired by Celestica, including the Company's facilities, do not
achieve growth sufficient to offset increased expenditures associated with
Celestica's expansion. In addition, the Company expects to incur significant
expenses in connection with the proposed Merger, whether or not it is
consummated. [If the Merger is not consummated, such expenses, which may include
the "break up" fees described in the section entitled "Recent Developments"
above, could materially and adversely affect the Company's results of
operations.]
In addition, at the time of the merger, each outstanding share of common
stock of the Company ("IMS Common Stock") will be converted into the right to
receive 0.40 of a Subordinate Voting Share of Celestica (a "Subordinate Voting
Share") or, at the election of the holder of such shares, $7.00 in cash (the
"Cash Consideration"), subject to pro-ration. Because both the Cash
Consideration and the Exchange Ratio are fixed, they will not increase or
decrease due to fluctuations in the market price of the common stock of either
Celestica or the Company. The specific value of the stock consideration to be
received by IMS stockholders in the Merger will depend on the market price of
the Subordinate Voting Shares at the time of the Merger. Subordinate Voting
Shares and IMS Common Stock have historically been subject to substantial price
volatility. We expect that the market prices of Subordinate Voting Shares and
IMS Common Stock will continue to fluctuate before the time of the Merger.
Variability of Operating Results
The primary factors affecting the Company's annual and quarterly
operating results are: timing of customer orders; price competition; volume of
orders received relative to the Company's capacity; announcements, introductions
and market acceptance of a customer's new products; evolution in the life cycles
of customer products; timing of expenditures in anticipation of future customer
orders; effectiveness in managing manufacturing processes; changes in cost and
availability of labor and components; fluctuations in material costs; the mix of
material costs relative to labor and manufacturing overhead costs; and the mix
of revenues derived from consignment and turnkey manufacturing (consignment
manufacturing, where the customer procures materials, tends to result in higher
gross margins but lower revenues, and turnkey manufacturing, where the Company
procures materials, tends to result in lower gross margins but higher revenues).
Other factors affecting operating results include the Company's level of
experience in manufacturing a particular product, the degree of automation used
in the assembly process, the efficiencies achieved by the Company in managing
inventories and fixed assets, and customer product delivery requirements. An
adverse change in any one of these factors or a combination thereof could have a
material adverse effect on the Company's future business, financial condition or
results of operations.
The Company has no long-term volume purchase commitments from any
customer other than Maxtor. From time to time, the Company may procure materials
without a customer purchase commitment. The Company must continually make other
significant decisions based on estimates of future conditions, including the
level of business that it will accept, production schedules, personnel needs and
other resource requirements. A variety of conditions, however,
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<PAGE> 16
both specific to particular customers and generally affecting the market
segments served by the Company, may cause customers to cancel, reduce or delay
orders. The level and timing of a customer's orders may vary due to a number of
factors including product design changes, the customer's attempts to balance its
inventory, changes in the customer's manufacturing strategy, acquisitions of or
consolidations among customers, and variations in demand for the customer's
products. Most of the Company's customers typically do not commit to firm
delivery dates more than one quarter in advance. The Company's inability to
forecast the level of customer orders with certainty makes it difficult to
schedule production and maximize utilization of manufacturing capacity. In the
past, anticipated orders from several of the Company's customers have failed to
materialize or have been deferred in certain cases. On other occasions,
customers have required rapid increases in production which have placed a
significant burden on the Company's resources. Such customer order fluctuations
and deferrals have had a material adverse effect on the Company's results of
operations in the past, and there can be no assurance that the Company will not
experience such effects in the future. In addition, the Company's customers have
the ability to request that manufacturing be performed on a consignment, turnkey
or partial turnkey basis, which can cause significant fluctuations in the
Company's revenues and gross margins.
The Company's business has experienced and is expected to continue to
experience significant seasonality due to, among other things, the slowdown
during the summer months, which historically has occurred in the electronics
industry. In addition, the market segments served by the Company are subject to
economic cycles and have in the past experienced, and are likely in the future
to experience, recessionary periods. A recessionary period affecting the
industry segments served by the Company could have a material adverse effect on
the Company's business, financial condition and results of operations. The
Company occasionally experiences constraints in production capacity around
national holidays in Thailand and China. Results of operations in any period
should not be considered indicative of the results to be expected for any future
period, and fluctuations in operating results may also result in variations in
the price of the Class A Common Stock. In future periods, the Company's total
revenues or results of operations may be below the expectations of public market
analysts and investors; in such event, the price of the Class A Common Stock
would likely be materially adversely affected.
Customer Concentration; Dependence on Certain Industries
For fiscal 1996, fiscal 1997, fiscal 1998 and for the six months ended
October 31, 1998, Maxtor accounted for approximately 83.1%, 48.6%, 41.5% and
27.0% of total revenues, respectively, and Nortel Networks accounted for
approximately 1.6%, 31.3%, 36.5% and 23.5% of the Company's total revenues,
respectively. The Company expects to continue to depend upon a relatively small
number of customers for a significant percentage of its total revenues. There
can be no assurance that the Company's principal customers will continue to
purchase services from the Company at current levels, or at all. In the past,
certain of the Company's customers have significantly reduced or delayed the
volume of manufacturing services ordered from the Company. There can be no
assurance that present or future customers will not terminate their
manufacturing arrangements with the Company or significantly change, reduce or
delay the manufacturing services ordered from the Company. Significant
reductions in sales to any of the Company's principal customers, or the loss of
any one or more major customers, would have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
has no long-term volume purchase commitments from any customers other than
Maxtor. The timely replacement of canceled, delayed or reduced contracts with
new business cannot be assured. These risks are accentuated because a majority
of the Company's sales are to customers in the electronics industry, which is
subject to rapid technological change and product obsolescence. Accordingly, the
Company is dependent upon the continued growth, viability and financial
stability of its customers, which are in turn substantially dependent on the
growth of the computer peripherals, data communications and telecommunication
markets. The industry is cyclical and has historically experienced periods of
oversupply and varying growth rates resulting in reduced demand and pricing
pressures on computer peripherals products. Any factors adversely affecting the
electronics industry in general, or any of the Company's major customers in
particular, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Risk of Defects
The electronics products manufactured for customers by the Company are
highly complex and at times may contain design or manufacturing defects which
cannot be detected by product acceptance test procedures. Such defects have been
discovered in the past, and there can be no assurance that, despite the
Company's quality control and quality
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<PAGE> 17
assurance efforts, such defects will not occur in the future. In the event such
defects occur, the Company could be forced to devote significant resources to
remedy the defect, which could have a material adverse effect on the Company's
business and operating results.
Maxtor Corporation - Business Risks; Affiliation
Maxtor historically has been the Company's largest customer. Maxtor
develops, manufactures and markets hard disk drive storage products for personal
computer systems. Maxtor's business depends in large part upon its ability to
continue to develop and market new hard disk drive products successfully. Any
adverse developments affecting Maxtor could adversely affect its demand for the
Company's services. Maxtor has experienced losses in each of the past five
fiscal years. During the first half of fiscal 1997, orders from Maxtor were
reduced significantly below what the Company expected, and the Company's
operating results were adversely affected. The loss of Maxtor's sales volume or
a significant portion thereof would have a material adverse effect on the
Company's business, financial condition and results of operations.
Maxtor is contractually entitled to one representative on the Company's
Board of Directors. Although Maxtor and the Company have separate managements
and boards of directors, Maxtor is a major customer of the Company, a major
stockholder, and an executive officer of Maxtor is a member of the Company's
board of directors. This creates the risk that the Company may give preference
to Maxtor over other customers in the allocation of components in short supply
or production capacity or in the pricing of manufacturing services. Concern over
such risks could affect the willingness of customers and potential customers of
the Company to conduct business with the Company. In an attempt to reduce
potential pricing and other conflicts, in June 1996, the Company and Maxtor
executed a three-year manufacturing services agreement (the "Manufacturing
Agreement"), the terms of which the Company believes are no less favorable to
the Company and no more favorable to Maxtor than arrangements that either
company could negotiate with others in an arm's-length transaction. Pursuant to
the Manufacturing Agreement, the Company has agreed to provide certain products
and services to Maxtor at competitive prices per unit. In addition, Maxtor has
agreed to place purchase orders for the Company's manufacture of such products
in accordance with certain minimum quarterly volume purchase commitments, which
commitments decrease upon each twelve month anniversary of the effective date of
the Manufacturing Agreement. Maxtor's commitment to place purchase orders for
the Company's manufacture of products is conditioned upon the Company's
providing products competitive in both price and quality with alternative
suppliers of Maxtor. In the event that Maxtor determines that the products the
Company manufactures are not price or quality competitive, and the Company fails
within a specified time period to become competitive in price or quality, then
Maxtor's quarterly volume purchase commitments shall be reduced to the extent
that products are not price or quality competitive. In addition, Maxtor has a
second source supplier of services provided by the Company. Conflicts of
interest could arise, however, notwithstanding such agreement or upon its
termination or renegotiation.
Short Period of Independent Operations; No Assurance of Future Profitability
The Company's Hong Kong operations, which commenced business in 1983,
were acquired in 1990 by Maxtor, a manufacturer of hard disk drives, along with
other manufacturing operations and assets. International Manufacturing Services,
Inc. was formed in November 1994 as a wholly-owned subsidiary of Maxtor. In June
1996, the Company was recapitalized as an independent company. Through December
1996, the Company was dependent upon Maxtor for certain financial and
administrative services. The Company has limited experience operating as an
independent entity, and there can be no assurance that it will be able to
operate effectively as an independent company. The Company only began
implementing independent financial and consolidated reporting systems and
procedures in June 1996. The Company believes that continued enhancements in
financial, management and operational information systems will be needed to
manage any expansion of the Company's operations. The failure to implement such
enhancements could have a material adverse effect upon the Company's business,
financial condition and operating results.
The Company's limited history of operations as an independent entity
make reliable predictions of future operating results difficult. In particular,
the Company's performance to date should not be considered indicative of future
results. There can be no assurance that any of the Company's business strategies
will be successful or that the Company will be able to sustain growth or
profitability on an annual or quarterly basis.
Limited Availability of Materials
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<PAGE> 18
A significant portion of the Company's total revenues is derived from
turnkey manufacturing, in which the Company performs both materials procurement
and assembly services and bears the risk of materials price increases. Almost
all products manufactured by the Company require one or more materials that are
ordered from single or sole sources. Some of these materials are allocated by
such single or sole sources in response to supply shortages. In some cases,
supply shortages may substantially curtail the Company's production of all
assemblies using that component. Further, at various times there have been
industry wide shortages of electronic components, particularly DRAMs, memory
modules, logic devices, microprocessors, specialized capacitors, crystals, ASICs
and other integrated circuits. From time to time, the Company has experienced
supply shortages with respect to various types of these components, although
such shortages have not had a material adverse effect on the Company's operating
results. Nonetheless, materials shortages in the future could result in
manufacturing and shipping delays or price increases, which could have a
material adverse effect on the Company's business, financial condition or
results of operations. Further, the Company relies on a variety of common
carriers for materials transportation and routes its materials through various
world ports. Any disruption in a common carrier for reason of work stoppage or
strike or the shutdown of a major port or airport could result in manufacturing
and shipping delays or expediting charges which could have a material adverse
effect on the Company's business, financial condition or results of operations.
Competition
The electronics assembly and manufacturing industry is intensely
competitive and includes numerous local, national and international companies, a
number of which have achieved substantial market share. The Company believes
that the primary competitive factors in its targeted markets are cost,
manufacturing technology, product quality, responsiveness and flexibility, the
range of services provided and the location of facilities. To be competitive,
the Company must provide technologically advanced manufacturing services, high
product quality levels, flexible production schedules and reliable delivery of
finished products on a timely and price competitive basis. Failure to satisfy
any of the foregoing requirements could materially and adversely affect the
Company's competitive position. The Company competes against numerous domestic
and foreign manufacturers, including Flextronics International Ltd., Jabil
Circuits, Inc., Sanmina Corporation, SCI Systems, Inc. ("SCI") and Solectron
Corporation, as well as certain large Asia entities. The Company also faces
indirect competition from the manufacturing operations of its current and
prospective customers, which continually evaluate the merits of manufacturing
products internally rather than using the services of EMS providers. Many of the
Company's competitors have more geographically diversified international
operations, as well as substantially greater manufacturing, financial, volume
procurement, research and development, and marketing resources than the Company.
In recent years, the EMS industry has attracted new entrants, including large
OEMs with excess manufacturing capacity, and many existing participants have
substantially expanded their manufacturing capacity by expanding their
facilities and adding new facilities through both internal expansion and
acquisitions. In the event of a decrease in overall demand for EMS services,
this increased capacity could result in substantial pricing pressures, which
could have a material adverse effect on the Company's business, financial
condition or operating results.
Future Capital Needs
The Company believes that, in order to achieve its long-term expansion
objectives and maintain and enhance its competitive position, it will need
significant financial resources over the next several years for capital
expenditures including investments in management information systems, working
capital and debt service. The Company has added significant manufacturing
capacity and increased capital expenditures over the past year. It has relocated
its Hong Kong manufacturing facilities to China, expanded its facilities in
Thailand, established a manufacturing facility in San Jose and, through the
acquisition of Pentagon Systems established a design and prototype production
operation in San Jose. Recently the Company committed to leasing additional
space in its China facility and entered into a new lease agreement to establish
a new manufacturing facility in Mexico, both of which will require additional
leasehold improvements and manufacturing equipment. The Company also continues
to invest in manufacturing equipment and management information systems. The
Company anticipates that its capital expenditures will continue to increase as
the Company expands its facilities in Asia and North America, invests in
necessary manufacturing equipment and continues to invest in new technologies
and equipment to increase the performance and the cost efficiency of its
manufacturing operations. Currently the Company has limited cash resources and
significant future obligations, and expects that it will require additional
capital to support future growth, if any. The precise amount and timing of the
Company's future funding
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<PAGE> 19
needs cannot be determined at this time and will depend upon a number of
factors, including the demand for the Company's services and the Company's
management of its working capital. The Company may not be able to obtain
additional financing on acceptable terms or at all. If the Company is unable to
obtain sufficient capital, it could be required to curtail its capital
expenditures and facilities expansion, which could materially adversely affect
the Company's business, financial condition and results of operations. Moreover,
the Company's need to raise additional capital through the issuance of equity
securities may result in additional dilution to earnings per share.
Risks of International Operations
Substantially all of the Company's manufacturing operations are located
in Thailand and China. The distance between Asia and the United States creates
logistical barriers, and the Company's success depends in part on its ability to
convince OEMs in the United States that the advantages of the Company's
Asia-based manufacturing facilities outweigh any perceived inconvenience or
uncertainty of overseas manufacturing.
The Company may be affected by economic and political conditions in each
of the countries in which it operates and certain other risks of doing business
abroad, including import duties, changes to import and export regulations
(including quotas), possible restrictions on the transfer of funds, employee
turnover, labor or civil unrest, long payment cycles, greater difficulty in
collecting accounts receivable, the burdens and cost of compliance with a
variety of foreign laws, and, in certain parts of the world, political
instability. For example, the Company could be adversely affected if the current
policies encouraging foreign investments or foreign trade by Thailand and China
were to be abandoned. In addition, the attractiveness of the Company's services
to its United States customers is affected by United States trade policies, such
as "most favored nation" status and trade preferences, which are reviewed
periodically by the United States government. In the past, United States
government officials have discussed the possible refusal of the United States to
extend China's "most favored nation" status. Changes in policies by the United
States or foreign governments could result in, for example, increased duties,
higher taxation, currency conversion limitations, hostility toward United
States-owned operations, limitations on imports or exports, or the expropriation
of private enterprises, any of which could have a material adverse effect on the
Company's business, financial condition or results of operations.
The Company's operations and assets are subject to significant
political, economic, legal and other uncertainties in Hong Kong, China and
Thailand. Under its current leadership, the Chinese government has been pursuing
economic reform policies, including the encouragement of foreign trade and
investment and greater economic decentralization. No assurance can be given,
however, that the Chinese government will continue to pursue such policies, that
such policies will be successful if pursued, or that such policies will not be
significantly altered from time to time. Moreover, despite progress in
developing its legal system, China does not have a comprehensive and highly
developed system of laws, particularly with respect to foreign investment
activities and foreign trade. Enforcement of existing and future laws and
contracts is uncertain, and implementation and interpretation thereof may be
inconsistent. As the Chinese legal system develops, the promulgation of new
laws, changes to existing laws and the preemption of local regulations by
national laws may adversely affect foreign operations in China. While Thailand
has a longer history of promoting foreign investments than China, Thailand has
recently experienced economic turmoil and a significant devaluation of the Thai
currency. There can be no assurance that this period of economic turmoil will
not result in the reversal of current policies encouraging foreign investment
and trade, restrictions on the transfer of funds overseas, employee turnover,
labor unrest or other domestic Thai economic problems that could adversely
affect the Company.
Risk of Increased Taxes
The Company has structured its global operations to take advantage of
the generally lower statutory income tax rates in Asian countries and certain
tax holidays in China and Thailand that have been extended to encourage foreign
investment. As part of this structure, the Company renders certain
administrative services on behalf of its Asia subsidiaries in the United States.
If tax rates were to rise, if the Company's tax holidays were not renewed or if
tax authorities were to challenge successfully the adequacy of the amounts paid
to the Company for these services or generally the manner in which profits are
recognized and allocated among the Company and its subsidiaries, the Company's
taxes would increase and its business, financial condition, results of
operations or cash flow could be materially adversely affected. The Company
believes that profits from its operations in Asia are not sufficiently connected
to the United States to give rise to United States taxation, but there can be no
assurance that United States tax
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<PAGE> 20
authorities will not challenge the Company's position or, if such challenge is
made, that the Company would prevail in any such dispute. In certain
circumstances, United States tax law requires a United States parent corporation
to recognize as current income profits earned by its foreign subsidiaries. The
Company believes that, except for certain passive income which is not expected
to be material in amount, these laws should not be applicable to the
subsidiaries activities and income, but there can be no assurance that United
States tax authorities will not challenge the Company's position or, if such
challenge is made, that the Company would prevail in any such dispute. If the
Company's profits from its Asia operations become subject to United States
income taxes, the Company's taxes could increase, and its results of operations
and cash flow could be materially adversely affected. The expansion by the
Company of its operations in the United States and Mexico may also increase its
effective tax rate. The current maximum United States and Mexico federal income
tax rates are 35.0% and 34% respectively.
Currency Fluctuations
While the Company transacts business predominately in United States
dollars, and substantially all of its revenues are collected in United States
dollars, a portion of the Company's costs are denominated in other currencies,
such as the Thai baht, the Hong Kong dollar and the Chinese renminbi. As a
result, changes in the relation of these and other currencies to the United
States dollar will affect the Company's costs of goods sold and operating
expenses and could result in exchange losses. To date, the recent economic
problems in Thailand, including the devaluation of the Thai baht, have not had
an adverse impact on the Company's business, financial condition or results of
operations, but there can be no assurance that there will not be such an impact
in the future. The impact of future exchange rate fluctuations on the Company's
results of operations cannot be accurately predicted. From time to time the
Company has engaged in, and may continue to engage in, exchange rate hedging
activities, although to date such hedging activities have not been material.
There can be no assurance that any hedging techniques implemented by the Company
will be successful.
Management of Growth and Expanded Operations
During fiscal 1997, fiscal 1998 and through the six months ended October
31, 1998, the Company experienced a period of rapid expansion through both
internal growth and acquisition. Expansion has caused, and is expected to
continue to cause, strain on the Company's infrastructure, including its
managerial, technical, financial and other resources. To manage further growth,
the Company must continue to enhance financial and operational controls, develop
additional executive officers and hire qualified personnel. Continued growth
will also require increased investments to add manufacturing capacity and to
enhance management information systems. The Company may experience certain
inefficiencies as it integrates new operations and manages geographically
dispersed operations. There can be no assurance that the Company will be able to
manage its expansion effectively, and a failure to do so could have a material
adverse effect on the Company's business, financial condition or results of
operations.
New operations, whether foreign or domestic, can require significant
start-up costs and capital expenditures. In the event that the Company continues
to expand its domestic or international operations, there can be no assurance
the Company will be successful in generating revenue to recover start-up and
operating costs.
Dependence on Key Personnel
The Company's continued success depends to a large extent upon the
efforts and abilities of key managerial and technical employees. The Company's
business will also depend upon its ability to continue to attract and retain
qualified employees. Although the Company has been successful in retaining key
managerial and technical employees to date, the loss of services of certain key
employees, in particular any of its executive officers, could have a material
adverse effect on the Company's business, financial condition or results of
operations. None of the Company's key employees is party to an agreement that
provides the Company with assurance as to his or her continued employment.
Moreover, the Company does not maintain key-man life insurance on any of its
personnel.
Risks Associated with Acquisitions
The Company's business strategy includes the expansion of its business
and manufacturing capabilities, including through acquisitions. Although the
Company is not currently contemplating any material acquisition or
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<PAGE> 21
reviewing any particular opportunity, the Company occasionally reviews various
acquisition prospects, including companies or manufacturing process technologies
complementary to the Company's business.
Acquisitions involve numerous risks, including: difficulties in the
assimilation of the operations, products, personnel and cultures of the acquired
companies; the ability to manage geographically remote units effectively; the
diversion of management attention from other day-to-day business concerns;
difficulties entering markets in which the Company has limited or no direct
experience; and the potential loss of key employees of the acquired companies.
In addition, acquisitions may result in dilutive issuances of equity securities;
incurrence of additional debt; reduction of existing cash balances; amortization
expenses related to goodwill and other intangible assets; and other charges to
operations that may have a material adverse effect on the Company's business,
financial condition or results of operations. Moreover, there can be no
assurance that any equity or debt financings proposed in connection with any
acquisition would be available to the Company on acceptable terms, or at all, if
suitable strategic acquisition opportunities were to arise. Although the Company
expects to analyze any opportunity before committing its resources, there can be
no assurance that any acquisition that is completed will result in long-term
benefits to the Company or that it will be able to manage the resulting business
effectively.
Technological Change and Process Development
The markets in which the Company's customers compete are characterized
by rapid technological change, evolving industry standards and frequent product
introductions and enhancements. The Company is continually evaluating the
advantages and feasibility of new manufacturing processes. The Company believes
that its future success will depend upon its ability to deliver manufacturing
services which meet changing customer needs and to successfully anticipate or
respond to technological changes in manufacturing processes on a cost-effective
and timely basis. There can be no assurance that the Company will be successful
in these efforts.
Year 2000 Compliance
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 just
over one year, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance. All aspects of operations at any company
including manufacturing, finance, shipping and even such areas as security
systems could be negatively impacted.
The Company has preliminarily evaluated its level of exposure to the
risks and costs associated with Year 2000 problems and has categorized its
analysis into four majors areas: information systems, equipment, suppliers and
customers. IMS has identified that of its information systems only its
manufacturing and financial applications software is not Year 2000 compliant. In
light of this the Company is currently implementing ERP software licensed from
SAP America, Inc. With the installation of this software system which is
expected to occur in early 1999, the Company believes that all of its critical
business systems will be Year 2000 compliant. The Company expects to spend a
total of $4 to $5 million on the project, a portion of which would relate to
newly purchased systems and would be capitalized. The Company has also
identified which of its network and communications equipment are not Year 2000
compliant and expects to have any corrections made by the first half of calendar
1999. The Company is currently conducting a survey to determine which of its
manufacturing equipment is not Year 2000 compliant and expects to complete the
survey and begin correcting any problems in early 1999. Once the project is
successfully completed the Company anticipates no disruptions in the
manufacturing services it provides to its customers as a result of Year 2000
problems; however, no assurance can be given that such updates will be fully
completed in a timely manner, that the cost will not become material or that
such disruptions will not occur. Moreover, the Company could be adversely
impacted by Year 2000 issues faced by major distributors, suppliers, customers,
vendors and financial service organizations with which the Company interacts. To
date the Company has not assessed the magnitude, if any, of these issues
although it has initiated a survey of its suppliers and customers which it
expects to complete by the end of its fiscal year. Any disruption in
manufacturing services provided by the Company as a result of Year 2000
noncompliance by the Company or its major suppliers, customers and vendors could
impact the Company's ability to procure material, manufacture, invoice
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<PAGE> 22
customers or pay suppliers and therefore could materially adversely affect the
Company's business, financial condition and results of operations. At this time
the Company has not developed a contingency plan.
Concentration of Stock Ownership
As of October 31, 1998, the current directors and executive officers of
the Company and their respective affiliates beneficially owned in the aggregate
approximately 80.0% of the Company's outstanding shares of Common Stock
(including shares issuable pursuant to stock options which may be exercised
within 60 days of October 31, 1998). As a result, such persons, acting together,
would have the ability to approve or disapprove significant corporate
transactions. In addition, the Company's board of directors has the authority to
issue up to 10,000,000 shares of undesignated preferred stock, to determine the
powers, preferences and rights and the qualifications, limitations or
restrictions granted to or imposed upon any unissued series of undesignated
preferred stock, and to fix the number of shares constituting any series and the
designation of such series, without any further vote or action by the Company's
stockholders. The preferred stock could be issued with voting, liquidation,
dividend and other rights superior to the rights of the Common Stock. The
concentration of ownership and the issuance of preferred stock under certain
circumstances could have the effect of delaying or preventing a change in
control of the Company.
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<PAGE> 23
INTERNATIONAL MANUFACTURING SERVICES, INC.
Part II. OTHER INFORMATION
Item 1: Legal Proceedings
None
Item 2: Changes in Securities
None
Item 3: Defaults upon Senior Securities
None
Item 4: Submission of Matters to Vote of Security Holders
At the Annual Meeting of Stockholders of the Company held on September
16, 1998, the following matters were acted upon by the stockholders of
the Company:
1. The election of Directors of the Company to hold office until the
next Annual Meeting of Stockholders or until their respective
successors are duly elected and qualified:
<TABLE>
<S> <C>
Robert G. Behlman
Shares in Favor 15,163,280
Shares Withheld 256,770
William J. Almon
Shares in Favor 15,412,320
Shares Withheld 7,730
Dixon R. Doll
Shares in Favor 15,412,290
Shares Withheld 7,760
John A. Downer
Shares in Favor 15,413,320
Shares Withheld 6,730
Fredric W. Harman
Shares in Favor 15,413,320
Shares Withheld 6,730
Mark Rossi
Shares in Favor 15,397,203
Shares Withheld 22,847
J. Larry Smart
Shares in Favor 15,413,320
Shares Withheld 6,730
Paul J. Tufano
Shares in Favor 15,413,320
Shares Withheld 6,730
</TABLE>
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<PAGE> 24
2. The approval of the amendment to the Company's 1997 Employee Stock
Purchase Plan to provide for an annual automatic share replenishment
feature:
Shares in Favor 11,109,547
Shares Against 1,123,880
Shares Abstained 16,180
No Vote 0
3. The ratification of the appointment of PricewaterhouseCoopers LLP as
the Independent Auditors of the Company for the fiscal year ending
April 30, 1999:
Shares in Favor 15,416,993
Shares Against 2,000
Shares Abstained 1,057
No Vote 0
The number of shares of Common Stock outstanding and entitled to vote
at the Annual Meeting was 16,054,904, and at least 15,420,050 shares of
Common Stock were present in person or represented by proxy at the
Annual Meeting.
Item 5: Other Information
None
Item 6: Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this report
27.01 Financial Data Schedule
(b) The Company filed a Form 8-K on November 9, 1998 in connection with
the merger with Celestica Inc.
INTERNATIONAL MANUFACTURING SERVICES, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: 11-30-1998 INTERNATIONAL MANUFACTURING SERVICES, INC.
(Registrant)
By: /s/ Nathan Kawaye
---------------------------------------
Nathan Kawaye
Senior Vice President, Chief Financial Officer
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<PAGE> 25
EXHIBIT INDEX
Exhibit 27.01 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> APR-30-1999
<PERIOD-START> MAY-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 10,330
<SECURITIES> 0
<RECEIVABLES> 59,366
<ALLOWANCES> 2,416
<INVENTORY> 40,756
<CURRENT-ASSETS> 110,328
<PP&E> 70,621
<DEPRECIATION> 36,627
<TOTAL-ASSETS> 147,966
<CURRENT-LIABILITIES> 78,495
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 54,677
<TOTAL-LIABILITY-AND-EQUITY> 147,966
<SALES> 218,694
<TOTAL-REVENUES> 218,694
<CGS> 207,078
<TOTAL-COSTS> 207,078
<OTHER-EXPENSES> 7,297
<LOSS-PROVISION> 1,626
<INTEREST-EXPENSE> 1,365
<INCOME-PRETAX> 1,328
<INCOME-TAX> 186
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,142
<EPS-PRIMARY> .06<F1>
<EPS-DILUTED> .06
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
