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 NOVEMBER 27, 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 1-11098
SOLECTRON CORPORATION
(Exact Name of Registrant as specified in its Charter)
Delaware 94-2447045
(State or other jurisdiction (IRS Employer
of Incorporation or Organization) Identification Number)
777 Gibraltar Drive, Milpitas, California 95035 (Address of
principal executive offices and Zip Code)
Registrant's telephone number, including area code: (408) 957-8500
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
At December 31, 1998, 118,961,232 shares of Common Stock of the Registrant were
outstanding.
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SOLECTRON CORPORATION
INDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
November 30, 1998 and August 31, 1998 3
Condensed Consolidated Statements of Income for
for the three months ended November 30, 1998
and 1997 4
Condensed Consolidated Statements of Cash Flows
for the three months ended November 30, 1998
and 1997 5 - 6
Notes to Condensed Consolidated Financial
Statements 7 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 27
Item 3. Quantitative and Qualitative Disclosures About 27
Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
Signature 29
2
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ITEM 1. FINANCIAL STATEMENTS
SOLECTRON CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
November 30, August 31,
1998 1998
ASSETS ----------- -----------
Current assets:
Cash, cash equivalents and
short-term investments $ 194.8 $ 308.8
Accounts receivable, net 872.2 670.2
Inventories 901.1 788.5
Prepaid expenses and other
current assets 138.3 120.0
---------- ----------
Total current assets 2,106.4 1,887.5
Net property and equipment 531.6 448.0
Other assets 74.7 75.0
---------- ----------
Total assets $ 2,712.7 $ 2,410.5
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt $ 11.2 $ -
Accounts payable 844.2 666.5
Accrued employee compensation 64.8 72.1
Accrued expenses 56.2 34.9
Other current liabilities 71.0 67.3
---------- ----------
Total current liabilities 1,047.4 840.8
Long-term debt 387.8 385.5
Other long-term liabilities 4.5 2.9
---------- ----------
Total liabilities 1,439.7 1,229.2
---------- ----------
Commitments
Stockholders' equity:
Common stock 0.1 0.1
Additional paid-in capital 536.4 510.8
Retained earnings 741.3 677.4
Accumulated other comprehensive income -
cumulative translation adjustment (4.8) (7.0)
---------- ----------
Total stockholders' equity 1,273.0 1,181.3
---------- ----------
Total liabilities and
stockholders' equity $ 2,712.7 $ 2,410.5
========== ==========
See accompanying notes to condensed consolidated financial statements.
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SOLECTRON CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
Three Months Ended
November 30,
-----------------------
1998 1997
---------- ----------
Net sales $ 1,945.6 $ 1,136.8
Cost of sales 1,769.7 1,013.1
---------- ----------
Gross profit 175.9 123.7
Operating expenses:
Selling, general and
administrative 70.8 51.9
Research and
development 7.9 4.4
---------- ----------
Operating income 97.2 67.4
Interest income 4.4 6.6
Interest expense (5.5) (6.5)
---------- ----------
Income before
income taxes 96.1 67.5
Income tax expense 32.2 22.6
---------- ---------
Net income $ 63.9 $ 44.9
========== =========
Net income per share:
Basic $ 0.54 0.39
========== =========
Diluted $ 0.52 0.38
========== =========
Shares used to compute net income per share:
Basic 118.4 114.8
========== =========
Diluted 128.7 126.0
========== ==========
See accompanying notes to condensed consolidated financial statements.
4
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SOLECTRON CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Three Months Ended
November 30,
-----------------------
1998 1997
---------- ----------
Cash flows from operating activities:
Net income $ 63.9 $ 44.9
Adjustments to reconcile net income
to net cash (used in) provided by operating
activities:
Depreciation and amortization 40.6 32.6
Other 0.6 5.3
Changes in operating assets and
liabilities:
Accounts receivable (201.7) (98.4)
Inventories (99.2) (92.3)
Prepaid expenses and other
current assets (18.2) 21.0
Accounts payable 177.6 94.8
Accrued expenses and other
current liabilities 17.7 (0.1)
---------- ---------
Net cash (used in) provided by operating
activities (18.7) 7.8
---------- ---------
Cash flows from investing activities:
Sales and maturities of short-term
investments 56.4 278.6
Purchases of short-term investments (9.7) (319.7)
Acquisition of manufacturing location (24.6) -
Capital expenditures (118.8) (88.5)
Proceeds from sale of property and equipment 5.0 -
Other 0.3 (0.8)
---------- ---------
Net cash used in investing
activities (91.4) (130.4)
---------- ---------
(continued on next page)
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SOLECTRON CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(In millions)
Three Months Ended
November 30,
------------------------
1998 1997
---------- ----------
Cash flows from financing activities:
Net proceeds from bank lines of credit 11.2 -
Repayments of long-term debt - (0.9)
Net proceeds from sale of common stock 25.6 10.9
Other 3.9 -
---------- ----------
Net cash provided by financing
activities 40.7 10.0
---------- ----------
Effect of exchange rate changes on
cash and cash equivalents 2.2 1.4
---------- ---------
Net decrease in cash and
cash equivalents (67.2) (111.2)
Cash and cash equivalents at
beginning of period 225.2 225.1
---------- ----------
Cash and cash equivalents at
end of period $ 158.0 $ 113.9
========== ==========
SUPPLEMENTAL DISCLOSURES
Cash paid during the period:
Income taxes $ 32.2 $ 19.4
Interest $ 12.6 $ -
See accompanying notes to condensed consolidated financial statements.
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SOLECTRON CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Basis of Presentation
The accompanying unaudited condensed consolidated balance sheets as of November
30, 1998 and August 31, 1998, the unaudited condensed consolidated statements of
income for the three months ended November 30, 1998 and 1997, and the unaudited
condensed consolidated statements of cash flows for the three months ended
November 30, 1998 and 1997 have been prepared on substantially the same basis as
the annual consolidated financial statements. Management believes the financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the Company's financial
position, operating results and cash flows for the periods presented. The
results of operations for the three months ended November 30, 1998 are not
necessarily indicative of results to be expected for the entire year. These
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto for the year ended
August 31, 1998 included in the Company's Annual Report to Stockholders.
For clarity of presentation, the Company has indicated its first fiscal quarters
as ending on November 30, and its fiscal year as ending on August 31, whereas in
fact, the Company's first quarter of fiscal 1999 ended on November 27, 1998, its
first quarter of fiscal 1998 ended on November 28, 1997 and its 1998 fiscal year
ended on August 28, 1998.
NOTE 2 - Inventories
Inventories consisted of (in millions):
November 30, August 31,
1998 1998
----------- -----------
Raw materials $ 635.0 $ 577.8
Work-in-process 266.1 210.7
----------- -----------
Total $ 901.1 $ 788.5
=========== ===========
NOTE 3 - Net Income Per Share
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share," replaced the previously reported primary and fully diluted net income
per share with basic and diluted net income per share. Basic net income per
share is calculated using the weighted average number of common shares
outstanding during the period. Diluted net income per share is calculated using
the weighted average number of common shares plus dilutive common equivalent
shares outstanding during the period. Common equivalent shares consist of stock
options that are computed using the treasury stock method and shares issuable
upon conversion of the Company's outstanding convertible notes. Net income per
share amounts for the three months ended November 30, 1997 have been restated to
conform to the requirements of SFAS No. 128. The following table sets forth the
computation of basic and diluted net income per share for the three months ended
November 30, 1998 and 1997.
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Three Months Ended
November 30,
-----------------------
1998 1997
---------- ----------
(in millions,
except per share data)
Net income - basic $ 63.9 $ 44.9
Interest expense from convertible
subordinated notes, net of taxes 2.4 2.4
---------- ----------
Net income - diluted $ 66.3 $ 47.3
========== ==========
Weighted average shares - basic 118.4 114.8
Common stock equivalents - stock options 3.5 4.4
Common shares issuable upon assumed
conversion of convertible subordinated
notes 6.8 6.8
---------- ----------
Weighted average shares - diluted 128.7 126.0
========== ==========
Net income per share - basic $ 0.54 $ 0.39
========== ==========
Net income per share - diluted $ 0.52 $ 0.38
========== ==========
For the first quarter ended November 30, 1998, options to purchase 244,000
shares of common stock with exercise prices greater than the average fair market
value of the Company's stock for the period of $53.53 were not included in the
calculation because the effect would have been antidilutive. For the first
quarter ended November 30, 1997, options to purchase 1.2 million shares of
common stock with exercise prices greater than the average fair market value of
the Company's stock for the period of $41.40 were not included in the
calculation because the effect would have been antidilutive.
NOTE 4 - Asset Securitization Arrangement
The Company has entered into an asset securitization arrangement with a bank
under which it may sell up to $120 million of eligible accounts receivable.
During December 1998, the Company sold a portion of its eligible accounts
receivable under the arrangement for $50 million in cash. As a result, the
Company has a remaining $70 million under the securitization arrangement. The
arrangement which expires in August 1999 is subject to certain financial
covenants and management representations.
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NOTE 5 - Commitments
The Company leases various facilities under operating lease agreements. The
facility leases expire at various dates through 2006. Substantially all leases
require the Company to pay property taxes, insurance and normal maintenance
costs. Payments under certain leases are periodically adjusted based on LIBOR
rates. The leases for certain of the Company's facilities in Milpitas and San
Jose, California, and Everett, Washington, provide the Company with the option
at the end of each of the leases of either acquiring the property at its
original cost or arranging for the property to be acquired. The Company is
contingently liable under a first loss clause for a decline in market value of
these leased facilities totaling up to $93.1 million in the event the Company
does not purchase the properties at the ends of the lease terms. The Company
must also maintain compliance with financial covenants similar to its credit
facilities.
During fiscal 1998, the Company entered into an arrangement with a third-party
leasing company under which certain of the Company's fixed assets with a
carrying value of approximately $31.3 million were sold to the leasing company
and leased back. The Company is accounting for these transactions as operating
leases.
Future minimum payments related to lease obligations, including the $93.1
million contingent liability discussed above, are $39.5 million, $29.8 million,
$20.9 million, $65.1 million and $44.9 million in each of the years in the
five-year period ending August 31, 2003 and an aggregate $2.6 million for
periods after that date.
NOTE 6 - Acquisition of Mitsubishi Assets
On October 1, 1998, the Company acquired the wireless telephone manufacturing
assets of Mitsubishi Consumer Electronics America, Inc.'s (MCEA) Cellular Mobile
Telephone (CMT) division in Braselton, Georgia. MCEA is a subsidiary of
Mitsubishi Electric Corporation (Mitsubishi). The acquisition has been accounted
for as a purchase of assets, and the purchase price of approximately $25 million
has been allocated to the assets acquired based on their relative fair values at
the date of acquisition. Under the terms of the agreement, the Company will
provide MCEA-CMT with a full range of manufacturing services for five years,
including New Product Introduction management, printed circuit board assembly
and full systems assembly for MCEA's branded and private-label cellular products
sold within North America. Additionally, Solectron hired approximately 400
MCEA-CMT manufacturing and support associates.
NOTE 7 - Pending Acquisition of IBM Assets in Texas
On January 6, 1999, the Company announced that it had signed agreements with IBM
to acquire IBM's Electronic Card Assembly and Test (ECAT) manufacturing assets
in Austin, Texas. Under the terms of the agreements, Solectron will provide
fully integrated printed circuit board (PCB) assembly manufacturing services to
IBM for the next three years. This includes physical design, early prototyping,
new product launch, PCB assembly and test, volume production, end-of-life
support, field return services and life-cycle management for all IBM
motherboards used in their mobile products manufactured worldwide. The Company
will also hire approximately 1,300 IBM design, test, and manufacturing
associates. In addition, Solectron has signed agreements governing intellectual
property rights and global supply for PCB assembly for motherboards used in
IBM's mobile products manufactured worldwide. The transaction is expected to be
completed by the end of the Company's
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second fiscal quarter of 1999. Completionof the transaction is subject to
applicable government approvals and various conditions of closing.
NOTE 8 - Newly Adopted Accounting Pronouncements
Effective in the first quarter of fiscal 1999, the Company adopted Statement of
Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive
Income," which requires the Company to report and display certain information
related to comprehensive income. Comprehensive income includes net income and
other comprehensive income. Other comprehensive income is classified separately
into foreign currency items, minimum pension liability adjustments, and
unrealized gains and losses on certain investments in debt and equity
securities. Solectron's other comprehensive income is comprised solely of
foreign currency translation adjustments. The components of comprehensive income
were as follows:
Three Months Ended
November 30,
-----------------------
1998 1997
---------- ----------
(in millions)
Net income $ 63.9 $ 44.9
Other comprehensive income -
foreign currency translation adjustments 2.2 4.5
---------- ----------
Comprehensive income $ 66.1 $ 49.4
========== ==========
The foreign currency translation adjustments are not currently adjusted for
income taxes since they relate to investments which are permanent in nature.
Effective in the first quarter of fiscal 1999, the Company adopted the American
Institute of Certified Public Accountants (AICPA) Statement of Position (SOP)
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." SOP 98-1 provides guidance on accounting for the costs of
computer software developed or obtained for internal use and for determining
when specific costs should be capitalized and when they should be expensed. The
impact of adopting SOP 98-1 was not significant to the Company's results of
operations or financial position.
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ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in the following Management's Discussion and
Analysis of Financial Condition and Results of Operations, including, without
limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," and words of similar import, constitute forward-looking
statements which involve risks and uncertainties. Solectron's actual results
could differ materially from those anticipated in these forward looking
statements as a result of certain factors, including those factors set forth
under "Trends and Uncertainties" below.
General
Solectron's net sales are derived from sales to electronics systems original
equipment manufacturers (OEMs). The majority of Solectron's customers compete in
the networking, data and voice communications, workstation, personal computer
and computer peripheral segments of the electronics industry. The Company
provides integrated solutions that span the entire product life cycle from
pre-production planning and design, to manufacturing, distribution and
end-of-life product service and support. Solectron offers its customers
competitive outsourcing advantages such as access to advanced manufacturing
technologies, shortened time-to-market, reduced cost of production and more
effective asset utilization. A discussion of some of the potential fluctuations
in operating results is included under "Trends and Uncertainties."
The Company has manufacturing operations in locations throughout the world,
including North America, Europe, Asia/Pacific and Latin America. Solectron also
has its Asia/Pacific headquarters office in Taipei, Taiwan and program offices
located in Japan and Israel. The Company's subsidiaries, Force Computers and
Fine Pitch Technologies, are both headquartered in San Jose, California. Force's
European headquarters and a significant portion of its operations are located in
Munich, Germany. In addition to its headquarters' locations, Force has sales
support offices in various locations in the United States and internationally.
During 1997, the Company established a strategic, global manufacturing
partnership with Ericsson Telecom AB's Business Area Infocom Systems (Ericsson).
The Company established a New Product Introduction center in Sweden, and
production from certain Ericsson plants worldwide was transferred to Solectron
manufacturing sites around the world. In October 1997, Solectron acquired
certain assets, primarily equipment and inventory, of Ericsson's printed circuit
board assembly operation located in Sao Paulo, Brazil. In addition, Solectron's
subsidiary, Solectron Brasil Ltda., hired approximately 370 associates formerly
employed by Ericsson Telecomunicacoes S.A. in Brazil.
In April 1998, the Company acquired NCR Corporation's (NCR) manufacturing assets
in three cities for a purchase price of approximately $91 million. The
acquisition was accounted for as a purchase of assets and the purchase price was
allocated to the assets acquired based on the relative fair values of the assets
at the date of acquisition. Under the terms of the agreement, NCR will outsource
the manufacturing of certain computer components to Solectron for at least five
years. Solectron also hired approximately 1,200 NCR manufacturing and related
support associates.
In June 1998, the Company acquired International Business Machines
Corporation's (IBM) Electronic Card Assembly and Test (ECAT)
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manufacturing assets in Charlotte, North Carolina and non-exclusive rights to
certain IBM intellectual property for a purchase price of approximately $96
million. The acquisition was accounted for as a purchase of assets and the
purchase price was allocated to the assets acquired, including the intellectual
property rights, based on their relative fair values at the date of acquisition.
Under the terms of the agreement, Solectron hired approximately 700 IBM
manufacturing and related support associates and the Company will provide
printed circuit board assembly services to IBM in North America for the next
three years. In addition, IBM has made available to Solectron 115 patents and 51
disclosures (collectively the intellectual property rights) covering a wide
spectrum of technologies and capabilities. IBM will also provide to Solectron
failure analysis and characterization tools for process development and
manufacturing, including fault detection and isolation.
In October 1998, the Company acquired the wireless telephone manufacturing
assets of Mitsubishi Consumer Electronics America, Inc.'s (MCEA) Cellular Mobile
Telephone (CMT) division in Braselton, Georgia. MCEA is a subsidiary of
Mitsubishi Electric Corporation (Mitsubishi). The acquisition was accounted for
as a purchase of assets and the purchase price of approximately $25 million was
allocated to the acquired assets based on their relative fair values at the date
of acquisition. Under the terms of the agreement, the Company will provide
MCEA-CMT with a full range of manufacturing services for five years, including
New Product Introduction management, printed circuit board assembly and full
systems assembly for MCEA's branded and private-label cellular products sold
within North America. In addition, Solectron hired approximately 400 MCEA-CMT
manufacturing and support associates.
Also in October 1998, the Company signed a definitive agreement with Ingram
Micro Inc. under which the two companies entered into a strategic alliance to
provide global build-to-order and configure-to-order assembly services for
personal computers, servers and related products in the United States, Canada,
Europe, Asia and Latin America. The alliance will be managed by both companies
under a joint management matrix that will include a sales and marketing staff,
program management, materials management, information technology resources and
test and process engineers and will, in most part, utilize existing facilities,
systems and personnel. The companies expect that shipments to customers will
begin in early calendar 1999.
On January 6, 1999, the Company announced that it had signed agreements with IBM
to acquire IBM's Electronic Card Assembly and Test (ECAT) manufacturing assets
in Austin, Texas. Under the terms of the agreements, Solectron will provide
fully integrated printed circuit board (PCB) assembly manufacturing services to
IBM for the next three years. This includes physical design, early prototyping,
new product launch, PCB assembly and test, volume production, end-of-life
support, field return services and life-cycle management for all IBM
motherboards used in their mobile products manufactured worldwide. The Company
will also hire approximately 1,300 IBM design, test, and manufacturing
associates. In addition, Solectron has signed agreements governing intellectual
property rights and global supply for PCB assembly for motherboards used in
IBM's mobile products manufactured worldwide. The transaction is expected to be
completed by the end of the Company's second fiscal quarter of 1999. Completion
of the transaction is subject to applicable government approvals and various
conditions of closing.
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Results of Operations
The electronics industry is subject to rapid technological change, product
obsolescence and price competition. These and other factors affecting the
electronics industry, or any of Solectron's major customers in particular, could
have an adverse material effect on Solectron's results of operations. See
"Trends and Uncertainties -- Potential Fluctuations in Operating Results" and
"Competition" for further discussion of potential fluctuations in operating
results.
The following table sets forth, for the periods indicated, certain items in the
Consolidated Statements of Income as a percentage of net sales. The financial
information and the discussion below should be read in conjunction with the
Condensed Consolidated Financial Statements and Notes thereto.
Three Months Ended
November 30,
------------------
1998 1997
----- -----
Net sales 100.0% 100.0%
Cost of sales 91.0 89.1
----- -----
Gross profit 9.0 10.9
Operating expenses:
Selling, general and administrative 3.6 4.6
Research and development 0.4 0.4
----- -----
Operating income 5.0 5.9
Net interest income (expense) (0.1) -
----- -----
Income before income taxes 4.9 5.9
Income taxes 1.6 2.0
----- -----
Net income 3.3% 3.9%
===== =====
Net Sales
Net sales for the first quarter of fiscal 1999 grew to $1.9 billion, an increase
of 71.1% over the same period in fiscal 1998. The sales growth was primarily
attributable to significant increases in sales volume from both existing and new
customers worldwide, as well as the acquisitions made during fiscal 1998
including Ericsson, NCR, and IBM. In addition, the recent acquisition of
Mitsubishi in October contributed $22.5 million in net sales for this quarter.
In the Americas, the new site in Mexico and newly acquired sites from NCR and
IBM were the largest contributors to the strong growth in the fiscal 1999 period
as compared to the fiscal 1998 period. The sales growth at the Texas site was
particularly strong as a result of start-up and new programs. The net sales
increase at the Milpitas, California site was offset partially by the planned
transfer of personal computer printed circuit board programs and computer
peripherals systems assembly programs to Mexico and networking business to
Penang which resulted from management's action to improve global load balancing
and specific product program transitioning. Sales in all of the Company's
European and Asian operations increased in fiscal 1999 over the same period of
fiscal 1998, principally as a result of core business growth and new accounts.
In particular, the sales growth at the Penang site was
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significant due primarily to improved demand from personal computer customers
and networking business transferred in from California. The growth at the
Scotland site was strong primarily due to increased demand from its
telecommunications customers. Although the Company does not currently anticipate
any future decline in sales, to lessen the potential impact of any possible
future declines related to customers within any particular region or market
segment, the Company is committed to seeking diversification of its customer
base among many countries, market segments and product lines within market
segments.
Hewlett-Packard Company (HP) was Solectron's largest customer in the first
quarters of both fiscal 1999 and 1998, accounting for 12.2% and 15.5%,
respectively, of consolidated net sales in those periods. Additionally, Sun
Microsystems, Inc. accounted for 10.0% of net sales in the first quarter of
fiscal 1998. No other customer accounted for more than 10% of net sales during
any of the periods presented.
Solectron's top ten customers accounted for 71.7% and 67.3% of consolidated net
sales in the first three months of fiscal 1999 and 1998, respectively. Solectron
is still dependent upon continued revenues from HP and the rest of its top ten
customers and there can be no guarantee that these or any other customers will
not increase or decrease as a percentage of consolidated net sales either
individually or as a group. Consequently, any material decrease in sales to
these or other customers could have an adverse material effect on Solectron's
results of operations.
In the first quarter of fiscal 1999, international locations contributed 39.2%
of consolidated net sales compared to 33.6% in the same period of fiscal 1998.
In addition to the sales growth factors for Europe and Asia noted above, the
Company's international sales also benefited from the growth of the sites in
Mexico and Brazil added during the first quarter of fiscal 1998 and the
acquisition of the Ireland site from NCR in April 1998. As a result of
Solectron's international sales and facilities, Solectron's operations are
subject to risks of doing business abroad. While to date these dynamics have not
had an adverse material effect on Solectron's results of operations, there can
be no assurance that there will not be such an impact in the future. See "Trends
and Uncertainties -- International Operations" for a further discussion of
potential fluctuations in operating results associated with the risks of doing
business abroad.
Solectron's operations in Milpitas, California contributed a substantial portion
of Solectron's net sales and operating income during the first quarters of
fiscal 1999 and fiscal 1998. Although management has been undertaking deliberate
actions to achieve improved global load balancing by transferring certain
projects from the Milpitas site to other sites worldwide, the performance of the
Milpitas operation is expected to continue as a significant factor in the
overall financial performance of Solectron. Any adverse material change to the
customer base, product mix, efficiency, or other attributes of this site could
have an adverse material effect on Solectron's consolidated results of
operations.
Solectron believes that its ability to continue to achieve growth will depend
upon growth in sales to existing customers for their current and future product
generations, successful marketing to new customers and future geographic
expansion. Customer contracts can be canceled and volume levels can be changed
or delayed. The timely replacement of delayed, canceled or reduced orders with
new business cannot be assured. In addition, there can be no assurance that any
of Solectron's current customers will continue to utilize Solectron's services.
Because of
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these factors, there can be no assurance that Solectron's historical revenue
growth rate will continue. See "Trends and Uncertainties" for a discussion of
certain factors affecting the management of growth, geographic expansion and
potential fluctuations in sales and results of operations.
Gross Profit
The gross margin percentage declined to 9.0% for the fiscal 1999 period from
10.9% for the first quarter of fiscal 1998. The decrease was primarily
attributable to a shift toward higher volume projects and systems build projects
which typically yield lower margins. Also, gross margins of the newly acquired
NCR operations are lower than the overall average margins of the rest of the
Company primarily due to the fact that the majority of its net sales are derived
from systems integration activities, which normally generate lower gross margins
than printed circuit board assembly. In addition, there was a somewhat seasonal
shift in product mix toward the lower margin personal computer products. After
the calendar year end, the personal computer industry typically reassesses
demand based on inventory levels that may cause the Company's product mix to
shift away from personal computers to other industry segments in the second
quarter.
For the foreseeable future, Solectron's gross margin is expected to depend
primarily on product mix, production efficiencies, utilization of manufacturing
capacity, start-up and integration costs of new and acquired businesses, the
percentage of sales derived from systems build projects, pricing within the
electronics industry and the cost structure at individual sites. Over time,
gross margins at the individual sites and for the Company as a whole may
continue to fluctuate. The Company anticipates that a larger percentage of its
sales may be derived from systems build projects in future periods. Systems
build projects typically have lower gross margin percentages than printed
circuit board assembly projects. Increases in systems build business, additional
costs associated with new projects and price erosion within the electronics
industry could adversely affect the Company's gross margin. Additionally,
changes in product mix could cause the Company's gross margin to fluctuate.
Also, while the availability of raw materials appears adequate to meet the
Company's current revenue projections for the foreseeable future, component
availability is still subject to lead time and other constraints that could
possibly limit the Company's revenue growth. Because of these factors and others
discussed under "Trends and Uncertainties" below, there can be no assurance that
the Company's gross margin will not fluctuate or decrease in future periods.
Selling, General and Administrative Expenses
In absolute dollars, selling, general and administrative (SG&A) expenses
increased 36.4% in the first quarter of fiscal 1999 over the same period of
fiscal 1998. The increase in fiscal 1999 period was primarily due to investment
in infrastructure such as personnel and related departmental expenses at all
manufacturing locations as well as continuing investment in information systems
to support the increased size and complexity of the Company's business. As a
percentage of net sales, SG&A expenses were 3.6% and 4.6% in the fiscal 1999 and
fiscal 1998 periods, respectively. The primary reason for the fiscal 1999
decrease in SG&A expenses as a percentage of net sales is the significant
increase in the sales base offset partially by the costs associated with
investments in starting up new sites and investments in the Company's
information systems. The Company anticipates SG&A expenses will continue to
increase in terms of absolute dollars in the future, and may possibly increase
as a
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percentage of revenue, as the Company continues to build the infrastructure
necessary to support its current and prospective business.
Research and Development Expenses
With the exception of its Force Computers operation, the Company's research and
development (R&D) activities have been focused primarily on the development of
prototype and engineering design capabilities, fine pitch interconnecting
technologies (which include ball-grid array, tape-automated bonding, multichip
modules, chip-on-flex, chip-on-board and flip chip), high reliability
environmental stress test technology and the implementation of environmentally
friendly assembly processes, such as VOC-free and no-clean. Force's R&D efforts
are concentrated on new product development and improvement of product designs
through improvements in functionality and the use of microprocessors in embedded
applications. Research and development expenses, in absolute dollars and as a
percentage of net sales, respectively, were $7.9 million and 0.4% in the first
quarter of fiscal 1999 and $4.4 million and 0.4% in the fiscal 1998 period. The
increase in R&D expenses in the fiscal 1999 period compared to fiscal 1998
period was primarily due to increased R&D effort at Force and new R&D projects
initiated at the Malaysia sites. The Company expects that R&D expenses will
increase in absolute dollars in the future and may increase as a percentage of
net sales as Force continues to invest in its R&D efforts and additional R&D
projects are undertaken at certain Asian sites.
Net Interest Income (Expense)
Net interest expense was $1.1 million for the first three months of fiscal 1999
compared to net interest income of $0.1 million in the same period of fiscal
1998. The net interest expense in the fiscal 1999 period resulted from the
Company's interest expense on long-term debt, which is approximately $6.2
million per quarter, not fully offset by the reduction of interest income earned
on undeployed cash and investments and the capitalization of interest expense.
The reduction of interest income reflects deployment of cash and short-term
investments to fund the acquisitions from NCR, IBM-ECAT and MCEA's CMT division
as well as to meet working capital requirements. In the first quarter of fiscal
1999, the Company capitalized approximately $1.4 million of interest expense
related to the costs of computer software developed for internal use and the
facility construction projects at the California and Brazil sites. Solectron
expects to utilize more of the undeployed cash during fiscal 1999 in order to
fund anticipated future growth. See "Trends and Uncertainties -- Management of
Growth," and "Potential Fluctuations in Operating Results."
Income Taxes
Income taxes increased to $32.2 million in the first quarter of fiscal 1999 from
$22.6 million in the fiscal 1998 period primarily due to increased income before
income taxes. Solectron's effective income tax rate was 33.5% in the fiscal 1999
and 1998 periods.
In general, the effective income tax rate is largely a function of the balance
between income from domestic and international operations. Solectron's
international operations, taken as a whole, have been taxed at a lower rate than
in the United States, primarily due to the tax holiday granted to the Company's
Malaysia sites. The Malaysian tax holiday is effective through January 31, 2002,
subject to certain conditions. The Company has also been granted various tax
holidays in
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China, which are effective for various termsand are subject to certain
conditions.
Liquidity and Capital Resources
Working capital was $1.1 billion at November 30, 1998 compared to $1.0 billion
at the end of fiscal 1998. During the same period, cash, cash equivalents and
short-term investments decreased to $194.8 million from $308.8 million which
reflects funding for required investments in working capital and capital
expenditures to support sales growth. In addition, the Company used
approximately $24.6 million for its acquisition of the wireless telephone
manufacturing assets of MCEA's CMT division during the first quarter of fiscal
1999. As Solectron continues to grow, it is expected that the Company will
require greater amounts of working capital to support its operations. The
Company believes that its current level of working capital and the Company's
available credit facilities will provide adequate working capital for the
foreseeable future. However, the Company may need to raise additional funds to
finance more rapid expansion, including establishing new locations or financing
additional acquisitions. There can be no assurance that such funds, if needed,
will be available on terms acceptable to the Company or at all.
Inventory levels fluctuate directly with the volume of the Company's
manufacturing. Changes or significant fluctuations in product market demands can
cause fluctuations in inventory levels which may result in changes in levels of
inventory turns and liquidity. Historically, the Company has been able to manage
its inventory levels with regard to these fluctuations. However, should material
fluctuations occur in product demand, the Company could experience slower turns
and reduced liquidity.
In the first quarter of fiscal 1999, the Company invested approximately $119
million in capital expenditures. A large portion of these expenditures related
to the purchase of new equipment, primarily surface mount assembly and test
equipment, to meet current and expected production levels, as well as to replace
or upgrade older equipment which was retired or sold. Significant expenditures
were also made for the acquisition of land and buildings for the Company's
manufacturing sites, principally in Brazil, Mexico, and Texas. The Company
expects total capital expenditures in fiscal 1999 to be in the range of $275
million to $325 million.
In addition to working capital as of November 30, 1998, which includes cash and
cash equivalents of $158.0 million and short-term investments of $36.8 million,
the Company has available a $100 million unsecured multicurrency revolving
credit facility and a $70 million asset securitization arrangement. Both of
these facilities are subject to financial covenants. The Company also has
approximately $93 million in unused foreign credit facilities available.
"Year 2000" Issues
The Company is aware of and is addressing the issues associated with the
programming code in existing computer systems as the year 2000 approaches. The
Year 2000 problem is pervasive and complex, as many computer systems,
manufacturing equipment and industrial control systems will be affected in some
way by the rollover of the two-digit year value to 00. Systems that do not
properly recognize such dates could generate erroneous information or cause a
system to fail. The Year 2000 issue creates risk for the Company from unforeseen
problems in its own systems
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and from third parties with whom the Company deals on business transactions
worldwide. Failures of the Company's and/or third parties' computer systems,
manufacturing equipment and industrial control systems would have an adverse
material impact on the Company's ability to conduct its business.
The Company has formed a worldwide task force and has implemented a
comprehensive program to analyze the Company's internal systems as well as all
external systems (such as vendor, customer, banking systems, etc.) upon which
the Company is dependent, to identify and evaluate any potential Year 2000
issues. This task force meets regularly and tracks progress against the program,
modifying it as needed to help ensure timely completion. The Company is
committed to achieving Year 2000 compliance; however, because a significant
portion of the problem is external to the Company and therefore outside of its
direct control, there can be no assurances that the Company will be fully or
even significantly Year 2000 compliant at the critical juncture. In addition, as
full testing of Year 2000 functionality must occur in a simulated environment,
the Company will not be able to test full system Year 2000 interfaces and
capabilities prior to the Year 2000.
As of November 30, 1998, the Company had completed an inventory of internal
systems, hardware, software, manufacturing equipment and embedded chips in
industrial control instruments. Each of these items was identified as mission
critical, mission essential, mission impaired or mission non-critical. The
Company is in the process of prioritizing and evaluating mission critical and
mission essential items, identifying fixes and resources as appropriate, and
performing and testing corrective measures. While the Company believes that its
evaluation has been comprehensive, there can be no assurance that all systems
critical to Year 2000 compliance have been identified, or that the corrective
actions identified will be completed on time.
As of November 30, 1998, the Company had inventoried every key supplier of goods
and services to the Company, and considered the potential impact on the Company
and its customers of Year 2000 compliance by these suppliers. The Company also
mailed surveys to many of these key suppliers, and is in the process of
evaluating responses and sending follow-up letters. The Company plans to
disqualify potentially non-compliant sources, look for alternative sources and
re-qualify new suppliers to help mediate potential business disruptions. The
Company is also involved with various geographic Year 2000 consortiums
worldwide, with the intent to leverage contacts and information for commonly
used suppliers and services such as utility companies. In addition, the Company
is in the process of reviewing EDI linkages and data transmission for its
customers and suppliers. While the Company believes that it will be able to
qualify alternative suppliers as needed, until all supplier and customer survey
responses have been received and evaluated, the Company can not fully evaluate
the extent of potential problems and the costs associated with corrective
actions.
The Company estimates the cost to complete its current compliance program to be
in the range of $28 million to $42 million. Of this amount, approximately $7
million is associated with the replacement of capital equipment, of which
approximately half is being purchased to replace non-compliant systems that
would not otherwise have been replaced at this time. The variability in these
estimates depends largely on the response from the Company's suppliers and the
extent to which supplier re-qualification is needed. Cost estimates will also be
re-evaluated as the status of the overall compliance program is updated. There
can be no assurance that actual costs will not be materially
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higher than currently anticipated. A significant portion of these costs is not
likely to be incremental costs to the Company, but rather will represent the
redeployment of existing information technology resources. Certain other
information technology projects have been delayed due to the focus on Year 2000
issues. The potential costs of the redeployment of personnel and delays in
implementing other projects is not known but could be substantial. The total
amount spent on the compliance program this fiscal year through November 30,
1998 was $5 million, of which $3 million pertained to the payroll costs of
personnel involved in the program and costs of outside consultants, and $2
million principally pertained to the replacement of capital equipment. Prior to
fiscal 1999, costs of software and hardware applications incurred for Year 2000
compliance were not material and related payroll costs for the Company's
information systems group were not tracked separately.
Although the Company has identified general contingency plans, such as the
replacement and re-qualification of suppliers, the stockpiling of supplies and
purchase of generators, a formal contingency plan will not be established until
at least the third quarter of fiscal 1999 when the evaluation of suppliers is
expected to be completed. The Company is unable to determine what effect the
failure of systems because of Year 2000 issues by the Company or its suppliers
or customers would have, but any significant failures could have an adverse
material effect on the Company's results of operations and financial condition.
Trends and Uncertainties
Customer Concentration; Dependence on the Electronics Industry
In the first quarter of fiscal 1999 and for the full years of fiscal 1998, 1997
and 1996, the Company's ten largest customers accounted for as much as 71.7% of
consolidated net sales. The Company is dependent upon continued revenues from
its top ten customers. Any material delay, cancellation or reduction of orders
from these or other significant customers could have an adverse material effect
on the Company's results of operations. During the first quarter of fiscal 1999,
HP accounted for 12.2% of net sales compared to 15.5% during the same period of
fiscal 1998. During fiscal 1998, HP, Cisco and Sun accounted for 13.9%, 10.7%
and 10.5%, respectively, of net sales, compared to 13.5% for HP and less than
10% for each of Cisco and Sun during fiscal 1997. There can be no assurance that
the Company will continue to do business with HP, Cisco, Sun or any other
customers.
The percentage of the Company's sales to its major customers may fluctuate from
period to period. Significant reductions in sales to any of these customers
would have an adverse material effect on the Company's results of operations.
The Company has long-term contracts (generally for terms of three to five years)
with Ericsson, NCR, IBM and Mitsubishi under which these customers have
committed to source production of certain products and components from the
Company. However, these commitments to source production do not include firm
volume purchase commitments. In addition, the Company has no firm long-term
volume purchase commitments from its other customers, and over the past few
years has experienced reduced lead times in customer orders. Also, customer
contracts can be canceled and volume levels can be changed or delayed. The
timely replacement of canceled, delayed or reduced contracts with new business
cannot be assured. These risks are increased 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. The factors affecting the
electronics industry in
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general, or any of the Company's major customers in particular, could have an
adverse material effect on the Company's results of operations.
There can be no assurance that sales to customers within any particular market
segment will not experience decreases which could have an adverse material
effect on the Company's sales.
Management of Growth; Geographic Expansion
The Company has experienced substantial growth over the last five fiscal years,
with net sales increasing from $1.5 billion in fiscal 1994 to $5.3 billion in
fiscal year 1998. Additionally, Solectron reported record sales of $1.9 billion
for the first quarter of fiscal 1999. In recent years, the Company has acquired
or established facilities in many locations. In the first quarter of fiscal
1998, the Company announced the opening of its Asia/Pacific headquarters office
in Taipei, Taiwan, began operations in Guadalajara, Mexico, and as further
discussed in "Partnership with Ericsson and Related Transactions," established a
manufacturing facility near Sao Paulo, Brazil and opened a New Product
Introduction center in Sweden. In April 1998, the Company announced plans to
open a manufacturing facility in Timisoara, Romania, and in May 1998, announced
the establishment of a program office in Israel. In addition, in April, June and
October 1998, the Company completed its acquisitions of certain manufacturing
assets from NCR, IBM and Mitsubishi, respectively. (See "Acquisition of NCR, IBM
and Mitsubishi Assets.") In October 1998, the Company signed a definitive
agreement with Ingram Micro, Inc. under which the two companies entered into a
strategic alliance. (See "Alliance with Ingram Micro.") In the first quarter of
fiscal 1999, the Company announced plans to build new manufacturing facilities
in Romania and Suwanee, Georgia. On January 6, 1999, announced that it had
signed agreements with IBM to acquire IBM's Electronic Card Assembly and Test
(ECAT) manufacturing assets in Austin, Texas. (See "Pending Acquisition of IBM
Assets in Texas.")
During fiscal 1997, the Company announced the establishment of new manufacturing
facilities in Suzhou, China; began operations at its manufacturing facility near
Boston, Massachusetts; and in November 1996, acquired Force Computers Inc.,
which has operations in California and Germany. The Company continually
evaluates growth and acquisition opportunities and may pursue additional
opportunities over time. There can be no assurance that the Company's historical
revenue growth will continue or that the Company will successfully manage the
facilities in China, Mexico, Brazil and Romania, the partnership with and
acquisitions from Ericsson, the acquisitions from NCR, IBM and Mitsubishi, the
alliance with Ingram Micro or any other businesses or assets it may acquire in
the future. As the Company manages its existing operations and expands
geographically, it may experience certain inefficiencies as it integrates new
operations and manages geographically dispersed operations. In addition, the
Company's results of operations could be adversely affected if its new
facilities do not achieve growth sufficient to offset increased expenditures
associated with geographic expansion. The Company's expenses and working capital
requirements will continue to increase as the new facilities become fully
operational. Should the Company increase its expenditures in anticipation of a
future level of sales that does not materialize, its profitability would be
adversely affected. On occasion, customers may require rapid increases in
production that can place an excessive burden on the Company's resources.
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Partnership with Ericsson and Related Transactions
During 1997, the Company established a strategic, global manufacturing
partnership with Ericsson Telecom AB's Business Area Infocom Systems. The
Company established a New Product Introduction center in Sweden, and production
from certain Ericsson plants worldwide was transferred to Solectron
manufacturing sites around the world. In October 1997, Solectron acquired
certain assets, primarily equipment and inventory, of Ericsson's printed circuit
board assembly operation located in Brazil. In addition, Solectron's subsidiary,
Solectron Brasil Ltda., hired approximately 370 associates formerly employed by
Ericsson Telecomunicacoes S.A. in Brazil. Under the terms of the agreement,
Ericsson contracted for Solectron's services from Solectron Brasil Ltda. through
September 1999. Thereafter, Solectron will bear the risk of filling the
manufacturing capacity at the site with renewed business from Ericsson and new
business from other customers.
The transactions with Ericsson entail a number of risks, including successfully
managing the integration of the operations, retention of key associates,
integrating purchasing operations and information systems, managing an
increasingly larger and more geographically disparate business and renewing the
Ericsson business or replacing it with new business after expiration of the
Ericsson commitment. In addition, the completion of the transactions with
Ericsson has increased Solectron's expenses and working capital requirements and
there is no assurance that Solectron will achieve sufficient revenue to offset
the increased expenses. There can be no assurance that Solectron will
successfully manage the risks of these transactions.
Acquisitions of NCR, IBM and Mitsubishi Assets
On April 27, 1998, the Company acquired NCR's manufacturing assets in three
cities, two in the United States and one in Ireland, for a purchase price of
approximately $91 million. As part of the transaction, Solectron hired
approximately 1,200 NCR manufacturing and related support associates currently
employed at these locations. Under the terms of the agreement, NCR will
outsource the manufacturing of certain computer, computer peripheral and server
components to Solectron for at least five years. Thereafter, Solectron will bear
the risk of filling the manufacturing capacity at the sites with renewed
business from NCR and new business from other customers.
On June 1, 1998, the Company acquired IBM's ECAT manufacturing assets in
Charlotte, North Carolina and non-exclusive rights to certain IBM intellectual
property for a purchase price of approximately $96 million. Under the terms of
the agreement, Solectron hired approximately 700 IBM manufacturing and related
support associates and the Company will provide printed circuit board assembly
services to IBM in North America for the next three years. In addition, IBM has
made available to Solectron 115 patents and 51 disclosures (collectively the
intellectual property rights) covering a wide spectrum of technologies and
capabilities. IBM will also provide to Solectron failure analysis and
characterization tools for process development and manufacturing, including
fault detection and isolation.
On October 1, 1998, the Company acquired the wireless telephone manufacturing
assets of Mitsubishi Consumer Electronics America, Inc.'s (MCEA) Cellular Mobile
Telephone (CMT) division in Braselton, Georgia. MCEA is a subsidiary of
Mitsubishi Electric Corporation (Mitsubishi). The purchase price was
approximately $25 million. Under the terms of the agreement, the Company will
provide MCEA-CMT with a full range of
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manufacturing services for five years, including New Product Introduction
management, printed circuit board assembly and full systems assembly for MCEA's
branded and private-label cellular products sold within North America. In
addition, Solectron hired approximately 400 MCEA-CMT manufacturing and support
associates.
The transactions with NCR, IBM and Mitsubishi entail a number of risks,
including successfully managing the integration of the operations, retention of
key associates, integrating purchasing operations and information systems,
managing an increasingly larger and more geographically disparate business,
obtaining customers other than NCR, IBM and Mitsubishi for these facilities and
renewing each of the NCR, IBM and Mitsubishi business or replacing it with new
business after expiration of NCR's, IBM's and Mitsubishi's respective
commitments. In addition, the transactions with NCR, IBM and Mitsubishi will
increase Solectron's expenses and working capital requirements and there is no
assurance that Solectron will achieve sufficient revenue to offset the increased
expenses. There can be no assurance that Solectron will successfully manage the
risks of these transactions.
Pending Acquisition of IBM Assets in Texas
On January 6, 1999, the Company announced that it had signed agreements with IBM
to acquire IBM's Electronic Card Assembly and Test (ECAT) manufacturing assets
in Austin, Texas. Under the terms of the agreements, Solectron will provide
fully integrated printed circuit board (PCB) assembly manufacturing services to
IBM for the next three years. This includes physical design, early prototyping,
new product launch, PCB assembly and test, volume production, end-of-life
support, field return services and life-cycle management for all IBM
motherboards used in their mobile products manufactured worldwide. The Company
will also hire approximately 1,300 IBM design, test, and manufacturing
associates. In addition, Solectron has signed agreements governing intellectual
property rights and global supply for PCB assembly for motherboards used in
IBM's mobile products manufactured worldwide. The transaction is expected to be
completed by the end of the Company's second fiscal quarter of 1999. Completion
of the transaction is subject to applicable government approvals and various
conditions of closing.
Alliance with Ingram Micro
On October 1, 1998, the Company announced that it signed a definitive agreement
with Ingram Micro Inc. under which the two companies entered into a strategic
alliance to provide global build-to-order and configure-to-order assembly
services for personal computers, servers and related products in the United
States, Canada, Europe, Asia and Latin America. The alliance will be managed by
both companies under a joint management matrix that will include a sales and
marketing staff, program management, materials management, information
technology resources and test and process engineers and will, in most part,
utilize existing facilities, systems and personnel.
The alliance with Ingram Micro entails a number of risks, including successfully
establishing the joint management matrix for the alliance, retention of key
associates, integrating purchasing operations and information systems and
obtaining customers for the services to be provided by the alliance. In
addition, the alliance with Ingram Micro will increase Solectron's expenses and
working capital requirements and there is no assurance that Solectron will
achieve sufficient revenue to offset the increased expenses. There can be no
assurance that Solectron
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will successfully manage the risks of this alliance or that the terms of the
alliance will be finalized.
International Operations
As a result of its international sales and facilities, the Company's operations
are subject to risks of doing business abroad, including but not limited to,
fluctuations in the value of currency, export duties, changes to import and
export regulations (including quotas), possible restrictions on the transfer of
funds, associate turnover, labor unrest, longer payment cycles, greater
difficulty in collecting accounts receivable, the burdens and costs of
compliance with a variety of foreign laws and in certain parts of the world,
political instability. In addition, the Company has operations in several
locations that are considered to have highly inflationary economies or volatile
currencies, including Mexico, Brazil, China and Romania. While to date these
factors have not had an adverse material impact on the Company's results of
operations, there can be no assurance that there will not be such an impact in
the future.
Southeast Asia and Latin America are currently experiencing currency, economic
and political instability. To date, the Company's operations have not
experienced significant adverse effects from this instability. However, to the
extent the Company's worldwide customers sell the products manufactured by
Solectron into the Southeast Asia and Latin America markets, the customers'
sales may be adversely affected, which could decrease demand for the Company's
manufacturing services. The Company cannot predict whether such a decrease in
demand will materialize and if it does, whether it will have an adverse material
effect on the Company's results of operations.
The Malaysian government recently adopted currency exchange controls, including
controls on ringgit held outside Malaysia, and established a fixed exchange rate
for the ringgit against the U.S. dollar. The Company does not hold ringgit
outside of Malaysia and therefore will not be affected by these controls. The
fixed exchange rate, when applied to local expenses denominated in ringgit, will
result in higher expenses when translated to U.S. dollars. However, such local
expenses represent a small percentage of the Company's total costs and therefore
the Company's results of operations will not be significantly affected in the
near future. The long term impact of such controls is not predictable due to
dynamic economic conditions that also affect or are affected by other regional
or global economies.
The Company has been granted a tax holiday for its Malaysia sites which is
effective through January 31, 2002, subject to certain conditions. The Company
has also been granted various tax holidays in China. These tax holidays are
effective for various terms and are subject to certain conditions. There is no
assurance that the current tax holidays will not be terminated or modified or
that any future tax holidays that the Company may seek will be granted. If the
current tax holidays are terminated or modified or if additional tax holidays
are not granted in the future, the Company's effective income tax rate would
likely increase.
Foreign Exchange Rate Sensitivity
The Company does not use derivative financial instruments for speculative
purposes. The Company's policy is to hedge its foreign currency denominated
transactions in a manner that substantially offsets the effects of changes in
foreign currency exchange rates. The Company
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uses foreign currency borrowings and foreign currency forward contracts to hedge
the currency risks of transactions denominated in foreign currencies. Gains and
losses on these foreign currency hedges are generally offset by corresponding
losses and gains on the underlying transaction. At November 30, 1998,
approximately 88% of its derivative instruments mature in three months or less.
There were no material deferred gains or losses at November 30, 1998, and the
Company does not hold or issue foreign exchange contracts for trading purposes.
In addition, the Company's international operations in some instances act as a
natural hedge because both operating expenses and a portion of sales are
denominated in local currency. In these instances, although an unfavorable
change in the exchange rate of a foreign currency against the U.S. dollar will
result in lower sales when translated to U.S. dollars, operating expenses will
also be lower in these circumstances. However, because less than 10% of net
sales are denominated in currencies other than the U.S. dollar, the Company does
not believe its total exposure to be significant.
Euro Conversion Issues
Effective January 1, 1999, 11 of the 15 member countries of the European Union
(the participating countries) established fixed conversion rates between their
existing sovereign currencies and the euro. For three years after the
introduction of the euro, the participating countries can perform financial
transactions in either the euro or their original local currencies. This will
result in a fixed exchange rate among the participating countries, whereas the
euro (and the participating countries' currencies in tandem) will continue to
float freely against the U.S. dollar and other currencies of non-participating
countries.
The Company has a task force which is constantly evaluating the effects of the
euro conversion on the Company. Solectron does not believe that significant
modifications of its information technology systems are needed in order to
handle euro transactions and reporting, and the Company is in the process of
evaluating its tax positions and all outstanding contracts in currencies of the
participating countries to determine the effects, if any, of the euro
conversion. The Company does not expect the euro conversion to have a
significant impact on its derivatives as the Company has already modified its
hedging policies to take the euro conversion into account. While the Company
currently believes that the effects of the conversion do not have a significant
adverse material effect on the Company's business and operations, there can be
no assurances that such conversion will not have an adverse material effect on
the Company's results of operations and financial position due to competitive
and other factors that may be affected by the conversion that cannot be
predicted by the Company.
Availability of Components
A substantial portion of the Company's net sales is derived from turnkey
manufacturing in which the Company provides both materials procurement and
assembly. In turnkey manufacturing, the Company potentially bears the risk of
component price increases, which could adversely affect the Company's gross
profit margins. At various times there have been shortages of components in the
electronics industry. If significant shortages of components should occur, the
Company may be forced to delay manufacturing and shipments, which could have an
adverse material effect on the Company's results of operations.
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Potential Fluctuations in Operating Results
The Company's operating results are affected by a number of factors, including
the mix of turnkey and consignment projects, the mix of printed circuit board
assembly and systems build projects, capacity utilization, price competition,
the degree of automation that can be used in the assembly process, the
efficiencies that can be achieved by the Company in managing inventories and
fixed assets, the timing of orders from major customers, fluctuations in demand
for customer products, the timing of expenditures in anticipation of increased
sales, customer product delivery requirements, and increased costs and shortages
of components or labor. Turnkey manufacturing currently represents a substantial
portion of Solectron's sales. Turnkey projects, in which Solectron procures some
or all of the components necessary for production, typically generate higher net
sales and higher gross profits with lower gross margin percentages than
consignment projects due to the inclusion in Solectron's operating results of
sales and costs associated with the purchase and sale of components. Solectron
assembles products with varying degrees of material content, which may cause
Solectron's gross margin to fluctuate. In addition, the degree of start-up costs
and inefficiencies associated with new sites and new customer projects may
affect Solectron's gross margin. All of these factors can cause fluctuations in
the Company's operating results.
Interest Rate Sensitivity
The primary objective of the Company's investment activities is to preserve
principal while at the same time maximizing yields without significantly
increasing risk. To achieve this objective, the Company maintains its portfolio
of cash-equivalents and short-term investments in a variety of securities,
including both government and corporate obligations, certificates of deposit and
money market funds. As of November 30, 1998, approximately 85% of the Company's
portfolio mature in less than 6 months. Because the Company's investments are
diversified and of relatively short maturity, a hypothetical 10% increase in
interest rates would not have a material effect on the Company's financial
position.
The Company has entered into an interest rate swap transaction under which
Solectron pays a fixed rate of interest hedging against the variable interest
rates charged by the lessor for the facility lease at Milpitas, California. The
interest rate swap expires in the year of 2002 which coincides with the maturity
date of the lease term. As the Company intends to hold the interest rate swap
until the maturity date, the Company is not subject to market risk. In fact,
such interest rate swap has fixed the interest rate for the facility lease
reducing interest rate risk.
The Company's debt instruments are subject to fixed interest rates and, in the
case of the convertible notes, to fixed conversion ratios into the Company's
common stock. In addition, the amount of principal to be repaid at maturity is
also fixed. Therefore, the Company is not subject to market risk from its debt
instruments.
Competition
The electronics manufacturing services industry is comprised of a large number
of companies, several of which have achieved substantial market share. The
Company also faces competition from current and prospective customers that
evaluate Solectron's capabilities against the merits of manufacturing products
internally. Solectron competes with different
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companies depending on the type of service or geographic area. Certain
competitors may have greater manufacturing, financial, research and development
and marketing resources than the Company. The Company believes that the primary
bases of competition in its targeted markets are manufacturing technology,
quality, responsiveness, the provision of value-added services and price. To be
competitive, the Company must provide technologically advanced manufacturing
services, high product quality levels, flexible delivery schedules and reliable
delivery of finished products on a timely and price competitive basis. The
Company currently may be at a competitive disadvantage as to price when compared
to manufacturers with lower cost structures, particularly with respect to
manufacturers with established facilities where labor costs are lower.
Intellectual Property Protection
The Company's ability to compete may be affected by its ability to protect its
proprietary information. The Company holds a limited number of U.S. patents
related to the process and equipment used in its surface mount technology. The
Company's subsidiary, Force Computers, also holds a number of patents related to
VME technology. The Company believes these patents are valuable. However, there
can be no assurance that these patents will provide meaningful protection for
the Company's manufacturing process and equipment innovations or Force's
technology. There can be no assurance that third parties will not assert
infringement claims against the Company or its customers in the future, either
against the patents the Company holds itself or against the IBM patents and
other intellectual property rights that the Company has the right to practice.
In the event a third party does assert an infringement claim, the Company may be
required to expend significant resources to develop a non-infringing
manufacturing process or technology or to obtain licenses to the manufacturing
process or technology that is the subject of litigation. There can be no
assurance that the Company would be successful in such development or that any
such licenses would be available on commercially acceptable terms, if at all. In
addition, such litigation could be lengthy and costly and could have an adverse
material effect on the Company's financial condition regardless of the outcome
of such litigation.
Environmental Compliance
The Company is subject to a variety of environmental regulations relating to the
use, storage, discharge and disposal of hazardous chemicals used during its
manufacturing process. Any failure by the Company to comply with present and
future regulations could subject it to future liabilities or the suspension of
production. In addition, such regulations could restrict the Company's ability
to expand its facilities or could require the Company to acquire costly
equipment or to incur other significant expenses to comply with environmental
regulations.
Dependence on Key Personnel and Skilled Associates
The Company's continued success depends to a large extent upon the efforts and
abilities of key managerial and technical associates. The loss of services of
certain key personnel could have an adverse material effect on the Company. The
Company's business also depends upon its ability to continue to attract and
retain senior managers and skilled associates. Failure to do so could adversely
affect the Company's operations.
26
<PAGE>
Possible Volatility of Market Price of Common Stock
The trading price of the common stock is subject to significant fluctuations in
response to variations in quarterly operating results, general conditions in the
electronics industry and other factors. In addition, the stock market is subject
to price and volume fluctuations that affect the market price for many high
technology companies in particular, and that often are unrelated to operating
performance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Management's Discussion and Analysis of Financial Condition and Results of
Operations "Trends and Uncertainties -- Interest Rate Sensitivity" and "--
Foreign Exchange Rate Sensitivity."
27
<PAGE>
SOLECTRON CORPORATION AND SUBSIDIARIES
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 a Vote of Security Holders
None
Item 5: Other Information
None
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule - Three Months Ended
November 27, 1998
27.2 Restated Financial Data Schedule - Three Months Ended
November 28, 1997
(b) Reports on Form 8-K
None
28
<PAGE>
SOLECTRON CORPORATION
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.
SOLECTRON CORPORATION
(Registrant)
Date: January 8, 1999 By: /s/ Susan Wang
----------------------
Susan S. Wang
Senior Vice President, Chief
Financial Officer and Secretary
(Principal Financial and
Accounting Officer)
29
<PAGE>
EXHIBIT INDEX
Exhibit Number Document
- -------------- --------
27.1 Financial Data Schedule - Three Months Ended November 27, 1998
27.2 Restated Financial Data Schedule - Three Months Ended
November 28, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000835541
<NAME> SOLECTRON CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-27-1999
<PERIOD-END> NOV-27-1998
<CASH> 158,037
<SECURITIES> 36,776
<RECEIVABLES> 876,535
<ALLOWANCES> 4,361
<INVENTORY> 901,163
<CURRENT-ASSETS> 2,106,429
<PP&E> 971,354
<DEPRECIATION> 439,739
<TOTAL-ASSETS> 2,712,764
<CURRENT-LIABILITIES> 1,047,368
<BONDS> 387,836
0
0
<COMMON> 118
<OTHER-SE> 1,272,926
<TOTAL-LIABILITY-AND-EQUITY> 2,712,764
<SALES> 1,945,643
<TOTAL-REVENUES> 1,945,643
<CGS> 1,769,745
<TOTAL-COSTS> 1,769,745
<OTHER-EXPENSES> 78,990
<LOSS-PROVISION> (280)
<INTEREST-EXPENSE> 5,541
<INCOME-PRETAX> 96,128
<INCOME-TAX> 32,203
<INCOME-CONTINUING> 63,925
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 63,925
<EPS-PRIMARY> 0.54
<EPS-DILUTED> 0.52
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<CIK> 0000835541
<NAME> SOLECTRON CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-28-1998
<PERIOD-END> NOV-28-1997
<CASH> 113,947
<SECURITIES> 298,945
<RECEIVABLES> 523,406
<ALLOWANCES> 3,913
<INVENTORY> 590,058
<CURRENT-ASSETS> 1,581,652
<PP&E> 729,939
<DEPRECIATION> 351,740
<TOTAL-ASSETS> 2,010,024
<CURRENT-LIABILITIES> 640,330
<BONDS> 386,785
0
0
<COMMON> 115
<OTHER-SE> 979,284
<TOTAL-LIABILITY-AND-EQUITY> 2,010,024
<SALES> 1,136,820
<TOTAL-REVENUES> 1,136,820
<CGS> 1,013,061
<TOTAL-COSTS> 1,013,061
<OTHER-EXPENSES> 56,457
<LOSS-PROVISION> (136)
<INTEREST-EXPENSE> 6,513
<INCOME-PRETAX> 67,502
<INCOME-TAX> 22,614
<INCOME-CONTINUING> 44,888
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 44,888
<EPS-PRIMARY> 0.39
<EPS-DILUTED> 0.38
</TABLE>
