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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 28, 1997
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OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ------- EXCHANGE ACT OF 1934.
For the transition period from to
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Commission File Number: 0-26472
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SMARTFLEX SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 33-0581151
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
14312 Franklin Avenue, Tustin, California 92781-2085
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(Address of principal executive offices) (Zip Code)
(714)838-8737
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(Registrant's telephone number, including area code)
14312 Franklin Avenue, Tustin, California 92680-7028
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(Former name, former address and former fiscal year, if changed since
last report.)
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. X Yes No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, $.0025 par value - 6,335,809 shares as of JULY 31, 1997
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Page 1 of 17
Exhibit Index on Page 17
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SMARTFLEX SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1997 and December 31, 1996 3
Consolidated Statements of Operations for the three and six months ended
June 30, 1997 and June 30, 1996 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 1997 and June 30, 1996 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and 7-14
Results of Operations
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
INDEX TO EXHIBITS 17
</TABLE>
2
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
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SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) (Unaudited) June 30, December 31,
1997 1996
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,461 $ 1,164
Short-term investments 21,414 24,796
Accounts receivable, net of allowance for doubtful accounts
of $705 at June 30, 1997 and $920 at December 31, 1996 21,018 18,837
Inventories:
Raw materials 9,853 7,722
Work-in-process 3,694 2,968
Finished goods 1,178 400
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Total inventories 14,725 11,090
Deferred tax asset 1,702 1,634
Prepaid expenses and other current assets 2,359 1,944
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Total current assets 62,679 59,465
Property and equipment, at cost:
Machinery and equipment 19,236 13,415
Office furniture and equipment 3,606 2,622
Leasehold improvements 3,369 2,581
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26,211 18,618
Less accumulated depreciation and amortization (8,687) (6,492)
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Total property and equipment 17,524 12,126
Other Assets 30 541
=============== ==============
$ 80,233 $ 72,132
=============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable to related parties $ 726 $ 2,041
Accounts payable 15,341 11,457
Accrued compensation and related costs 1,168 1,452
Other accrued liabilities 2,229 2,215
Current portion of notes payable 977 587
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Total current liabilities 20,441 17,752
Deferred tax liability 909 909
Long-term debt less current portion 5,113 722
Stockholders' equity:
Preferred stock, $.001 par
value:
Authorized shares -- 5,000,000
Issued and outstanding -- none - -
Common stock, $.0025 par value:
Authorized shares -- 25,000,000
Issued and outstanding shares -- 6,335,334 at June 30, 1997
and 6,301,313 at December 31, 1996, respectively 16 16
Additional paid-in capital 35,878 35,649
Retained earnings 17,876 17,084
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Total stockholders' 53,770 52,749
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$ 80,233 $ 72,132
=============== ==============
</TABLE>
See accompanying notes. 3
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SMARTFLEX SYSTEMS, INC.
Consolidated Statements of Operations
(In thousands except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
--------------------------------- ---------------------------------
1997 1996 1997 1996
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<S> <C> <C> <C> <C>
Net revenues $ 37,003 $ 34,290 $ 67,275 $ 74,315
Cost of revenues 33,412 29,936 61,731 64,949
-------------- ---------------- -------------- ---------------
Gross margin 3,591 4,354 5,544 9,366
Costs and expenses:
Marketing and sales expense 963 635 1,820 1,280
General and administrative expense 1,807 1,318 3,106 2,832
-------------- ---------------- -------------- ---------------
Operating income 821 2,401 618 5,254
Interest income 251 255 527 486
Interest expense (196) (33) (260) (97)
Other expense (113) (2) (92) (5)
-------------- ---------------- --------------- ---------------
Income before income taxes 763 2,621 793 5,638
Income tax provision 205 977 1 2,082
-------------- ---------------- --------------- ---------------
Net income $ 558 $ 1,644 $ 792 $ 3,556
============== ================ ============== ===============
Net income per common and common
equivalent share:
Primary $ 0.09 $ 0.26 $ 0.12 $ 0.56
============== ================ ============== ===============
Fully diluted $ 0.09 $ 0.26 $ 0.12 $ 0.56
============== ================ ============== ===============
Common and common equivalent
shares used in computing per
share amounts:
Primary 6,428 6,420 6,444 6,397
============== ================ ============== ===============
Fully diluted 6,428 6,420 6,444 6,397
============== ================ ============== ===============
</TABLE>
See accompanying notes. 4
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SMARTFLEX SYSTEMS, INC.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30
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1997 1996
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<S> <C> <C>
Net cash flow from operating activities:
Net income $ 792 $ 3,556
Adjustments to reconcile net income to cash (used in) provided by
operating activities:
Depreciation and amortization 2,054 1,337
Loss on sale of property and equipment 150 40
Provision for doubtful accounts (189) -
Provision for inventory obsolescence 34 120
Deferred income taxes (68) -
Other changes in operating assets and liabilities:
Receivables (1,992) 4,237
Inventories (3,669) 5,799
Prepaid expenses and other assets 96 (242)
Accounts payable to related parties (1,315) (1,274)
Accounts payable and accrued expenses 3,615 (4,526)
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Net cash (used in) provided by operating activities (492) 9,047
Cash flow from investing activities:
Capital expenditures (7,593) (2,817)
Purchase of short-term investments (7,978) (9,860)
Proceeds from the sale of short-term investments 11,352 7,366
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Net cash used in investing activities (4,219) (5,311)
Cash flow from financing activities:
Net proceeds from sale of common stock 228 425
Net borrowings (repayments) on revolving line of credit 2,874 (2,505)
Borrowings (repayments) on term loan 1,906 (281)
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Net cash provided by (used in) financing activities 5,008 (2,361)
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Net increase in cash 297 1,375
Cash at beginning of period 1,164 1,398
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Cash at end of period $ 1,461 $ 2,773
=============== ==============
Supplemental disclosures of cash flow information:
Interest paid $ 161 $ 124
Taxes paid 101 2,040
</TABLE>
See accompanying notes. 5
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SMARTFLEX SYSTEMS, INC.
Notes to Consolidated Financial Statements
June 30, 1997
(Unaudited)
Note (A) --- Basis of Presentation
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The accompanying unaudited consolidated financial statements include
the accounts of Smartflex Systems, Inc. and its wholly owned subsidiaries
("Smartflex" or "the Company"), and 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
accruals) considered necessary for a fair presentation have been included.
Operating results for the three- and six-month periods ended June 30, 1997 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 1997. For further information, refer to the consolidated
financial statements and foot notes thereto included in the Company's Annual
Report to Stockholders for the year ended December 31, 1996.
Note (B) --- Fiscal Year
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The Company's fiscal year is 52 or 53 weeks, ending on the Saturday
nearest December 31 each year, and follows a four-four-five week quarterly
cycle. For clarity of presentation, the Company has presented its fiscal years
as ending December 31, and its fiscal quarters as ending on March 31, June 30,
September 30 and December 31.
Note (C) --- Use of Estimates
- -----------------------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
Note (D) -- Credit Facility
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On October 4, 1996, the Company amended its bank credit facility
("facility") which provides for aggregate borrowings of $15.0 million under a
revolving line of credit ("credit line"). Borrowings under the credit line
include a sublimit for the issuance of up to $2.0 million in commercial or
standby letters of credit for the purchase of inventory. Outstanding balances on
the credit line bear interest at the bank's reference rate or, at the Company's
option, LIBOR plus 1.5%, and unused portions of the credit line bear interest at
0.25% per annum. Interest is payable monthly and principal is payable at
maturity on September 30, 1998. At June 30, 1997, borrowings under the revolving
loan totaled $2.9 million; there were no letters of credit outstanding as of
that date. The facility additionally provides for an unsecured term loan
totaling $2.2 million, all of which the Company had borrowed as of June 30,
1997. The expiration date of such unsecured term loan is September 30, 1997.
Note (E) -- Impact of newly issued pronouncement by the Financial Accounting
Standards Board
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In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, Earnings per Share, which is required to be adopted on
December 31, 1997. At that time, the Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. The impact is expected to
result in an increase of $0.01 in primary earnings per share for the six months
ended June 30, 1997 and June 30, 1996, respectively. The Company has not yet
determined what the impact of Statement 128 will be on the calculation of fully
diluted earnings per share.
6
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SMARTFLEX SYSTEMS, INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following information includes forward-looking statements, the
realization of which may be impacted by certain important factors discussed in
"Risk Factors," below.
OVERVIEW
Smartflex provides custom design and turnkey manufacturing of flexible
interconnect assemblies to customers who are manufacturers of compact,
high-performance electronic products. The Company specializes in precision
surface mount ("SMT") and direct chip attach technologies on flexible circuit
substrates. Smartflex's customer base includes hard disk drive ("HDD") and
non-HDD manufacturers. To date, HDD revenues have represented the Company's
predominant market. For the six months ended June 30, 1997, HDD revenues
comprised 80.5% of total revenues, compared to 59.1% for the same period last
year.
During the second quarter of 1997, certain component availability
difficulties, including the restricted availability of ceramic substrates, which
negatively impacted the first quarter results, were resolved. All three of the
Company's ceramic substrate suppliers achieved their planned production goals
during the second quarter. Net revenues for the second quarter ended June 30,
1997, increased 22.2% from the first quarter of 1997 and 7.9% from the
comparable quarter in the prior year. During the second quarter total unit
shipments were approximately 910,000 more than the first quarter of 1997 and
622,000 more than the comparable quarter of the prior year. HDD unit shipments
increased 32.9% over the first quarter of 1997 and 41.0% over the same period in
the prior year. However, during the second quarter of 1997, demand for the
high-end disk drives softened due to increased inventories and competition
experienced by a key customer. As a result of this reduced demand coupled with
the component shortage that limited the results of the first quarter, net
revenues in the first half of 1997 were 9.5% lower than the comparable period in
the prior year.
During the second quarter of 1997, the Company also made substantial
changes at each of its four facilities with an outlay of approximately $5.9
million. Operations in Monterrey, Mexico were moved to a new facility with
double the floor space of the previous facility; a SMT line was added to the
Cebu, Philippines facility, almost doubling its SMT capacity; and the SMT and
COF capacity in Singapore were increased by 25% and 20%, respectively. While the
international facilities were expanded to provide additional low cost
manufacturing capabilities, the Tustin, California facility has been positioned
to serve as a quick-turn, prototype, and development center.
RESULTS OF OPERATIONS
Net Revenues
Net revenues for the quarter ended June 30, 1997 were $37.0 million, an
increase of 22.2% compared to the first quarter of 1997 and 7.9% compared to the
same period in the prior year. The increase in revenues during the second
quarter was primarily due to increases in the HDD business, reflecting a 41.0%
increase in HDD unit shipments over the previous quarter, and 32.9% increase in
HDD unit shipments over the same period in the prior year. Net revenues for the
six months ended June 30, 1997 decreased 9.5% to $67.3 million from $74.3
million for the six months ended June 30, 1996. HDD unit shipments increased
38.8% during the six months ended June 30, 1997 from the shipment levels
achieved during the same period in the prior year. Total unit shipments during
the six months ended June 30, 1997 increased 18.1% from the unit levels achieved
during the six months ended June 30, 1996. Revenues generated from increases in
volume were partially offset by decreases in component costs, generally passed
through to customers in the form of lower prices, and by price decreases due to
competitive pressures.
Net HDD revenues were 9.3% higher than those in the first quarter of
1997, and 32.9% higher than the same period last year. Net revenues from the
non-HDD segment of the business almost doubled compared to the first quarter of
1997 due to increases in scanner programs, tape programs and array product
shipments which
7
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were all restricted in the prior quarter. However, net revenues attributable to
non-HDD programs decreased 32.9% during the second quarter of 1997 compared to
the same period in 1996, and 56.8% during the first half of 1997 compared to the
first half of 1996. This was primarily due to lower component costs passed on to
the customers in the form of lower average selling prices, as well as due to
reduced demand from a key customer who experienced competitive pressures for its
products.
The Company's export sales arise primarily from the shipment of
assembled products to international operations of U.S.-based companies. Total
export sales as a percent of net sales were 88.9% in the second quarter of 1997
compared to 78.6% during the same period in 1996, and were 86.6% in the six
months ended June 30, 1997 compared to 66.5% during the same period in the prior
year. The increase was due to growth in the volumes of SMT products shipped
directly to international head stack assemblers of the Company's customers as
well as due to the relocation of a customer's facilities from a domestic to an
international location.
Gross Margins
Gross margins, as a percentage of net revenues, declined during the
three and six months ended June 30, 1997 as compared to the comparable periods
in the prior year. Gross margins were 9.7% and 12.7% for the three months ended
June 30, 1997 and 1996, respectively, and 8.2% and 12.6% for the six months
ended June 30, 1997 and 1996, respectively. The addition of fixed costs to
expand capacity in the various manufacturing facilities impacted gross margins
negatively. Gross margins also declined due to a lower rate of absorption of
these increased manufacturing costs resulting from component shortages in the
first quarter and demand slow-down for the high-end disk drives in the second
quarter.
Marketing and Sales Expense
Marketing and sales expenses consist primarily of salaries, facility
costs, advertising expenses, and travel costs for marketing, sales and customer
service personnel, and sales commissions paid to direct sales personnel and
sales representative organizations. Marketing and sales expenses increased 42.2%
to $1.8 million for the six months ended June 30, 1997 from $1.3 million during
the same period in the prior year, primarily due to new advertising expense, as
well as salary and overhead increases. As a percentage of net revenues, these
expenses increased to 2.7% for the six months ended June 30, 1997 from 1.7% for
the same period in fiscal 1996.
General and Administrative Expenses
General and administrative ("G & A") expenses increased both as a
percentage of net revenues, and in absolute dollars, for the six months ended
June 30, 1997, compared to the same period in the prior year. As a percentage of
net revenues, G & A expenses were 4.6% for the six months ended June 30, 1997,
compared to 3.8% for the six months ended June 30, 1996. The increase in G & A
expenses is primarily due to additions to administrative staff at the Company's
international facilities.
Interest Income
Interest income increased to $527,000 during the six months ended June
30, 1997 compared to $486,000 during the same period in the prior year. Higher
average balances in short-term investments due to the investment of cash
generated from operations and the reinvestment of interest earnings contributed
to this increase.
Income Taxes
The Company has provided $205,000 for income taxes during the three
months ended June 30, 1997 as compared to $977,000 during the same period in the
prior year. The reduced provision for income taxes is primarily the result of
reduced operating income in the current period compared to the same period in
the last year. Domestic tax benefits primarily resulting from the successful
conclusion of an Internal Revenue Service
8
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examination and tax holidays granted by certain foreign taxing authorities also
contributed to the reduction in provision for income taxes.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1997, the Company's principal sources of liquidity included
$22.8 million in cash and short-term investments, and $12.1 million in available
borrowings under its bank credit facility ("facility"). The facility was amended
on October 4, 1996, which provides for aggregate borrowings of $15.0 million
under a revolving line of credit ("credit line"). Borrowings under the credit
line include a sublimit for the issuance of up to $2.0 million in commercial or
standby letters of credit for the purchase of inventory. Outstanding balances on
the credit line bear interest at the bank's reference rate or, at the Company's
option, LIBOR plus 1.5%, and unused portions of the credit line bear interest at
0.25% per annum. Interest is payable monthly and principal is payable at
maturity on September 30, 1998. At June 30, 1997, borrowings under the revolving
loan totaled $2.9 million; there were no letters of credit outstanding as of
that date. The facility additionally provides for an unsecured term loan
totaling $2.2 million, all of which the Company had borrowed as of June 30,
1997. The expiration date of such unsecured term loan is September 30, 1997.
Short-term investments at June 30, 1997 totaled $21.4 million, and
consisted primarily of holdings in municipal bonds and money market instruments
in accordance with the Company's investment policy, which is designed to
maintain a highly liquid portfolio with minimal risk. The Company's short-term
investments, which are classified as available-for-sale, decreased $3.6 million
and $3.4 million during the three and six months ended June 30, 1997,
respectively, primarily due to investments in plant and equipment in the
Company's manufacturing facilities. For all short-term investments at June 30,
1997, cost approximated fair market value.
During the six months ended June 30, 1997, inventories increased $3.6
million, from $11.1 million to $14.7 million at the end of the prior year.
Inventory levels fluctuate directly with the volume of the Company's
manufacturing; changes or significant fluctuations in market demands for
products can cause fluctuations in inventory levels, which may result in changes
in levels of inventory turns and liquidity. See "Risk Factors."
During the six months ended June 30, 1997, the Company had invested
$7.6 million in capital equipment and leasehold improvements, primarily for
expansion of its international manufacturing facilities. In Monterrey, Mexico,
the Company completed its new plant and moved its operations. With double the
floor space of its previous facility in Monterrey, the Company's new
manufacturing facility will give additional capacity to support both precision
SMT and Chip-on-Flex ("COF") technologies. In Cebu, the Philippines, an
additional SMT line was added, more than doubling that plant's SMT capacity, and
the COF capability was expanded which is expected to begin customer
qualifications soon. In Singapore, the Company increased its SMT capacity and
COF capacity by 25% and 20%, respectively.
On July 18, 1996, the Company entered into a facilities and services
agreement with Silicon Systems, Inc. ("SSI"), a wholly owned subsidiary of Texas
Instruments Incorporated, whereby SSI provides certain administrative services
and facilities to the Company for agreed-upon fees, totaling approximately
$16,000 per month at June 30, 1997. This agreement is in effect until June 1998,
at which time it may be automatically renewed for additional twelve-month
periods unless terminated by either party with proper notice. Management
believes that neither renewal nor termination of this arrangement would
adversely affect the Company's financial or operating results.
The Company believes that existing cash and investments balances, funds
generated from operations and funds available under its current bank credit
facility will be sufficient to meet the Company's cash requirements during the
next twelve months. See "Risk Factors."
9
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RISK FACTORS
Important Factors Related to Forward-Looking Statements and Associated Risks
This Quarterly Report on Form 10-Q contains forward-looking statements
that are based on current expectations and involve a number of risks and
uncertainties. Factors that may materially affect revenues, expenses and
operating results include, without limitation, the impact of competitive
products and pricing, interruption of the flow of components from a limited
number of suppliers, subsequent changes in business strategy or plan, timely
customer qualification of the Company's new Chip-On-Ceramic ("COC") process,
timely customer qualification of, and commencement of volume production at, the
Company's new facilities in Cebu and Monterrey, and structural and strategic
changes affecting certain of the Company's existing customers, suppliers and
competitors.
The forward-looking statements included herein are based on current
assumptions that the Company will continue to develop, market, manufacture and
ship new products on a timely basis, that competitive conditions within the
Company's market will not change materially or adversely, that demand for the
Company's products and services will remain strong, that the market will accept
the Company's new products and services, that the Company will retain existing
key management personnel, that inventory risks due to shifts in market demand
will be minimized, that the Company's forecasts will accurately anticipate
market demand, and that there will be no material adverse change in the
Company's operations or business. Assumptions relating to the foregoing involve
judgments that are difficult to predict accurately and are subject to many
factors that can materially affect results. Budgeting and other management
decisions are subjective in many respects and thus susceptible to
interpretations and periodic revisions based on actual experience and business
developments, the impact of which may cause the Company to alter its marketing,
capital expenditure, or other budgets, which may in turn affect the Company's
results. In light of the factors that can materially affect the forward-looking
information included herein, the inclusion of such information should not be
regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved.
Because of these and other factors affecting the Company's operating
results, past financial performance should not be relied upon as an indicator of
future performance, and investors should not overly rely upon historical trends
to anticipate results or trends in future periods. The following factors also
may materially affect results and therefore should be considered.
Substantial Fluctuations in Future Operating Results
The Company has experienced substantial fluctuations in its annual and
quarterly operating results, and such fluctuations are expected to continue in
future periods. The Company's operating results are affected by a number of
factors, many of which are beyond the Company's control. All products
manufactured by the Company are custom designed and assembled for a specific
customer's requirement in anticipation of the receipt of volume production
orders from that customer, which may not always materialize. The Company
typically incurs significant start-up costs in the production of a particular
product, which costs are expensed as incurred. Accordingly, the Company's level
of experience in manufacturing a particular product and its efficiency in
minimizing start-up costs will affect the Company's operating results during the
periods in which production begins and ramp-up occurs. The efficiencies of the
Company in managing inventories and fixed assets, shortages of components or
labor, the degree of automation used in the assembly process, fluctuations in
material costs and the mix of materials, labor, manufacturing and overhead costs
are also significant factors affecting annual and quarterly operating results.
Other factors contributing to fluctuations in the Company's operating results
include price competition, the inability to pass on cost overruns, the timing of
expenditures in anticipation of increased sales, customer product delivery
requirements and the range of services provided. In addition, the amount and
timing of orders placed by a customer may vary due to a number of factors,
including inventory balancing, changes in manufacturing strategy and variation
in product demand attributable to, among other things, product life cycles,
competitive factors and general economic conditions. Any one of these factors,
or a combination thereof, could adversely affect the Company's annual and
quarterly results of operations.
<PAGE> 11
The Company's customers generally require short delivery cycles, and a
substantial portion of the Company's backlog is typically scheduled for delivery
within 90 days. Quarterly sales and operating results therefore depend in large
part on the volume and timing of bookings received during the quarter, which are
difficult to forecast. The short lead time for the Company's backlog also
affects its ability to accurately plan production and inventory levels. In
addition, a significant portion of the Company's operating expenses are
relatively fixed in nature and planned expenditures are based in part on
anticipated orders. Any inability to adjust spending by a sufficient amount or
quickly enough to compensate for any revenue shortfall may magnify the adverse
impact of such revenue shortfall on the Company's results of operations.
Dependence on Hard Disk Drive Industry
The Company's principal market is the HDD industry, which is
characterized by intense competition, relatively short product life cycles,
rapid technological change, significant fluctuations in product demand and
significant pressure on vendors to reduce or minimize costs. The HDD industry is
also highly cyclical and has experienced periods of increased demand and rapid
growth followed by periods of oversupply and contraction. The impact of cyclical
trends on suppliers to this industry has been exacerbated by the tendency of HDD
manufacturers to order components in excess of their needs during growth
periods, followed by a sharp reduction in demand for components during periods
of contraction. The Company's operating results have been adversely affected
from time to time during HDD industry slowdowns and could be materially
adversely affected in the event of significant slowdowns in this industry in the
future. Although the Company is attempting to reduce its dependence on the HDD
industry, the Company expects revenues attributable to this market to continue
to represent the majority of its revenues for the foreseeable future.
Customer Concentration
The Company's customer base is highly concentrated. In the first half
of 1997 and 1996, the Company's five largest customers (which include, in some
cases, multiple divisions) accounted for approximately 86% and 87.3% of net
revenues, respectively. Although the Company is attempting to reduce its
dependence on a limited number of customers, the Company expects that sales to a
relatively small number of original equipment manufacturers ("OEMs") will
continue to account for a substantial portion of net revenues for the
foreseeable future, and the loss of, or a decline in orders from, one of the
Company's key customers would have a material adverse effect on the Company's
financial and operating results.
Competition
The Company operates in a highly competitive industry and competes
against several domestic and foreign providers of electronics manufacturing
services. The principal competitors in the high-end segment of the flex assembly
market include Solectron Corporation, CTS Corporation, and ADFlex Solutions,
Inc. ("ADFlex"). The Company also faces competition from the manufacturing
operations of its current and potential OEM customers, which the Company
believes continue to evaluate the merits of manufacturing flex assemblies
internally, and from offshore contract manufacturers, which, because of their
lower labor rates, enjoy a comparative advantage over the Company with respect
to labor-intensive, high-volume production. The Company has also experienced
competition from head stack assemblers in the past; however, most competition
from such manufacturers has been in the lower-end SMT segment of the market in
which the Company does not direct a significant amount of resources. The Company
expects to encounter future competition from other large electronics
manufacturers that currently provide or may begin to provide contract
manufacturing services. A number of the Company's competitors have substantially
greater manufacturing, financial, technical, marketing and other resources, and
offer a broader line of services, than does the Company. In addition, many of
the Company's competitors have a broader scope and presence of operations on a
worldwide basis.
Significant competitive factors in the high-end flexible assembly
market include quality, price, responsiveness, the ability to manufacture
fine-pitch assemblies in volume, and test capabilities. While the Company
believes that it currently competes favorably with respect to these factors,
there can be no assurance that the Company will be able to continue to do so in
the future. The continuing trend of shorter product life cycles, particularly in
the HDD industry, is expected to result in more intense competition as each new
customer program is
11
<PAGE> 12
generally open to bidding by the Company and its competitors. Furthermore, the
Company is often only one of two or more contract manufacturers supplying a
particular customer requirement and is therefore subject to continuing
competition on existing programs. In order to remain competitive, the Company
must continually provide timely technologically advanced manufacturing services,
assure the quality of its products and compete favorably with respect to price.
If the Company were to fail to compete favorably with respect to the principal
competitive factors in its industry, the Company's business and operating
results would be adversely affected.
Component Supply and Sources
Substantially all of the Company's manufacturing services are provided
on a turnkey basis in which the Company, in addition to providing design,
assembly and testing services, is responsible for the procurement of the
components that are assembled by the Company for the customer. In certain
circumstances, the Company is required to bear the risk of component price
fluctuations, which could adversely affect the Company's gross margins. In
addition, in order to assure an adequate supply of certain key components which
have long procurement lead times, such as integrated circuits, the Company often
must order such components prior to receiving customer purchase orders for the
assemblies which require such components. Failure to accurately anticipate the
volume or timing of customer orders can result in component shortages or excess
component inventory, which in either case could adversely affect the Company's
financial and operating results.
Some of the assemblies manufactured by the Company require one or more
components that are ordered from, or which may be available from, only one
source or a limited number of sources. In particular, the Company relies on the
timely supply of components from ADFlex (which is also a competitor, as
mentioned in "Competition" above), Mektec Corporation, SSI, Toshiba America,
Inc., and VTC, Inc. During the first six months of 1997 and the year ended 1996,
the Company purchased flex components primarily from ADFlex and Mektec
Corporation, and integrated circuits primarily from SSI and VTC, Inc. Delivery
problems relating to components purchased from any one of these or the Company's
other key suppliers could have a material adverse impact on the financial
performance of the Company. From time to time, the Company's suppliers allocate
components among their customers in response to supply shortages. In some cases,
supply shortages will substantially curtail production of all assemblies using a
particular component. In addition, at various times there have been
industry-wide shortages of electronic components, such as servo or read/write
circuits. The Company has experienced shortages of components in the recent
past, and there can be no assurance that substantial component shortages will
not occur in the future. Any such shortages could have a material adverse effect
on the Company's operating results.
In the first quarter of 1997, the Company experienced a shortage of
ceramic substrates for its COC program. During the second quarter of 1997 this
issue was resolved since all three of the Company's ceramic substrate suppliers
were able to reach their planned production goals. However, there can be no
assurance that such shortages will not recur in the future or that such
shortages would not have a material adverse effect on the Company's operating
results.
International Operations
The Company maintains international manufacturing operations in
Singapore, Mexico, and the Philippines. In light of the continued growth of
offshore facilities on the part of the Company's customers, Smartflex
anticipates that it will be required to increase its presence overseas through
internal growth, acquisitions, or a combination of both. Manufacturing and sales
operations outside the United States are accompanied by a number of risks
inherent in international operations, including, but not limited to, imposition
of governmental controls, compliance with a wide variety of foreign and United
States export laws, currency fluctuations, unexpected changes in trade
restrictions, tariffs and barriers, political and economic instability, longer
payment cycles typically associated with foreign sales, difficulties in
administering business overseas, labor union issues and potentially adverse tax
consequences. The Company historically has denominated all export sales in
United States dollars. The Company's production employees at the Mexico facility
are represented by a labor union and covered by a collective bargaining
agreement that is subject to revision annually under Mexican law. The current
agreement is subject to revision in February 1998. While the Company believes
that it has established good relationships with its labor force in Mexico, there
can be no assurance that such relationships will continue in the future.
12
<PAGE> 13
Variability of Customer Requirements and Customer Financing
The level and timing of orders placed by customers vary due to the
customers' attempts to balance their inventory, changes in customers'
manufacturing strategies and variations in demand for the customers' products.
Due in part to these factors, most of the Company's customers do not commit to
firm production schedules for more than three months in advance of requirements.
The Company's inability to forecast the level of customer orders with certainty
makes it difficult to schedule production and optimize utilization of
manufacturing capacity. In the past, the Company has been required to increase
staffing and incur other expenses in order to meet the anticipated demand of its
customers. From time to time, anticipated orders from some of the Company's
customers have failed to materialize and delivery schedules have been deferred
as a result of changes in a customer's business needs, both of which have
adversely affected the Company's operating results. On other occasions,
customers have required rapid increases in production which have placed an
excessive burden on the Company's resources. Such customers' order fluctuations
and deferrals have had an adverse effect on the Company's operating results in
the past, and there can be no assurance that the Company will not experience
such effects in the future. In addition, the Company incurs significant accounts
receivable in connection with providing manufacturing services to its customers.
If one or more of the Company's principal customers were to become insolvent, or
otherwise were to fail to pay for the services and materials provided by the
Company, the Company's operating results and financial condition would be
adversely affected.
Rapid Technological Change
The Company's customer base competes in markets that are characterized
by rapid technological change and short product life cycles. In particular, the
HDD, computer and communications markets are prone to rapid product obsolescence
by new technologies. The flexible interconnect industry could experience future
competition from new or emerging technologies that render existing technology
less competitive or obsolete. The inability of the Company to develop
technologies to meet the evolving market requirements of its customer base could
have a material adverse effect on the Company's business, financial condition
and results of operations, including the Company's ability to maintain its
revenue base.
Management of Growth
The Company has experienced certain periods of rapid growth which has
placed, and is expected to continue to place, a significant strain on the
Company's management, operational and financial resources. The Company's growth
is expected to require the addition of new management personnel and the
development of additional expertise by existing management personnel. The
Company's ability to manage growth effectively, particularly given the
increasingly international scope of its operations, will require it to continue
to implement and improve its operational, financial and management information
systems as well as to develop the management skills of its managers and
supervisors and to train, motivate and manage its employees. The Company's
failure to effectively manage growth could have a material adverse effect on the
Company's results of operations.
Dependence on Key Employees
The Company is highly dependent on its Chief Executive Officer, William
L. Healey, and other principal members of its management team, the loss of whose
services could have a material adverse effect upon the business and financial
condition of the Company, as well as the ability of the Company to achieve its
development objectives. None of such persons has an employment contract with the
Company. The Company is also dependent on other key personnel, and on its
ability to continue to attract, retain and motivate highly skilled personnel.
The competition for such employees is intense, and there can be no assurance
that the Company will be successful in attracting, retaining or motivating key
personnel.
Environmental Compliance
The Company is subject to a variety of environmental regulations
relating to the use, storage, discharge and disposal of hazardous chemicals and
substances used in its manufacturing process. While the Company believes that it
is in material compliance with all existing applicable environmental statutes
and regulations, any
13
<PAGE> 14
failure by the Company to comply with statutes and regulations presently
existing or enacted in the future could subject it to liabilities or the
suspension of production. In addition, compliance with such statutes and
regulations could restrict the Company's ability to expand its facilities or
require the Company to acquire costly equipment or to incur other significant
expenses.
Factors Inhibiting Change of Control
The Company's Certificate of Incorporation includes a provision that
allows the Board of Directors to issue up to 5,000,000 shares of Preferred Stock
and to determine the rights, preferences, privileges and restrictions of those
shares without stockholder approval. Preferred Stock could be issued with
voting, liquidation and dividend rights superior to those of holders of Common
Stock. An issuance of Preferred Stock also could have the effect of delaying or
preventing a change of control of the Company.
In addition, Section 203 of the Delaware General Corporation Law
restricts certain business combinations with any "interested stockholder" as
defined by such statute.
The Company's Shareholder Rights Plan provides for holders of Common
Stock (other than certain acquirors) to have the right to purchase stock of the
Company or an acquiring person at 50% of its fair market value following certain
events. The Shareholder Rights Plan could have the effect of delaying or
preventing a change of control of the Company.
Such provisions may reduce the price that certain investors may be
willing to pay in the future for shares of the Company's Common Stock, and may
reduce the possibility of any acquisition of the Company at a premium price,
unless such acquisition meets with approval by the Company's Board of Directors.
14
<PAGE> 15
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its Annual Meeting of Stockholders on May 14, 1997.
The following is a brief description of each matter voted upon at the meeting
and a statement of the number of votes cast for, the number withheld or against,
as the case may be, and the number of abstentions with respect to each matter.
Both proposals were approved by the stockholders.
(a) The stockholders approved the election of the Company's board of directors.
<TABLE>
<CAPTION>
DIRECTOR FOR WITHHELD ABSTAINED
-------- --- -------- ---------
<S> <C> <C> <C>
William L. Healey 5,399,724 194,591 ---
William E. Bendush 5,399,724 194,591 ---
Alan V. King 5,399,724 194,591 ---
William A. Klein 5,399,724 194,591 ---
Gary E. Liebl 5,399,724 194,591 ---
</TABLE>
(b) The stockholders approved the appointment of Ernst & Young LLP as the
auditors of the Company for the fiscal year ending December 31, 1997.
<TABLE>
<CAPTION>
FOR AGAINST ABSTAINED
--- ------- ---------
<S> <C> <C>
5,581,604 8,400 4,311
</TABLE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits --- See Exhibit Index.
(b) No reports on Form 8-K were filed during the three months ended June 30,
1997.
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
SMARTFLEX SYSTEMS, INC.
-----------------------
(Registrant)
<TABLE>
<S> <C>
August 11, 1997 By: /s/ John W. Hohener
- ---------------------------------------- -------------------------------------------------------------
Date John W. Hohener
Vice President, Chief Financial Officer, and
Duly Authorized Officer
(Principal financial and accounting officer)
</TABLE>
16
<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- --------- ---------------------------------------------------------------
<S> <C>
10.32 * Second Amendment to Smartflex Systems, Inc. 1995 Employee Stock
Purchase Plan
11.1 Computation of Earnings per Share
27 Financial Data Schedule (filed electronically)
</TABLE>
* A management contract or compensatory plan or arrangement
17
<PAGE> 1
EXHIBIT 10.32
SECOND AMENDMENT
TO
SMARTFLEX SYSTEMS, INC.
1995 EMPLOYEE STOCK PURCHASE PLAN
WHEREAS, the Smartflex Systems, Inc. (the "Company") 1995
Employee Stock Purchase Plan, as amended, (the "Plan") provides that an employee
is entitled to participate in the Plan only after becoming an Eligible Employee,
and then generally only on the start date of the next offering period that
follows the date such individual becomes an Eligible Employee;
WHEREAS, the Company desires to amend the Plan to provide that
once an employee becomes an Eligible Employee, such individual shall be entitled
to participate in the Plan for the then current offering period, provided there
is at least one payroll occurring prior to the expiration of the offering period
then in effect; and
WHEREAS, effective as of April 16, 1997, the Board of
Directors of the Company approved an amendment to the Plan incorporating the
aforementioned change and has authorized and directed the officers of the
Company to amend the Plan to accommodate such change.
NOW, THEREFORE, BE IT RESOLVED, that the Plan is hereby
amended, effective as of April 16, 1997, as follows:
1. Section V.A.2. of the Plan shall be deleted in its entirety
and replaced with the following new Section V.A.2.:
"2. An individual who first becomes an
Eligible Employee after the start date of any offering period
under the Plan may enter that offering period on the date in
which he/she first becomes an Eligible Employee, provided
there is at least one payroll occurring prior to the
expiration of such offering period. Such date shall become
such individual's Entry Date for that offering period, and on
that date such individual shall be granted his/her purchase
right for that offering period. Should such individual not
enter the offering period in effect on the date he/she first
becomes an Eligible Employee, then he/she may not subsequently
join that particular offering period on any later date."
2. Except as amended hereby, the Plan shall remain in full
force and effect.
Capitalized terms not defined herein shall be given the
meaning ascribed them in the Plan.
The undersigned, as Secretary of the Company, hereby executes
this amendment under authority granted by the Board of Directors of the Company.
Dated: May 14, 1997
---------------------------
Nick E. Yocca, Secretary
<PAGE> 1
EXHIBIT 11.1
SMARTFLEX SYSTEMS, INC.
Computation of Earnings per Share
(In thousands except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
------------------------------- -------------------------------
1997 1996 1997 1996
-------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Net income $ 558 $ 1,644 $ 792 $ 3,556
============== ============== =============== ==============
Weighted average number of common
shares outstanding during the period 6,334 6,270 6,333 6,256
Incremental common shares attributable
to exercise of outstanding options 94 150 111 141
-------------- -------------- --------------- --------------
Total shares 6,428 6,420 6,444 6,397
============== ============== =============== ==============
Primary earnings per share $ 0.09 $ 0.26 $ 0.12 $ 0.56
============== ============== =============== ==============
Net income $ 558 $ 1,644 $ 792 $ 3,556
============== ============== =============== ==============
Weighted average number of common
shares outstanding during the period 6,334 6,270 6,333 6,256
Incremental common shares attributable
to exercise of outstanding options 94 150 111 141
-------------- -------------- --------------- --------------
Total shares 6,428 6,420 6,444 6,397
============== ============== =============== ==============
Fully diluted earnings per share $ 0.09 $ 0.26 $ 0.12 $ 0.56
============== ============== =============== ==============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 1,461
<SECURITIES> 21,414
<RECEIVABLES> 21,723
<ALLOWANCES> 705
<INVENTORY> 14,725
<CURRENT-ASSETS> 62,679
<PP&E> 26,211
<DEPRECIATION> 8,687
<TOTAL-ASSETS> 80,233
<CURRENT-LIABILITIES> 20,441
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 53,754
<TOTAL-LIABILITY-AND-EQUITY> 80,233
<SALES> 67,275
<TOTAL-REVENUES> 67,275
<CGS> 61,731
<TOTAL-COSTS> 61,731
<OTHER-EXPENSES> 4,926
<LOSS-PROVISION> (189)
<INTEREST-EXPENSE> 260
<INCOME-PRETAX> 793
<INCOME-TAX> 1
<INCOME-CONTINUING> 792
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 792
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
