<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
Commission File Number: 0-24416
ADFLEX SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3186513
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2001 W. CHANDLER BLVD., CHANDLER, AZ 85224
(602) 963-4584
(Address, including zip code, and telephone number,
including area code, of registrant's
principal executive offices)
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 the filing requirements for the past 90 days.
Yes X No
The number of shares outstanding of the issuer's common stock, as of June 30,
1998:
COMMON STOCK, $.01 PAR VALUE: 8,842,871 SHARES
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ADFLEX SOLUTIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 1998 and December 31, 1997..........................................................3
Condensed Consolidated Statements of Operations -
Three and Six Months Ended June 30, 1998 and 1997............................................4
Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1998 and 1997......................................................5
Notes to Condensed Consolidated Financial Statements.............................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..............................................8
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.......................................15
Item 6. Exhibits and Reports on Form 8-K..........................................................15
SIGNATURES ...................................................................................................16
</TABLE>
EXHIBITS
(11.1) Computation of Net Income (Loss) per Share
(27.1) Financial Data Schedule (filed only electronically with the
SEC)
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
ADFlex Solutions, Inc.
Condensed Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash & cash equivalents $ 4,527 $ 9,092
Accounts receivable, net 23,890 31,581
Other receivables 948 1,167
Inventories 16,366 19,297
Prepaid taxes 3,078 2,951
Other current assets 1,509 1,400
-------- --------
Total current assets 50,318 65,488
Property, plant & equipment, net 52,015 42,257
Intangible Assets 2,191 2,449
Deferred tax assets 5,187 5,481
Other assets 22 24
-------- --------
$109,733 $115,699
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit $ 3,500 $ 7,000
Notes Payable 1,375 2,250
Accounts payable 15,401 22,692
Accrued liabilities 7,473 6,548
Current portion of long-term debt and
capitalized leases 5,462 1,959
-------- --------
Total current liabilities 33,211 40,449
Deferred tax liabilities 1,211 1,113
Long-term debt and capitalized leases 24,642 23,230
Stockholders' equity 50,669 50,907
-------- --------
$109,733 $115,699
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
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ADFlex Solutions, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 44,304 $ 56,244 $ 94,327 $ 104,465
Cost of sales 43,151 47,154 82,656 87,944
--------- --------- --------- ---------
Gross profit 1,153 9,090 11,671 16,521
Operating expenses:
Engineering, research & development 1,979 1,971 4,100 4,189
Selling, general & administrative 3,139 4,062 7,037 7,429
Amortization of intangible assets 129 -- 258 --
--------- --------- --------- ---------
Total operating expenses 5,247 6,033 11,395 11,618
Operating income (loss) (4,094) 3,057 276 4,903
Interest income 142 49 197 77
Interest expense (838) (511) (1,424) (945)
Other income (expense), net (174) 48 (360) (164)
Minority interest in earnings of
consolidated joint venture 0 (32) 0 (49)
--------- --------- --------- ---------
Income (loss) before income taxes (4,964) 2,611 (1,311) 3,822
Income taxes (1,390) 731 (368) 1,070
--------- --------- --------- ---------
Net income (loss) $ (3,574) $ 1,880 $ (943) $ 2,752
===============================================================
Net income per share:
Basic $ (.40) $ 0.22 $ (.11) $ 0.32
===============================================================
Diluted $ (.40) $ 0.21 $ (.11) $ 0.31
===============================================================
Number of shares used in computing
net income per share:
Basic 8,835 8,682 8,820 8,674
===============================================================
Diluted 8,835 8,800 8,820 8,784
===============================================================
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
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ADFlex Solutions, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income (loss) $ (943) $ 2,752
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization 4,339 3,191
Deferred taxes 391 (24)
Net gain/loss on disposal of assets (103) 0
Changes in operating assets and liabilities:
Accounts receivable 7,691 (8,065)
Duties/VAT receivable 219 452
Inventories 2,931 (3,817)
Prepaid Taxes (127) (105)
Other current assets (109) (974)
Accounts payable and accrued liabilities (6,366) 5,033
-------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 7,923 (1,557)
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Capital expenditures (13,733) (4,423)
(Increase)/decrease in other assets 2 1
Investment in joint venture 50
-------- --------
NET CASH (USED IN) INVESTING ACTIVITIES (13,731) (4,372)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Net activity on line of credit (3,500) (10,000)
Proceeds from issuance of long-term debt 5,000 25,000
Payments on long-term debt -- (10,000)
Payments on note payable (875) --
Payments on capitalized lease obligations (85) (73)
Issuance of common stock, net of expenses 703 498
-------- --------
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES 1,243 5,425
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (4,565) (504)
Cash and cash equivalents at beginning of period 9,092 6,097
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,527 $ 5,593
======== ========
</TABLE>
5
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ADFLEX SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring items) considered necessary for a fair
presentation have been included. Preparing financial statements requires the use
of estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. Actual results may differ from these
estimates. Operating results for the six month period ended June 30, 1998 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 1998. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended December 31, 1997.
The accompanying unaudited condensed consolidated financial statements
include the accounts of the Company and its subsidiaries. All intercompany
accounts and transactions have been eliminated in consolidation.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed for or Obtained for Internal-Use, which requires the
capitalization of certain costs incurred in connection with developing or
obtaining computer software. The Company elected to adopt SOP 98-1 effective
January 1, 1998 in connection with the purchase of a manufacturing cost control
system. Capitalized costs will be amortized on a straight-line basis over a
period of three years upon completion of the project in September 1998.
(2) ACCOUNTS RECEIVABLE, NET
Accounts receivable consists of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Accounts receivable trade $ 24,862 $ 33,331
Allowance for doubtful accounts and returns (972) (1,750)
-------- --------
$ 23,890 $ 31,581
======== ========
</TABLE>
(3) INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Raw materials $ 7,915 $ 12,688
Work-in-process 8,556 8,849
Finished goods 1,414 595
Allowance for obsolescence and excess inventory (1,519) (2,835)
-------- --------
$ 16,366 $ 19,297
======== ========
</TABLE>
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(4) ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Salaries and benefits $ 3,917 $ 3,259
Income taxes payable (1,075) --
Accrued interest 577 138
Accrued relocation 346 429
Accrued commissions 519 346
Accrued restructuring charges 178 339
Accrued severance and termination costs 900 --
Deferred tax liability 934 385
Other 1,177 1,652
------- -------
$ 7,473 $ 6,548
======= =======
</TABLE>
(5) LINE OF CREDIT AND LONG-TERM DEBT
In February 1998, the Company amended its existing credit facility to
more adequately meet its working capital requirements by increasing the existing
revolving line of credit from $20.0 million to $25.0 million. In addition, the
existing $25.0 million term loan was replaced with a $35.0 million term loan. In
July 1998, the Company reevaluated its financial needs, and determined that
credit facility commitments of a $20.0 million revolving line of credit and a
$30.0 million term loan are sufficient to meet its liquidity requirements, and
cancelled $10.0 million of existing credit facility commitments, $5 million
relating to the revolving line of credit and $5 million relating to the term
loan. The $30.0 million term loan requires equal principal payments of $1.8
million each quarter beginning with the quarter ending December 31, 1998 through
the quarter ending December 31, 1999, increasing to equal principal payments of
$2.2 million each quarter thereafter with the last payment due December 31,
2002. Borrowing under the line of credit is limited to 80% of the aggregate
value of all eligible domestic accounts receivable plus 70% of the aggregate
value of all eligible foreign accounts receivable. Under the terms of the credit
facility, any outstanding balance bears interest at BankBoston, N.A.'s prime
interest rate or LIBOR plus an applicable margin ranging from 1.25% to 2.25%
based on the Company achieving certain financial objectives at the end of each
quarter. The credit facility is secured by all assets of the Company and a
pledge by the Company of 66 2/3% of the stock of its subsidiaries. The Company
is required, under the credit agreement, to maintain certain financial ratios,
meet certain net worth and indebtedness tests and maintain an operating income
or net income position for any period comprised of two consecutive fiscal
quarters. As of June 30, 1998, the Company was in technical default of the
interest coverage and the operating/net income requirements which have been
waived by the lenders for the three month period ended June 30, 1998. The
Company was also in technical default of certain financial covenants due to the
amount of capital expenditures incurred during the three month period ended June
30, 1998, which have been waived by the lenders through December 31, 1998. In
addition, the existing credit facility was amended in May 1998 to limit capital
expenditures to $23.0 million during the fiscal year ending December 31, 1998.
The amended credit facility prohibits the payment of dividends. At June 30,
1998, the Company had $17.7 million available for borrowing based on collateral
requirements under the revolving line of credit with an outstanding balance of
$3.5 million and $30.0 million was outstanding under the term loan.
(6) RESTRUCTURING CHARGES
At the close of the third quarter of 1996, the Company's Board of
Directors approved a plan to restructure its assembly operation in the U.K. and
transfer production from the U.K. to the Company's manufacturing facility in
Lamphun, Thailand. As part of this restructuring, the Company recorded the
following charges: $13.5 million write-off in intangible assets, $8.8 million
write-down of property, plant and equipment and $6.9 million in employee and
lease termination charges. To date, the Company has paid and charged to the
liability $6.0 million in employee and
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lease termination charges. In addition, the Company reallocated $0.8 million of
the reserve for employee and lease termination costs to be used for additional
write-down of property, plant and equipment. The remaining accrual for employee
termination costs is approximately $0.1 million, which the Company believes is
adequate to cover the remaining liabilities.
(7) SPECIAL CHARGES
During the three month period ended June 30, 1998, the Company
implemented new cost and productivity improvement measures designed to address
current adverse industry trends such as intense price competition from Asian
suppliers and decreased demand by certain customers supplying the personal
computer markets - in particular the hard disk drive (HDD) segment. These
actions included the consolidation of administrative functions, a 10% reduction
in staffing, the closing of two manufacturing plants in Mexico and the transfer
of selected manufacturing programs from Mexico to Thailand. As a result, the
Company incurred a special charge of approximately $1.4 million, $0.5 million
related to the workforce reduction which was paid in June 1998 and $0.9 million
related to employee and termination costs associated with the closing of the two
plants in Mexico.
(8) INCOME TAXES
The Internal Revenue Service (IRS) has concluded a field audit of the
Company's income tax returns for the tax year 1993. In connection with this
audit, the IRS issued a 90-day letter in January of 1998 proposing adjustments
to the Company's income and tax credits for the year, which would result in an
additional assessment of $1.6 million, excluding interest. The major proposed
adjustment, which relates to the allocation of the purchase price of assets
obtained from Rogers Corporation (Rogers) pursuant to acquisition agreements
between the Company and Rogers, would extend the period over which the tax
benefit for the purchase price would be recovered. The Company disagrees with
the proposed adjustments and has timely filed a petition in the United States
Tax Court for a judicial determination of these issues. In the opinion of the
Company's management, the final disposition of these matters will not have a
material adverse effect on the Company's business, financial condition, results
of operations and cash flows.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
Net Sales
Net sales for the three and six month periods ended June 30, 1998
decreased $11.9 million or 21.2% and $10.1 million or 9.7%, respectively, over
the same periods in 1997. For the three and six month periods ending June 30,
1998, the Company's net sales were impacted by weaker demand experienced by
certain customers supplying the personal computer markets, particularly the hard
disk drive (HDD) segment. In addition, sales were negatively impacted by intense
price competition from Asian suppliers as they tried to mitigate the demand void
that was created by the Asian financial crisis.
Gross Profit
Gross profit as a percentage of net sales (gross margin) for the three
and six months ended June 30, 1998 was 2.6% and 12.3% as compared to 16.2% and
15.8%, respectively, for the same periods in 1997. The Company's decrease in
gross margin during the three and six month period ended June 30, 1998, was
attributable to several factors: underutilization of factories caused by reduced
demand, low yields on new product ramps as customers accelerated new programs to
bolster demand, intense price competition from Asian suppliers and charges of
approximately $1.4 million, of which $0.5 million related to the workforce
reduction and $0.9 million relates to employee and termination costs associated
with the closing of the two plants in Mexico.
Operating Expenses
Engineering, research & development expenses were essentially unchanged
for the three and six month period ended June 30, 1998 at $2.0 million and $4.1
million, respectively, compared with $2.0 million and $4.2 million for the same
periods in 1997, respectively. Sales, general & administrative (SG&A) expenses
were $3.1 million and $7.0 million for the three and six month period ended June
30, 1998, respectively, compared with $4.1 million and $7.4 million for the same
periods in 1997, respectively. These results reflect the Company's cost-
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containment efforts and general reductions in discretionary spending during
the three month period ending June 30, 1998. These benefits were partially
offset by charges of approximately $0.3 million for severance costs related to
workforce reduction in June 1998.
In connection with the acquisition of Hana's 20% interest in ADFlex
Thailand Limited (ATL) in September 1997, the Company recorded goodwill which is
being amortized over its estimated useful life of five years. Amortization of
intangible assets was $0.1 million, or 0.2% of net sales, for the three month
period ended June 30, 1998.
Interest and Other Income (Expense)
For the three month period ended June 30, 1998, interest expense
includes $0.8 million of interest expense related to borrowings under the line
of credit, the term loan and capital lease obligations. Interest expense for the
same period in 1997 represents $0.2 million of interest expense on the
subordinated debenture and $0.3 million of interest expense related to borrowing
on the line of credit, the term loan and capital lease obligations. Other income
(expense) for both periods represents the net impact of bank fees and exchange
gains and losses realized on the settlement of transactions associated with the
Company's foreign subsidiaries.
For the six month period ended June 30, 1998, interest expense includes
$1.4 million related to borrowings under the line of credit, term loan and
capital lease obligations. Interest expense for the same period in 1997 includes
$0.3 million of interest expense on the subordinated debenture and $0.6 million
of interest expense related to borrowings under the line of credit, the term
loan and capital lease obligations. Other income (expense) for both periods
represents the net impact of bank fees and exchange gains and losses realized on
the settlement of transactions associated with the Company's foreign
subsidiaries. Exchange gains and losses associated with short-term forward
foreign currency exchange contracts, which the Company began entering into in
December 1997 to manage its exposure, are also included in other income
(expense) for the six month period ended June 30, 1998. No foreign currency
exchange contracts were entered into during the three month period ended June
30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its growth and operations liquidity needs to
date primarily through cash generated from operations, the use of bank credit
lines and through proceeds from the sale of its Common Stock. The primary uses
of cash have been for increased working capital, funding of capital expenditures
and expansion of ADFlex Thailand.
In February 1998, the Company amended its existing credit facility to
more adequately meet its working capital requirements by increasing the existing
revolving line of credit from $20.0 million to $25.0 million. In addition, the
existing $25.0 million term loan was replaced with a $35.0 million term loan. In
July 1998, the Company reevaluated its financial needs and determined that
credit facility commitments of a $20.0 million revolving line of credit and a
$30.0 million term loan are sufficient to meet its liquidity requirements.
Accordingly, the Company cancelled $10 million of existing credit facility
commitments, $5 million relating to the revolving line of credit and $5 million
relating to the term loan. The $30.0 million term loan requires equal principal
payments of $1.8 million each quarter beginning with the quarter ending December
31, 1998 through the quarter ending December 31, 1999, increasing to equal
principal payments of $2.2 million each quarter thereafter with the last payment
due December 31, 2002. Borrowing under the line of credit is limited to 80% of
the aggregate value of all eligible domestic accounts receivable plus 70% of the
aggregate value of all eligible foreign accounts receivable. Under the terms of
the credit facility, any outstanding balance bears interest at BankBoston,
N.A.'s prime interest rate or LIBOR plus an applicable margin ranging from 1.25%
to 2.25% based on the Company achieving certain financial objectives at the end
of each quarter. The credit facility is secured by all assets of the Company and
a pledge by the Company of 66 2/3% of the stock of its subsidiaries. The Company
is required, under the credit agreement, to maintain certain financial ratios,
meet certain net worth and indebtedness tests and maintain an operating income
or net income position for any period comprised of two consecutive fiscal
quarters. As of June 30, 1998, the Company was in technical default of the
interest coverage and the operating/net income requirements which have been
waived by the lenders for the three month period ended June 30, 1998. The
Company was also in technical default of certain financial covenants due to the
amount of capital expenditures incurred during the three month period ended June
30, 1998, which have been waived by the lenders through December 31, 1998. In
addition, the existing credit facility was amended in May 1998 to limit capital
expenditures to $23.0 million during
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the fiscal year ending December 31, 1998. The amended credit facility prohibits
the payment of dividends. At June 30, 1998, the Company had $17.7 million
available for borrowing based on collateral requirements under the revolving
line of credit with an outstanding balance of $3.5 million and $30.0 million was
outstanding under the term loan.
Net cash provided by operating activities for the six month period
ended June 30, 1998 was $7.9 million compared with net cash used by operations
of $1.6 million for the same period in 1997. During these same periods net
income (loss) was ($1.0 million) and $2.8 million, respectively. Decreased sales
levels for the six month period ended June 30, 1998 resulted in the Company
maintaining a low level of working capital, primarily a decreased level of
accounts receivable, inventory and accounts payable.
Net cash used in investing activities was $13.7 million for the six
month period ended June 30, 1998 compared with $4.4 million for the same period
in 1997. Capital expenditures during the periods were financed from existing
cash balances and from borrowings under the Company's bank line of credit. The
Company currently expects to spend an additional $6.0 million on capital
expenditures in 1998 to support expansion of worldwide manufacturing operations,
primarily for machinery, systems and equipment, and expansion of operations in
Thailand.
Net cash provided by financing activities for the six month period
ended June 30, 1998 was $1.2 million compared with $5.4 million for the same
period in 1997. The Company borrowed an additional $5.0 million on its term loan
during the six months ended June 30, 1998, which was used to pay down the
Company's bank line of credit. Net repayments on the Company's bank line of
credit totaled $3.5 million during the six months ended June 30, 1998 compared
to net repayments of $10.0 million for the same period in 1997. Under the
original credit agreement as discussed above, the Company borrowed $25.0 million
under the term loan during the six month period ended June 30, 1997. Of the
$25.0 million term loan proceeds, approximately $7.5 million in principal plus
$2.0 million in accrued interest was used to retire, ahead of schedule, the
subordinated debenture issued in the acquisition of the Company's U.K.
operation, approximately $15.0 million was used to repay borrowings under the
Company's existing line of credit and the remainder was used to finance working
capital of the Company. In addition, the Company remitted $2.5 million in
principal plus $0.8 million in accrued interest in January 1997 in payment of
the subordinated debenture. Funding for this payment came from the Company's
line of credit. The Company generated $0.7 million and $0.5 million in the six
months ended June 30, 1998 and 1997, respectively, through sales of its Common
Stock. During the year ended December 31, 1997, the Company paid $0.5 million at
closing and issued a note in the principal amount of $2.8 million payable at
various dates through September 30, 1998 in connection with the acquisition of
Hana's 20% interest in ATL. As required by the terms of the note, the Company
remitted $0.9 million during the six months ended June 30, 1998. Funding for
this payment came from the Company's line of credit. As of June 30, 1998, $1.4
million was outstanding under the note.
The Company may require additional capital to finance enhancement to,
or expansion of, its manufacturing capacity in accordance with its business
strategy. Management believes that the level of working capital should continue
to grow at a rate generally consistent with the growth of the Company's
operations. Although no assurance can be given that future financing will be
available on terms acceptable to the Company, the Company may seek additional
funds from time to time through public or private debt or equity offerings or
through bank borrowings. Management believes, however, that existing cash
balances, funds generated from operations and borrowings under its existing line
of credit will be sufficient to permit the Company to meet its liquidity and
expansion requirements for the next twelve months.
OTHER MATTERS
Foreign Operations
The Company's primary finishing and assembly facilities are located in
Agua Prieta, Mexico and Lamphun, Thailand and the Company maintains a technology
and pilot production facility in Havant, England. While the Company believes
that it has established good relationships with its labor force and the local
governments, the spread of the manufacturing process over multiple countries
subjects the Company to risks inherent in international operations. While the
Company transacts business predominately in U.S. Dollars and most of its net
sales are collected in U.S. Dollars, a portion of its sales and expenses are
denominated in other currencies. Changes in the relation of other currencies to
the U.S. Dollar will affect the Company's cost of goods sold and operating
margins and could result in exchange gains or losses. In order to reduce the
impact of certain foreign
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currency fluctuations, the Company enters into short-term forward foreign
currency exchange contracts (hedges) in the regular course of business to manage
its exposure. The forward exchange contracts generally require the Company to
exchange U.S. Dollars for foreign currencies at maturity, at rates agreed to at
inception of the contracts. The gains or losses on hedges of transaction
exposure are included in income in the period in which the exchange rates
change. The gains and losses on unhedged foreign currency transactions are
included in income. No assurance can be given that the Company's hedging
strategies will prevent future currency fluctuations from adversely affecting
the Company's business, financial condition, results of operations and cash
flows.
Expansion of Thailand Operations
In April 1998, the Company commenced expansion of its Thailand
operations with the construction of a new plant. The expansion will initially
provide 100,000 square feet of manufacturing space - 65,000 feet for flex
fabrication and 35,000 feet for assembly - bringing the total size of the
facility to 140,000 square feet. The expanded facility, which will increase the
total assembly area by nearly 50%, includes state-of-the-art clean rooms and the
production capability to process up to 750,000 circuit assemblies per week. The
new flex fabrication area will feature advanced surface finishing, laser
processing and automated optical profiling technologies. The total estimated
cost of the expansion is approximately $9.0 million and is expected to be
operational by the second quarter of 1999, including customer qualification and
ramp into volume production. The Company anticipates that the new Thailand
facility will enable it to attain significant cost reductions that are crucial
to mitigating competitive price pressures in Asia and help sustain the Company's
implementation of a complete flexible circuit interconnect solution including
design, fabrication, assembly and testing. No assurance can be given that the
Company's expansion strategies will not have any material, adverse effects on
the Company's business, financial condition, results of operations and cash
flows.
Future Operations
The Company is subject to a variety of environmental laws relating to
the storage, discharge, handling, emission, generation, manufacture, use and
disposal of chemicals, solid and hazardous waste and other toxic and hazardous
materials used to manufacture the Company's products. The Company conducted
environmental studies of its facility in Chandler, Arizona which revealed a
limited amount of soil contamination that may require remediation. Based on
these studies, the Company believes that the costs associated with remediation
will not have a material adverse effect on its operations or financial
condition. Pursuant to the acquisition agreements pertaining to the initial
formation of the Company, Rogers Corporation (Rogers) retained all environmental
liabilities existing prior to the acquisition. While Rogers currently has
sufficient assets to fulfill its obligations under the acquisition agreements,
if additional pre-closing environmental liabilities requiring remediation are
discovered and the Company was unable to enforce the acquisition agreement
against Rogers, the Company could become subject to costs and damages relating
to such environmental liabilities. Any such costs and damages imposed on the
Company could materially adversely affect the Company's business, financial
condition and results of operations.
In mid 1995, the Company acquired a manufacturing facility located in
Agua Prieta, Mexico. In connection with this acquisition, the Company conducted
an environmental study of the facility which indicated the contamination by
hazardous materials in the soil and groundwater. Pursuant to the purchase
agreement, the seller submitted a remediation plan to the appropriate Mexican
authorities, which was approved in May 1997. Subsequent remediation was
completed in December 1997. The seller is awaiting acknowledgement that the
remediation plan has been approved and no further action is required by the
Mexican authorities. The seller's obligation for cost of remediation is limited
to $2.5 million. A total of $1.0 million was originally held in escrow pending
seller's performance of their environmental obligations under the agreement. One
third of the escrow balance was used to conduct the remediation, one third was
released to the seller according to the agreement and one third remains in
escrow and will be released to the seller upon closure of the issue by the
Mexican authorities with certification that no further action is required. Given
the uncertainties associated with environmental contamination, including
possible claims by third parties in the U.S., there can be no assurance that
future remedial costs or liabilities will not have a material adverse impact on
the Company.
The Company believes that it has been operating its facilities in
substantial compliance in all material respects with existing environmental
laws. However, the Company cannot predict the nature, scope or effect of
legislation or regulatory requirements that could be imposed or how existing or
future laws or regulations will be administered or interpreted with respect to
products or activities to which they have not previously been applied.
11
<PAGE> 12
Dependence on Electronics Industry
The Company's principal customers are electronics original equipment
manufacturers and contract manufacturers. The electronics industry as a whole is
characterized by intense competition, relatively short product life-cycles and
significant fluctuations in product demand. In addition, the electronics
industry is generally subject to rapid technological change and product
obsolescence. Discontinuance or modifications developed in connection with next
generation products containing flexible circuit interconnects manufactured by
the Company could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, the electronics industry
is subject to economic cycles and has in the past experienced, and is currently
experiencing, a recessionary period. A recession or any other event leading to
excess capacity or a downturn in the electronics industry will and have resulted
in intensified price competition, reduced gross margins and a decrease in unit
volume, all of which would have and are currently having a material adverse
effect on the Company's business, financial condition, results of operations and
cash flows.
Fluctuations in Operating Results
The Company has experienced substantial fluctuations in its quarterly
and annual operating results in the past, and the Company's future operating
results could vary substantially from quarter to quarter. The Company's
operating results for a particular quarter or longer periods can be materially
and adversely affected by numerous factors, such as the receipt and shipment of
large orders, plant utilization, product mix, manufacturing process yields, the
timing of expenditures in anticipation of future sales, raw material
availability, product and price competition, the length of sales cycles and
economic conditions in the electronics industry. Variations in orders and in the
mix of products sold by the Company have significantly impacted net sales and
gross profit. Many of these factors are outside the control of the Company.
Concentration Risk
The Company provides flexible interconnect products to a diverse group
of markets. Through ongoing diversification and new market expansion efforts,
primarily directed toward the communications and consumer markets, the Company
is continuing its efforts to reduce its dependence on the HDD market. Sales to
the HDD market accounted for 35% of net sales compared to 50% of net sales for
the six month periods ended June 30, 1998 and 1997, respectively. Though the
Company is continuing its efforts to reduce its dependence on the HDD industry,
net sales attributable to this market are expected to continue to represent the
largest portion of net sales for the foreseeable future and could return to a
majority of the Company's net sales. The loss of any HDD customer, or a
substantial reduction in orders by any significant customer, including
restriction due to market, competitive or economic conditions, would have a
material adverse effect on the Company's business, financial condition, results
of operations and cash flows.
Competition
The Company experiences competition worldwide from a number of
leading foreign and domestic providers, such as Nippon Mektron ("NOK"), Fujikura
Ltd. ("Fujikura") , Multi-Fineline Electronix, Inc. ("M-Flex"), Sheldahl, Inc.
("Sheldahl"), Parlex Corporation ("Parlex"). NOK and Fujikura are Japan-based
suppliers substantially larger than the Company with greater financial and other
resources. M-Flex, Sheldahl and Parlex are U.S.-based flexible circuit
manufacturers that have lower sales of polyimide flexible circuits than the
Company and have historically targeted suppliers of computers, communication and
automotive services, and the military, respectively. Expansion of the Company's
existing products or services could expose the Company to new competition.
Moreover, new developments in the electronics industry could render existing
technology obsolete or less competitive and could potentially introduce new
competition into the market. There can be no assurance that the Company's
competitors will not develop enhancements to, or future generations of,
competitive products or services that will offer superior price or performance
features to those of the Company or that new competitors will not enter the
Company's markets. Finally, as many of the Company's competitors are based in
foreign countries, they have cost structures and prices based on foreign
currencies. Accordingly, currency fluctuations could cause the Company's
dollar-priced products to be less competitive than its competitors' products
priced in other currencies.
The Company also competes in assembly matters with leading flexible
circuit assembly providers such as Smartflex Systems, Inc. and Solectron Corp.
The Company believes that competition in assembly matters is primarily driven by
availability of assembly technology, price and cycle time. The Company believes
that it will compete favorably with these competitors because it offers its
customers a complete flexible circuit interconnect solution including design,
fabrication, assembly and testing (referred to as the one-stop-shop strategy).
12
<PAGE> 13
The Company's competitors can be expected to continue to improve the
design and performance of their products and to introduce new products with
competitive price/performance characteristics. Competitive pressures often
necessitate price reductions which can adversely affect operating results. The
Company will be required to make a continued high level of investment in product
development and research, sales and marketing and ongoing customer service and
support to remain competitive. There can be no assurance that the Company will
have sufficient resources to continue to make such investments or that the
Company will be able to make the technological advances necessary to maintain
its competitive position in the flexible circuit interconnect market. There can
be no assurance that existing or future competitors will not be able to
duplicate the Company's strategies, that the Company will be able to compete
successfully in the future, or that competitive pressures faced by the Company
will not have a material adverse effect on the Company's business, financial
condition, results of operations and cash flows.
Volatility of Stock Price
The trading price of the Company's Common Stock is expected to continue
to be subject to wide fluctuations in response to quarter-to-quarter variations
in operating results, announcements of technological innovations or new products
by the Company's customers, general conditions in the disk drive and computer
industries, and other events or factors. In addition, stock markets have
experienced extreme price volatility in recent years. This volatility has had a
substantial effect on the market price of securities issued by many high
technology companies, in many cases for reasons unrelated to the operating
performance of the specific companies, and the Company's Common Stock has
experienced volatility not necessarily related to announcements of Company
performance. Broad market fluctuations may adversely affect the market price of
the Company's Common Stock.
Cancellation and Regrant of Stock Option Grants
On June 22, 1998, the Compensation Committee of the Company's Board of
Directors approved the cancellation of all outstanding options granted on June
3, 1997, October 1, 1997 and April 7, 1998 (with an original exercise price of
$15.50, $22.063 and $17.063 per share, respectively) and the regrant and
replacement of these options with new options at an exercise price per share of
$8.50, the fair market value of the Company's Common Stock on the date of the
Committee's determination. Each optionee has the opportunity to elect to retain
his or her old options or accept a new option with an exercise price of $8.50
per share. Each new option has a term of ten years and becomes exerciseable for
25% of the option share on June 22, 1999 and for the balance of the shares in a
series of equal monthly installments over the 36-month period thereafter,
assuming continued employment with the Company or one of its subsidiaries. The
Compensation Committee elected not to reprice any other outstanding options at
that time.
The Compensation Committee approved the cancellation-regrant program
because it believes that equity interests are a significant factor in the
Company's ability to attract and retain key employees who are critical to the
Company's long-range success. During the three and six month period ended June
30, 1998, the market value of the Common Stock had fallen, in part, as a result
of market factors that affected many stocks in the industry in which the Company
engaged including the stock of the Company's customers. As a result of the
decrease in the fair market value of the Common Stock, the Committee believed
that the Company's ability to retain existing employees was adversely affected
and to attract talented individuals in the future would be impaired.
Accordingly, the Committee approved the cancellation-regrant program as a means
to ensuring that optionees have a meaningful equity interest in the Company.
New Accounting Standards
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer
Software Developed for or Obtained for Internal-Use, which requires the
capitalization of certain costs incurred in connection with developing or
obtaining computer software. The Company elected to adopt SOP 98-1 effective
January 1, 1998 in connection with the purchase of a manufacturing cost control
system. Capitalized costs will be amortized on a straight-line basis over a
period of three years upon completion of the project in September 1998.
Income Taxes
The Company's effective tax rate of 28% for the three and six month
period ended June 30, 1998 is an estimated annual rate based upon projected
profit levels at each of the Company's entities. As the actual tax rate for each
entity varies in accordance with the taxing authority in whose jurisdiction they
reside, a significant change in operating income at any one location can result
in a change in the overall effective tax rate for the Company. The
13
<PAGE> 14
Company monitors the effective tax rate on a continuous basis and makes
adjustments as conditions warrant. The effective tax rate for the three and six
month period ended June 30, 1997 was also 28%.
The Internal Revenue Service (IRS) has concluded a field audit of the
Company's income tax returns for the tax year 1993. In connection with this
audit, the IRS issued a 90-day letter in January of 1998 proposing adjustments
to the Company's income and tax credits for the year, which would result in an
additional assessment of $1.6 million, excluding interest. The major proposed
adjustment, which relates to the allocation of the purchase price of assets
obtained from Rogers Corporation (Rogers) pursuant to acquisition agreements
between the Company and Rogers, would extend the period over which the tax
benefit for the purchase price would be recovered. The Company disagrees with
the proposed adjustments and has timely filed a petition in the United States
Tax Court for a judicial determination of these issues. In the opinion of the
Company's management, the final disposition of these matters will not have a
material adverse effect on the Company's business, financial condition, results
of operations and cash flows.
Impact of Year 2000
The Year 2000 Issue is a result of computer programs being written
using two digits rather than four to define the applicable year which, if left
uncorrected, could result in a system failure or miscalculations causing
disruptions of operations. Since the Company's current manufacturing/cost
control system does not function properly with respect to dates from the year
2000, the Company entered into an agreement with SAP America, Inc. (SAP) to
license the rights to SAP's proprietary R/3 software, which will function
properly with respect to dates in the year 2000 and beyond. The software will
replace the Company's current manufacturing/cost control systems and the Company
anticipates completing the conversion in September 1998. The total cost of
implementing the new system, including software, implementation, hardware and
training, is expected to be $4.9 million. The cost of acquiring and implementing
the new system will be recorded as an asset by the Company and will be amortized
over its estimated
benefit period.
In addition, the Company has evaluated the software associated with its
manufacturing equipment and has concluded that there is no exposure to
contingencies related to the Year 2000 Issue. Therefore, the Company does not
believe that the Year 2000 Issue will have a material impact on the operations
of the Company. There can be no assurances that the systems of customers,
suppliers and other companies on which the Company relies will be timely
converted and will not have an adverse effect of the Company's systems or
operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report contains forward-looking statements that involve risks and
uncertainties, including but not limited to, the risks of concentration of sales
in markets, and in particular the HDD market, and customers, which have caused
and in the future could cause materially adverse fluctuations in operating
results; the risks of being a supplier to the electronics industry in general,
which is characterized by rapid technological change, product obsolescence and
price competition, which could materially adversely affect operating results;
the risk that growth in demand for products that use flex, and the corresponding
demand for flex, will not continue to increase as anticipated; the risk that the
Company's fully integrated one-stop-shop strategy will continue to be accepted
by customers, and the risk that competitors may seek to duplicate this strategy,
which could materially adversely affect operating results; the risk that the
Company's expansion of manufacturing facilities in Thailand will not result in
sustainable, increased efficiencies, cost savings or improved margins as
anticipated or at the time anticipated, general risks inherent in international
operations, including currency fluctuations and government-mandated wage
increases; general manufacturing risks, including environmental risks related to
manufacturing operations and clean-up of the Mexican manufacturing facility;
uncertainty with respect to the Internal Revenue Service report on the Company's
1993 tax return and the ultimate financial impact, if any, thereof; the risk
that the Company's implementation of a new manufacturing/cost control system
will not occur as scheduled or that such implementation will not resolve the
Company's Year 2000 Issue; the risk that other systems on which the Company
relies, such as suppliers and customers, will function properly with respect to
dates in the year 2000 and thereafter; the risk that all of the foregoing
factors or other factors could cause fluctuations in the price of the Company's
Common Stock; and other risks detailed herein, in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997 and Quarterly Report on Form 10-Q
for the quarter ended March 31, 1998 and other Securities and Exchange
Commission filings.
14
<PAGE> 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of the shareholders of ADFlex Solutions
Inc. held on April 28, 1998, the following matters were submitted to a vote:
PROPOSAL I - ELECTION OF DIRECTORS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Rolando C. Esterverena For - 6,968,308 Withheld - 20,309
Richard P. Clark For - 6,968,308 Withheld - 20,309
Wade Meyercord For - 6,970,628 Withheld - 17,989
Steve Sanghi For - 6,967,728 Withheld - 20,889
William Kennedy Wilkie For - 6,967,746 Withheld - 20,871
</TABLE>
PROPOSAL II - RATIFICATION OF THE APPOINTMENT OF ERNST & YOUNG LLP AS
AUDITORS
For - 6,954,876 Against - 17,698 Abstain - 16,043
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
(11.1) Computation of Net Income Per Share
(27.1) Financial Data Schedule (filed only electronically with
the SEC)
(b) Reports on Form 8-K.
The registrant did not file any reports on Form 8-K during the
quarter ended June 30, 1998.
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADFlex Solutions, Inc.
Date: August 14, 1998 By /s/ Donald E. Frederick
------------------ -------------------------------------
Donald E. Frederick
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial and Accounting
Officer)
16
<PAGE> 17
Index to Exhibits
Exhibit 11.1 Computation of Net Income Per Share
Exhibit 27.1 Financial Data Schedule
<PAGE> 1
EXHIBIT 11.1
ADFLEX SOLUTIONS, INC.
EXHIBIT (11.1) - COMPUTATION OF NET INCOME (LOSS) PER SHARE
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- --------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) $ (3,574) $1,880 $ (943) $2,752
======== ====== ============ ======
COMPUTATION OF SHARES USED IN NET INCOME (LOSS) PER
SHARE:
Weighted average common shares outstanding 8,835 8,682 8,820 8,674
Incremental common equivalent shares representing
shares issuable upon exercise of stock
options (1) -- 118 -- 110
-------- ------ ------------ ------
Total weighted average shares -
Diluted 8,835 8,800 8,820 8,784
======== ====== ============ ======
Total weighted average shares -
Basic 8,835 8,682 8,820 8,674
======== ====== ============ ======
Net income (loss) per diluted common and
common equivalent share $ (.40) $ .21 $ (.11) $ .31
======== ====== ============ ======
Net income(loss) per basic common
and common equivalent share $ (.40) $ .22 $ (.11) $ ..32
======== ====== ============ ======
</TABLE>
- --------
(1) Amount calculated using the treasury stock method and fair market values
for stock.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 4,527
<SECURITIES> 0
<RECEIVABLES> 24,862
<ALLOWANCES> (972)
<INVENTORY> 16,366
<CURRENT-ASSETS> 50,318
<PP&E> 68,617
<DEPRECIATION> (16,602)
<TOTAL-ASSETS> 109,733
<CURRENT-LIABILITIES> 33,211
<BONDS> 0
0
0
<COMMON> 88
<OTHER-SE> 50,581
<TOTAL-LIABILITY-AND-EQUITY> 109,733
<SALES> 94,327
<TOTAL-REVENUES> 94,327
<CGS> 82,656
<TOTAL-COSTS> 82,656
<OTHER-EXPENSES> 11,395
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,424)
<INCOME-PRETAX> 0
<INCOME-TAX> (368)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (943)
<EPS-PRIMARY> (.11)
<EPS-DILUTED> (.11)
</TABLE>
