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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 March 28, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ____________________ to _____________________
Commission File Number: 0-26472
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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 (I.R.S. Employer
of incorporation or organization) Identification No.)
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)
NOT APPLICABLE
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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 - 6,431,420 shares as of May 4, 1998
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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
Condensed Consolidated Balance Sheets (Unaudited) as of
March 31, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations (Unaudited)
for the three months ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (Unaudited) for
the three months ended March 31, 1998 and 1997 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
INDEX TO EXHIBITS 17
</TABLE>
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.
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PART I --- FINANCIAL INFORMATION
Item 1. Financial Statements
SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Balance Sheets (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
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<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,676 $ 2,069
Short-term investments 23,745 26,051
Accounts receivable, net of allowance for doubtful accounts
of $1,786 at March 31, 1998 and $1,384 at December 31, 1997 15,987 19,252
Inventories:
Raw materials 4,539 6,943
Work-in-process 2,509 2,725
Finished goods 2,598 2,432
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Total inventories 9,646 12,100
Deferred income taxes 3,541 3,541
Prepaid expenses and other current assets 1,348 1,755
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Total current assets 56,943 64,768
Property and equipment, at cost:
Machinery and equipment 22,949 20,930
Office furniture and equipment 3,695 3,148
Leasehold improvements 4,701 4,460
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31,345 28,538
Less accumulated depreciation and amortization (12,965) (12,260)
-------- --------
Total property and equipment 18,380 16,278
Deferred income taxes 350 350
Other assets 574 510
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$ 76,247 $ 81,906
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable to related parties $ 113 $ 533
Accounts payable 13,510 18,990
Accrued compensation and related costs 1,624 1,569
Accrued restructuring liabilities 3,874 3,923
Other accrued liabilities 4,887 5,050
Current portion of notes payable 934 1,063
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Total current liabilities 24,942 31,128
Long-term portion of notes payable 1,376 1,689
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares -- 5,000,000
Issued and outstanding -- none -- --
Common stock, $.0025 par value:
Authorized shares -- 25,000,000
Issued and outstanding shares -- 6,373,752 at
March 31, 1998 and 6,362,477 at December 31, 1997,
respectively 16 16
Additional paid-in capital 36,130 36,118
Retained earnings 13,783 12,955
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Total stockholders' equity 49,929 49,089
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$ 76,247 $ 81,906
======== ========
</TABLE>
See accompanying notes. -3-
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SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Statements of Operations
(In thousands except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
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1998 1997
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<S> <C> <C>
Net revenues $ 37,005 $ 30,272
Cost of revenues 32,860 28,319
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Gross margin 4,145 1,953
Costs and expenses:
Marketing and sales expense 930 857
General and administrative expense 2,081 1,299
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Operating income (loss) 1,134 (203)
Interest income 263 277
Interest expense (62) (65)
Other (expense) income (73) 21
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Income before income taxes 1,262 30
Income tax provision (benefit) 434 (204)
======== ========
Net income $ 828 $ 234
======== ========
Net income per share:
Basic $ 0.13 $ 0.04
======== ========
Diluted $ 0.13 $ 0.04
======== ========
Shares used in computing net income
per share:
Basic 6,371 6,442
======== ========
Diluted 6,462 6,442
======== ========
</TABLE>
See accompanying notes. -4-
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SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
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<S> <C> <C>
Net cash flow from operating activities:
Net income $ 828 $ 234
Adjustments to reconcile net income to cash provided by
(used in) operating activities:
Depreciation and amortization 705 919
Provision for doubtful accounts 165 (189)
Provision for inventory obsolescence 1,941 --
Other changes in operating assets and liabilities:
Receivables 3,100 2,189
Inventories 513 (4,158)
Prepaid expenses and other assets 343 (1,950)
Accounts payable to related parties (420) (199)
Accrued restructuring cost (49) --
Accounts payable and accrued expenses (5,588) 3,793
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Net cash provided by operating activities 1,538 639
Cash flow from investing activities:
Capital expenditures (2,807) (1,701)
Purchase of short-term investments 2,492 (4,241)
Proceeds from the sale of short-term investments (186) 3,985
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Net cash used in investing activities (501) (1,957)
Cash flow from financing activities:
Net proceeds from sale of common stock 12 44
Net borrowings (repayments) on revolving line of credit -- 1,695
Repayments on term loan (442) (143)
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Net cash provided by (used in) financing activities (430) 1,596
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Net increase in cash 607 278
Cash at beginning of period 2,069 1,164
======= =======
Cash at end of period $ 2,676 $ 1,442
======= =======
Supplemental disclosures of cash flow information:
Interest paid $ 55 $ 36
Taxes paid 500 --
</TABLE>
See accompanying notes. -5-
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SMARTFLEX SYSTEMS, INC.
Notes to Unaudited Condensed Consolidated Financial Statements
March 31, 1998
Note (A) -- Basis of Presentation
The accompanying unaudited condensed 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-month period ended March 31, 1998 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. These financial statements should be read in
conjunction with the consolidated financial statements and footnotes thereto
included in the Company's Annual Report to Stockholders for the year ended
December 31, 1997.
Note (B) -- Fiscal Year
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
On September 26, 1997, the Company amended its bank credit facility
("facility") to provide for aggregate borrowings of $25.0 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
.125% per annum. Interest is payable monthly and principal is payable at
maturity on September 30, 1999. At March 31, 1998, there were no borrowings on
the credit line and no letters of credit outstanding as of that date. The
facility additionally provides for an unsecured term loan totaling $2.2 million
for the purchase of equipment. The loan bears interest at the bank's reference
rate plus .5% or, at the Company's option, LIBOR plus 2%. Principal and interest
are payable monthly and the loan matures on March 30, 2001. At March 31, 1998,
the outstanding balance of the term loan was approximately $1.9 million.
Note (E) -- Impact of newly issued pronouncement by the Financial Accounting
Standards Board
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130"), which
establishes standards for reporting and displaying comprehensive income and its
components in the financial statements. For the three months ended March 31,
1998 and 1997, the Company did not have any components of comprehensive income
as defined in SFAS 130.
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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, and the other information in this Form 10-Q.
OVERVIEW
Smartflex provides custom design and turnkey manufacturing of flexible
interconnect assemblies to customers who are manufacturers of compact,
high-performance electronic products. Smartflex specializes in precision surface
mount ("SMT") and direct chip attach technologies on flexible circuit
substrates. The Company's customer base includes hard disk drive ("HDD") and
non-HDD manufacturers. Examples of flex assemblies used in non-HDD applications
include read/write head assemblies in tape drives and removable personal storage
products, and flex assemblies in miniaturized packaging for gene chips and fluid
analyzers. Revenues from the HDD customers have represented the Company's
predominant market. For the three months ended March 31, 1998, HDD revenues
comprised 53.3% of total revenues, compared to 73.0% for the same period last
year.
During the first quarter of 1998, due to the changing business dynamics
of the data storage industry, many Original Equipment Manufacturers ("OEM") had
higher inventories, reduced demand, and competitive pricing pressures. As a
result, some of the OEMs began to change their methodology of inventory
management. They began the move to a "build-to-order" or "pull" system of
inventory management from the traditional "build-to-forecast" system of
inventory management. Such a change in business dynamics results in reducing the
Company's visibility for orders, which in turn reduces order backlog.
Net revenues in the first quarter of 1998 increased 22.2% from the same
period in the prior year and decreased 2.8%, from the previous quarter. During
the first quarter ended March 31, 1998, total unit shipments were approximately
1.1 million units more than the fourth quarter of 1997, and approximately 3.3
million units more than the same period in 1997. HDD unit shipments increased
approximately 1.6 million units or 107% over the prior quarter and 9.6% over the
comparable quarter of the prior year. This increase is primarily due to
shipments to Samsung, which became a volume customer in the first quarter of
fiscal 1998. Average selling prices ("ASP") decreased during this period from
the comparable period in the prior year primarily due to component cost
decreases passed through to customers in the form of lower prices and price
decreases as a result of competitive pressures.
RESULTS OF OPERATIONS
Net Revenues
Net revenues for the quarter ended March 31, 1998 increased 22.2% from
the comparable period in 1997. The increase is attributable to the absence of
component availability issues and customer shipment postponements, which had
impacted net revenues in the first quarter of the prior year. Revenues, were
negatively impacted by decreases in component costs, which were passed through
to customers in the form of lower prices, and price decreases as a result of
competitive pressures.
Net revenues from HDD units accounted for 53.3% of total revenues as
compared to 73.0% during the same period in the prior year. Net revenues
attributable to non-HDD programs increased to 46.7% from 27.0% in the comparable
quarter of the prior year primarily due to increases in the removable storage
programs.
Export sales arise primarily from the shipment of assembled products to
international operations of U.S.-based customers as well as shipments to
intermediary companies that also service these accounts.
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Total export sales rose to 93.4% from 80.7% for the fourth quarter of 1997 and
83.2% in the comparable quarter in 1997. These increases were primarily due to
the continuing trend of production transfers to the international operations of
the Company's U.S.-based customers.
Restructuring
The Company restructured its worldwide operations in the third quarter
of 1997, moving volume manufacturing from Singapore to the Company's lower-cost
facility in Cebu. The Singapore operations are intended to become the focal
point of Smartflex customer support in Asia as the Company's Far East Regional
Services and Technology Center. The restructuring also included a reduction of
manufacturing and other personnel from the Company's Tustin, California
operations. As part of this restructuring, the Company provided for the
following in the third quarter of 1997: $1.4 million for the write-off of
inventories included in the cost of revenues, $3.5 million for the write-down
of non-current assets and other expenses, $1.1 million for severance and other
employee-related costs associated with the reduction in force, and approximately
$500,000 towards a potential Singapore tax liability. During fiscal 1997 and to
the end of March 1998, the Company had used approximately $1.9 million for the
write-down of non-current assets and other expenses and has paid approximately
$607,000 in severance and other employee-related costs. The Company expects to
utilize the remaining portion of the restructuring expense provision in 1998.
See "Risk Factors."
Gross Margins
Gross margins as a percentage of net revenues were 11.2% and 6.5% for
the first quarters of fiscal 1998 and 1997, respectively. The increase was
primarily due to factory unit growth in support of higher sales volume and the
decrease in expense as a result of the restructuring in the third quarter of the
prior year.
Marketing and Sales Expense
Marketing and sales expenses consist primarily of salaries, facility and
travel costs for marketing, sales and customer service personnel, and sales
commissions paid to direct sales personnel and sales representative
organizations. These expenses increased to $930,000 in the first quarter of
fiscal 1998 from $857,000 in the first quarter of fiscal 1997. As a percentage
of net revenues, these expenses decreased to 2.5% for the quarter ended March
31, 1998, compared to 2.8% for the same period in fiscal 1997.
General and Administrative Expenses
General and administrative ("G & A") expenses increased both as a
percentage of net revenues, and in absolute dollars, for the quarter ended March
31, 1998 compared to the same period in 1997. In absolute dollars G & A expenses
were $2.1 million in the first quarter of fiscal 1998, an increase of
approximately $782,000 from the G & A expenses in the first quarter of fiscal
1997. As a percentage of net revenues, G & A expenses were 5.6% for the current
year's first quarter, compared to 4.3% for the quarter ended March 31, 1997.
This increase was primarily due to provision for bad debts in the first quarter
of fiscal 1998 compared to a reversal of bad debt expense during the same period
in the prior year. The increase in G & A was also due to accrual for profit
sharing expense in the first quarter of 1998, which was absent in the first
quarter of 1997, as well as due to the increase in information systems expense,
a portion of which is allocated to G & A.
Interest Income
Interest income decreased $14,000 for the three months ended March 31,
1998, compared to the same prior-year period due to a slightly reduced level of
short-term investments in the first quarter of fiscal 1998 compared to the first
quarter of fiscal 1997.
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Income Taxes
The Company's provision for income taxes was approximately $434,000 in
the three months ended March 31, 1998, as compared to an income tax benefit of
approximately $204,000 for the three months ended March 31, 1997. The Company's
tax liability in the first quarter of the prior year was reduced due to domestic
tax benefits resulting from a successful conclusion of the Internal Revenue
Service examination and profits in foreign operations offset by domestic losses
in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998, the Company's principal sources of liquidity included
$26.4 million in cash and short-term investments, and $25.0 million in available
borrowings under its bank credit facility ("facility"), net of borrowings under
the term loan. On September 26, 1997, the facility was amended to provide for
aggregate borrowings of $25.0 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 2.0%, and unused
portions of the credit line bear interest at .125% per annum. Interest is
payable monthly and principal is payable at maturity on September 30, 1999. At
March 31, 1998, there were no borrowings on the credit line and no letters of
credit outstanding as of that date. The facility additionally provides for an
unsecured term loan totaling $2.2 million for the purchase of equipment. The
loan bears interest at the bank's reference rate plus .5% or, at the Company's
option, LIBOR plus 2%. Principal and interest are payable monthly and the loan
matures on March 30, 2001. At March 31, 1998, the outstanding balance of the
term loan was approximately $1.9 million.
Short-term investments at March 31, 1998 totaled $23.7 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 $2.3 million
for the quarter ended March 31, 1998 as compared to the comparable period in the
prior year, primarily due to the use of cash to pay down current liabilities.
For all short-term investments at March 31, 1998, cost approximated fair market
value.
Over the three months ended March 31, 1998, inventory levels decreased
$2.4 million. Inventory levels fluctuate directly with the volume of the
Company's manufacturing; changes or significant fluctuations in market demands
can cause fluctuations in inventory levels which may result in changes in levels
of inventory turns and liquidity. See "Risk Factors."
During the three months ended March 31, 1998, the Company acquired $2.8
million in capital equipment and leasehold improvements, primarily for the
expansion of its offshore manufacturing facilities.
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."
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. All information herein, which is not historic, and any inference
from historic information concerning future periods, is a forward-looking
statement. Factors
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that may materially affect revenues, expenses and operating results include,
without limitation, the impact of competitive products and pricing, the
transition of volume manufacturing operations from Singapore to the Philippines,
efficient utilization of manufacturing facilities, interruption of the flow of
components from a limited number of suppliers, subsequent changes in business
strategy or plan, timely qualification of, and commencement of volume production
at the Company's new facilities in Cebu and Monterrey, timely completion of the
business systems implementation, 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 overly 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.
The Company has experienced substantial fluctuations in its annual and
quarterly operating results, and such fluctuations are expected to continue in
future periods, and are unpredictable as to timing and magnitude. 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
materially adversely affect the Company's annual and quarterly results of
operations.
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
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<PAGE> 11
production and inventory levels. In addition, a significant portion of the
Company's operating expenses is 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 the Data Storage Market
The Company's principal market is the data storage 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 storage
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 manufacturers of data storage products 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 storage industry slowdowns
and could be materially adversely affected in the event of further slowdowns in
this industry now or in the future. Although the Company is attempting to reduce
its dependence on the storage industry, revenues attributable to this market
represent a majority of its revenues, and the Company's dependence on the data
storage industry is expected to continue or increase in the foreseeable future.
Customer Concentration
The Company's customer base is highly concentrated. During fiscal 1997
and 1996, the Company's five largest customers (which include, in some cases,
multiple divisions) accounted for approximately 90% and 89% of net revenue,
respectively. The Company expects that sales to a relatively small number of
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.
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 which 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 Solutions, Inc. ("ADFlex"), IBM, Mektec
Corporation ("Mektec"), Texas Instruments, Inc. ("TI"), Silicon Systems, Inc. (a
wholly owned subsidiary of TI), Toshiba America, Inc., and VTC, Inc. ADFlex is
also one the Company's competitors. During fiscal 1997, 1996 and 1995, the
Company purchased a majority of its flex components from either ADFlex or
Mektec, a majority of its integrated circuits from IBM, TI 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
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<PAGE> 12
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. For example, 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. Any such shortages could have a material adverse effect
on the Company's operating results.
International Operations
The Company maintains international operations in Singapore, Mexico, and
the Philippines. In September 1997, the Company announced a restructuring plan
to streamline worldwide operations. As part of this restructuring, the Company
is in the process of moving its volume manufacturing from Singapore to its
lower-cost manufacturing facility in Cebu. The Singapore operations are intended
to become the focal point of Smartflex customer support in Asia as the Company's
Far East Regional Services and Technology Center. In light of the continued
relocating to offshore facilities on the part of the Company's customers,
Smartflex anticipates that it will be required to increase its presence
overseas. 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, and accordingly, if the relative
value of the U.S. dollar in comparison to the currency of the Company's foreign
customers or competitors should increase, the resulting effective price increase
of the Company's products to such foreign customers could result in decreased
sales. 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 1999. 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.
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.
During the first quarter of 1998, due to the changing business dynamics
of the data storage industry, many Original Equipment Manufacturers ("OEM") had
higher inventories, reduced demand, and competitive pricing pressures. As a
result, some of the OEMs began to change their methodology of
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<PAGE> 13
inventory management. They began the move to a "build-to-order" or "pull" system
of inventory management from the traditional "build-to-forecast" system of
inventory management. Such a change in business dynamics results in reducing the
Company's visibility for orders, which in turn reduces order backlog.
Rapid Technological Change
The Company and 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 expects
that continued growth would 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 each of the 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 objectives. None of such persons has a formal employment contract
with the Company. Principal members of management are entitled to severance
benefits in certain circumstances in accordance with a Company severance plan.
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 or that personnel cost increases will not have an adverse effect on
the Company's net income or results of operations.
The Year 2000 issue
The "Year 2000 issue" variously known as "Y2K issue" or the "Millennium
Bug" arises out of the fact that many existing computer programs use only two
digits to identify a year in the date field, and if uncorrected, would fail or
create erroneous results by or at the Year 2000.
Early in 1997, the Company evaluated the Y2K issue and its impact on the
Company's operations. Currently, the Company uses IBM AS400 applications, which
are not Y2K compliant, and various desktop applications, which are Y2K
compliant.
A project to implement the latest versions of the IBM AS400 applications
was launched in late 1997. This project also addresses the Y2K issue. The
project team consists of both dedicated resources and key functional
participants. Maintenance or modification costs will be expensed as incurred,
while the costs of new software will be capitalized and amortized over the
software's useful life. The project is
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<PAGE> 14
estimated to be completed by the middle of fiscal 1999 at a cost of
approximately $750,000, most of which will be spent in the remaining quarters of
the current fiscal year. Failure to complete this project as scheduled
could cause disruption of the Company's operations.
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 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. Also see "Environmental Concerns."
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 acquirers) 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.
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<PAGE> 15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits --- See exhibit index
(b) A current report on Form 8-K dated March 3, 1998, was filed reporting the
appointment of Anthony R.W. Richardson to the position of Executive Vice
President and Chief Operating Officer.
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<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)
May 12, 1998 By: /s/ John W. Hohener
- ---------------------------- -----------------------------------
Date John W. Hohener
Vice President, Chief Financial
Officer, and Duly Authorized Officer
(Principal financial and
accounting officer)
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<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
27 Financial Data Schedule (filed electronically).
</TABLE>
-17-
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 2,676
<SECURITIES> 23,745
<RECEIVABLES> 17,773
<ALLOWANCES> 1,786
<INVENTORY> 9,646
<CURRENT-ASSETS> 56,943
<PP&E> 31,345
<DEPRECIATION> 12,965
<TOTAL-ASSETS> 76,247
<CURRENT-LIABILITIES> 24,942
<BONDS> 0
16
0
<COMMON> 0
<OTHER-SE> 49,913
<TOTAL-LIABILITY-AND-EQUITY> 76,247
<SALES> 37,005
<TOTAL-REVENUES> 37,005
<CGS> 32,860
<TOTAL-COSTS> 32,860
<OTHER-EXPENSES> 3,011
<LOSS-PROVISION> 165
<INTEREST-EXPENSE> 62
<INCOME-PRETAX> 1,262
<INCOME-TAX> 434
<INCOME-CONTINUING> 828
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 828
<EPS-PRIMARY> 0.13
<EPS-DILUTED> 0.13
</TABLE>
