<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
-------------------------
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM N/A TO N/A
COMMISSION FILE NUMBER: 0-26472
SMARTFLEX SYSTEMS, INC.
- --------------------------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
-------------------------
DELAWARE 33-0581151
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
14312 FRANKLIN AVENUE, P.O. BOX 2085, TUSTIN, CALIFORNIA 92781-2085
- --------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 838-8737
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.0025 PAR VALUE
------------------------------
RIGHTS TO PURCHASE SERIES A JUNIOR PARTICIPATING PREFERRED STOCK
----------------------------------------------------------------
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the Registrant's Common Stock held by
non-affiliates on March 16, 1998 (based on the last reported price of the Common
Stock on the Nasdaq Stock Market on such date) was $49,794,213
The number of shares outstanding of the registrant's Common Stock as of March
16, 1998 was 6,372,952
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Annual Report to Stockholders for the fiscal year ended
December 31, 1997, is incorporated by reference in this Form 10-K to the extent
stated herein. The Registrant's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held on or about May 20, 1998, and to be filed
with the Commission not later than April 28, 1998, is incorporated by reference
in Part III of this Form 10-K to the extent stated herein.
<PAGE> 2
SMARTFLEX SYSTEMS, INC.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ITEM 1. BUSINESS 3
ITEM 2. PROPERTIES 19
ITEM 3. LEGAL PROCEEDINGS 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 19
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS 20
ITEM 6. SELECTED FINANCIAL DATA 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 20
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 20
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 21
ITEM 11. EXECUTIVE COMPENSATION 21
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 21
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K 22
</TABLE>
The Company operates and reports financial results on a 52- or 53-week
year, 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 described all periods presented as if the fiscal year ended December 31.
2
<PAGE> 3
PART I
ITEM 1. BUSINESS
The information contained in this Annual Report on form 10-K, other than
historic information, is comprised of forward-looking statements relating to
future events or the future financial performance of the Company, and the
Company intends that such forward-looking statements be subject to the
safeharbors created within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934. Readers are
cautioned that such forward-looking statements, which may be identified by words
such as "anticipates," believes," "intends," "estimates," "expects," and similar
expressions, are only predictions or estimations and are subject to known and
unknown risks and uncertainties. In evaluating such statements, readers should
consider the various factors identified in this Annual Report on Form 10-K,
including matters set forth in "Risk factors," which could cause actual events,
performance or results to differ materially from those indicated by such
statements.
DESCRIPTION OF THE COMPANY
Smartflex Systems, Inc. ("Smartflex" or the "Company") provides custom
design and turnkey manufacturing of interconnect solutions to customers who are
driven by market demands to design and manufacture compact, high-performance
electronic products. The Company's assemblies enable its customers to respond to
these demands by providing advanced performance and the physical flexibility to
accommodate motion, contour and size constraints. The Company's sophisticated
electronic assemblies and sub-assemblies, provide comprehensive interconnect
solutions, which feature precision surface mount and direct chip attach ("DCA")
technologies on multiple circuit substrates. The Company believes it is a
leading supplier of advanced surface mount technology ("SMT"), Chip-On-Flex
("COF"), and Flip-Chip-On-Flex ("FCOF") assemblies to the hard disk drive
("HDD") and non-HDD markets. The Company's principal HDD customers include
International Business Machines Corporation ("IBM"), Samsung Corporation
("Samsung"), Seagate Technology, Inc. ("Seagate") and Western Digital
Corporation ("Western Digital"). The Company's principal non-HDD customers
include Iomega Corporation ("Iomega"), Hewlett-Packard Company ("H-P"), and
Quantum Corporation ("Quantum"). The Company's net revenues have grown from $31
million in fiscal 1991 to $133 million in fiscal 1997.
The Company's manufacturing services consist of product design and
prototyping, materials procurement and management, high-volume automated
assembly and subassembly test. Smartflex utilizes complex assembly techniques
and believes it was one of the first to commercialize the COF and FCOF process
technology for the computer industry. COF and FCOF technologies, in which a bare
silicon die (without the standard lead frame package) is mounted directly on
substrate material, enable improved performance, a greater density of components
and reduced size when compared with traditional assembly technologies. Smartflex
currently serves its customers from four locations, one in each of Tustin,
California ("Tustin"); Singapore; Monterrey, Mexico ("Monterrey"); and Cebu, the
Philippines ("Cebu").
INDUSTRY BACKGROUND
Manufacturers of electronic products, including computers, communication
devices and consumer electronics, are continually innovating and redesigning
these products to make them smaller and lighter, at lower cost and with higher
performance. Facilitating this process has required advances in integrated
circuits, increased use of miniaturized components and new packaging methods.
These trends have been particularly pronounced in the HDD industry, where rapid
technological advances and intense competition have contributed to the
proliferation of smaller form factor, higher capacity, higher performance
drives. Development of new products in the HDD market has been enabled in part
by advances in flexible interconnect assemblies ("flex assemblies"), which
provide an intelligent interface between the read/write heads and the
electronics in the disk drive. Also see "Risk Factors."
3
<PAGE> 4
An electronic interconnect is used to provide electrical connections
between components in electronic systems. Substrates used for interconnects
include primarily rigid printed circuit boards and flexible circuits. Advances
in technology have enabled the placement of integrated circuits and other
components on a flexible substrate to create a flex assembly. Although only a
small percentage of the flexible circuits produced today are incorporated into
flexible assemblies, the Company believes that the forces which have driven the
use of flex assemblies in the HDD market, including the need for rapid product
development, miniaturization and increased performance, will create additional
opportunities for flex assemblies in other markets. Also see "Risk Factors."
Flex assemblies provide the physical flexibility to accommodate motion,
contour and size constraints. In HDD applications, for example, flexible
interconnect assemblies must flex hundreds of millions of times throughout the
life of the drive. Flex assemblies also enhance performance in HDD's by allowing
components to be positioned closer to the read/write heads, thereby improving
signal-to-noise ratios, allowing increased transfer rates and reducing the
number of interconnections. 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.
In recent years, COF technology has been used to produce flex assemblies
for high-performance, high-capacity (greater than 4 gigabyte) HDDs where
performance and size constraints are especially critical. Eliminating the
standard package from the integrated circuit enables improved performance,
reduced size and a greater density of components on the flex assembly. These
characteristics are expected to become increasingly important as
magneto-resistive ("MR") read/write heads, which require twice the number of
interconnections as do other head technologies, become more prevalent. MR head
technology is now being used in very high end disk drives and is expected to
become more widely utilized as new HDD products come to market.
The outsourcing of flex assemblies is part of a larger trend in the
electronics industry toward the outsourcing of manufacturing services.
Electronics original equipment manufacturers ("OEMs") increasingly choose to
access leading manufacturing processes from third parties and focus on their
core competencies, such as product development and marketing. Also see "Risk
Factors." This allows the OEM to reduce capital investment and product costs,
while reducing time to market. The complex process of assembling integrated
circuits on flexible substrates requires special processes and skills due to the
flexibility and thinness of the substrate material and, in the case of COF and
FCOF, the delicate nature of the bare silicon die. These processes and skills
include advanced automation and tooling for surface mount assembly,
semiconductor assembly for COF and FCOF attachment, and semiconductor test
capabilities. The know-how required to master these assembly processes has
helped to establish companies, such as Smartflex, which specialize in providing
contract manufacturing services in this area.
STRATEGY
The Company's objective is to combine leading precision assembly
technology with high-volume manufacturing expertise to serve its target markets.
Also see "Risk Factors." The key elements of the Company's strategy are as
follows:
Focus on High-Volume, Precision Manufacturing Services
The Company focuses on providing precision manufacturing of high-volume
precision assemblies on a turnkey basis. This process involves the exact
placement of miniaturized components on rigid and flexible circuit boards and
requires the design and effective implementation of fine tooling, extensive
automation and advanced vision systems capable of reliable, high-volume
throughput, and sophisticated semiconductor test capabilities. The Company
believes that focusing on precision, high-volume requirements
4
<PAGE> 5
allows it to maximize value to the customer while achieving optimum utilization
of its equipment and facilities. Also see "Patents."
Extend Technology Leadership
Smartflex focuses on assemblies that are based on advanced, complex
assembly techniques. To date, these techniques have generally been based on
automated fine-pitch SMT, advanced COF and advanced FCOF. Smartflex believes
that its focus on advanced assembly processes is critical to maintaining and
building market share and to preserving its profitability. Also see "Patents."
Target Leading Customers
Smartflex directs its efforts toward OEMs which have established leading
market share in the Company's target markets and with which the Company can work
closely in the design and development of future products. In particular,
Smartflex intends to become the leading supplier to OEM customers who hold a
significant share of their respective markets. These customers presently include
H-P, IBM, Iomega, Quantum, Samsung, Seagate, and Western Digital. Smartflex
seeks to establish long-term partnering relationships with its major OEM
customers.
Expand in Growing Market Segments
Smartflex has applied the technology and processes it developed for the
HDD industry to other storage devices, such as disk array storage systems,
removable personal storage, tape drives and optical drives, other computer
peripherals, scanners, portable computers and communications products. The
Company expects that the technological characteristics of its precision
assemblies will help accommodate the trend toward smaller, lighter and more
powerful electronics products. The Company plans to increase revenues from these
non-HDD products by following its traditional strategy of affiliating with
leading OEMs in its target markets.
Exploit Global Manufacturing Presence
Smartflex currently has operations in California, Singapore, Monterrey,
and Cebu. The Company believes that its facilities in these diverse geographic
locations enable it to better address its customers' objectives regarding cost,
shipping location and frequency of interaction with manufacturing specialists,
as well as local content requirements of end-market countries. In order to
better align the Company's capabilities with business opportunities and to
increase operational efficiencies, the Company realigned its operations in 1997.
Volume manufacturing was moved from Singapore to Cebu. The Tustin, California
and Singapore facilities are designated as the Regional Technology and Services
Centers for the regions they support (the Americas and Asia, respectively),
providing state-of-the-art prototype and low-volume production capabilities.
Similarly, the Monterrey and Cebu facilities serve as major volume production
facilities in the Americas and Asia, respectively.
MANUFACTURING SERVICES
The Company's manufacturing services consist of design, procurement,
assembly and test.
Design--Working interactively with the OEM customer and the substrate
fabricator, the Company designs a specific packaging configuration to satisfy
the customer's requirements for functionality, manufacturability and
reliability. In the selection of substrate materials, the Company advises its
customers with respect to a number of factors, including cost, mechanical
strength, electrical performance and thermal characteristics. In the selection
of integrated circuits, the Company provides assistance to its customers with
respect to critical issues such as size, power requirements and package type.
The Company believes that its understanding of the interaction of flex
substrates and integrated circuits is crucial to success at the design stage.
5
<PAGE> 6
Procurement--Early involvement in the design process allows the Company
to assist in the selection of suppliers and components in order to enhance
manufacturability and logistical support of volume programs. As part of the
procurement process, the Company offers its customers material planning and
procurement, and inventory management and handling services. From time to time,
the Company's suppliers allocate components among their customers in response to
supply shortages. By assuming responsibility for procurement, the Company may be
required to bear the risks of fluctuations in component price and availability.
In certain cases, the Company can leverage its position as a manufacturing
partner to large OEMs to receive more favorable price and volume allocations
from its key suppliers.
Assembly--Precision assembly involves the exact placement of
miniaturized components on multiple substrate types. The Company's current
assembly techniques are highly automated and based almost exclusively on
advanced SMT and Direct Chip Attach ("DCA"). SMT is a method of affixing
electronic components, including integrated circuits, onto the surface of the
substrate. Components mounted in SMT assemblies can be of relatively small size
due to the use of fine lead-to-lead spacings ("pitch"), which currently can be
as small as 4 mils. The Company's SMT assembly process has become increasingly
complex because of these smaller dimensions and tighter tolerances, and
accordingly requires the use of expensive automated assembly equipment and
engineering expertise.
Following a multi-year development program, the Company expanded COF
production in 1993. COF involves mounting a semiconductor die (which lacks the
standard lead frame package) directly onto the flex substrate. This is
accomplished by wire bonding directly from the silicon die onto conductors in
the flex. This elimination of the semiconductor package enables improved
performance and a greater density of components, thus reducing size.
High-performance, high-capacity (greater than 4 gigabyte) HDDs were the
first products to benefit from the use of COF assemblies. COF enables improved
product performance while simultaneously producing a much smaller design. This
is particularly beneficial for MR head technology, which requires twice as many
leads to the head as do competitive head technologies.
COF has enjoyed significant customer acceptance. The Company has
increased its shipments of assemblies which include COF to more than 150,000
units, on average, per week. COF assemblies have been manufactured in volume for
certain of the Company's customers, including IBM, Seagate, and Western Digital.
Assemblies incorporating COF technology accounted for approximately 50%, 44%,
and 51% of net revenues in fiscal 1997, 1996, and 1995, respectively.
As electronic designs require increasingly smaller circuitry, the
attachment of integrated circuits to flex substrates is expected to require
greater precision. The Company has invested in the development of advanced
integrated circuit assembly technologies which offer higher precision and thus
greater component densities. Also see "Risk Factors."
The Company also utilizes the Chip-On-Ceramic ("COC") assembly process
in which one or more semiconductor die(s), without the standard lead frame
package is/are attached directly on ceramic substrates.
In 1997, Smartflex began volume production using the FCOF process.
Flip-Chip mounting eliminates wire bonding, permitting a smaller semiconductor
"footprint." FCOF uses the flex circuit as part of the integrated circuit
leadframe structure, thereby greatly reducing the surface area required on the
flex. This can also result in thinner cross section profiles of the flex
assemblies, which permits further reduction in package size.
In addition to FCOF, these advanced integrated circuit assembly
technologies include Tape Automated Bonding ("TAB"), both on the flex
("TAB-on-Flex") and within the flex structure ("TAB-in-Flex"). TAB technology
utilizes a very thin gold lead frame attached directly to the flex, which
replaces the need for wire bonding.
Test--Using sophisticated integrated circuit test systems, the Company
tests complex assemblies in order to assure that each assembly performs to
customer specifications. This is especially important in DCA
6
<PAGE> 7
technologies, because the Company is essentially performing the final test of
integrated circuits, a process that is normally performed by the integrated
circuit component supplier. Also, the Company's investment in manufacturing
defect analyzers enables customers to specify a range of test options to meet
their needs.
INTERNATIONAL MANUFACTURING CAPABILITY
The Company presently serves its major markets from four manufacturing
facilities strategically located to support both U.S. and international markets.
In 1997, the Company realigned its operations such that the California and
Singapore facilities, where most of the customer design activities take place,
would operate as Regional Technology and Services Centers, offering development,
engineering and quick-turn manufacturing capabilities to the two regions they
support, namely, the Americas and Asia. As soon as a customer's product is
established in the marketplace and volume production begins, the Company
transfers manufacturing from Tustin and Singapore to one of its international
volume manufacturing facilities, located in Monterrey, or Cebu.
The Company's state-of-the-art facilities in Monterrey and Cebu, serve
as high-volume, lower-cost manufacturing centers supporting the Americas and
Asia. The Monterrey facility, with approximately 65,000 square feet of
manufacturing space, is capable of producing over 400,000 interconnect
assemblies per week. Similarly, the Cebu facility, with approximately 30,000
square feet of manufacturing space, is capable of producing 300,000 interconnect
assemblies per week, when fully equipped. Also see "Risk Factors."
The chart below outlines the services of these facilities.
<TABLE>
<CAPTION>
SUPPORTS
THE AMERICAS
AND EUROPE SUPPORTS ASIA
------------------- -----------------
TUSTIN MONTERREY SINGAPORE CEBU
------ --------- --------- ----
<S> <C> <C> <C> <C>
Design Services . o
Prototyping . .
New Technologies/Processes . o o o
Procurement . .
Volume SMT . .
COF Capable . . . .
FCOF Capable . o o
Test Services . . . .
Distribution . . . .
ISO 9002 Registered . . . .
Customer Service . .
</TABLE>
- ----------
. -- Currently available
o -- Planned within 6-18 months
MARKETS
HDD Market
To date, the rapid advance of technology in HDDs has driven the market
for precision flex assemblies. High-performance flex assemblies have found the
most significant application in the small form
7
<PAGE> 8
factor (3.5" and smaller), high-capacity (4 gigabyte and greater) portion of the
HDD market. The Company believes that COF technology is the predominant
interconnect technology in this portion of the HDD market. Also see "Risk
Factors."
Intense competition, relatively short product life cycles and rapid
technological change have characterized the HDD market in the recent past. As a
result, HDD manufacturers have been forced to aggressively pursue technologies,
which improve performance and cost. The Company has focused its efforts to meet
the needs of this demanding market. The Company is a leading supplier of
automated fine-pitch SMT flex assemblies and was one of the first to
commercialize the COF process as an enabling technology for high-end drives. The
Company is able to manufacture advanced flex assemblies at low cost due to high
manufacturing yields and to spread the high capital costs necessary to perform
high-volume, precision manufacturing of these assemblies across a large number
of units. The Company therefore should be able to capitalize on the competitive
pressures affecting the HDD market. Also see "Risk Factors."
At the end of 1997, the Company changed the way it classifies its
markets. The removable storage business, which was previously reported as hard
disk drive business, will be reported as non-hard disk drive business, combined
with the tape and optical storage business. Under this modified method of
reporting, the Company's hard disk drive business represented 55%, 50% and 65%
of net revenues in fiscal 1997, 1996 and 1995, respectively. Under the old
method of reporting, the hard disk drive business would have represented 75%,
61% and 71% for fiscal 1997, 1996 and 1995. In addition, sales to the HDD market
have generally been concentrated among a few large customers, including IBM,
Maxtor, Samsung, Seagate and Western Digital.
The Company primarily manufactures advanced flexible assemblies for
products with high-storage (currently greater than 4 gigabyte) capacities. The
Company's flex assemblies incorporate SMT techniques, and also utilize COF
processes for the highest capacity markets, particularly in drives incorporating
emerging MR head technology.
The following diagram depicts the key components of a typical HDD,
including a COF assembly. The head stack assembly travels across the spinning
disk storage media to read and write information. The flex assembly accommodates
this motion and incorporates preamp circuitry as close as possible to the
read/write heads, thereby improving signal-to-noise ratios, allowing increased
transfer rates and reducing the number of interconnections.
[HARD DISK DRIVE DIAGRAM]
8
<PAGE> 9
The following table lists the markets served by the Company, describes
the function of the flex assembly supplied by the Company to each market and
lists representative customers for each market.
<TABLE>
<CAPTION>
APPLICATION SEGMENT FLEXIBLE ASSEMBLY FUNCTION REPRESENTATIVE CUSTOMERS
- ------------------- -------------------------- ------------------------
<S> <C> <C>
Hard Disk Drives Read/write head assemblies IBM, Samsung, Seagate,
Western Digital
Removable Storage Read/write head assemblies Iomega
Disk Arrays SCSI interface assemblies H-P, Sequent Computer
Xyratex
Optical Drives RF/Laser optics and carriage H-P
assemblies
Tape Drives Head preamp assemblies Quantum
Scanners Charge-coupled device (CCD) H-P
control assemblies
Printers Printhead assemblies Topaz,
Rastergraphics
Communications Headset interconnect assemblies, Motorola, Plantronics
cellular battery and control
panel assemblies
Biomedical DNA analyzer cartridge Nanogen
</TABLE>
Emerging Markets
The Company believes that the forces that have driven the HDD market,
including rapid product development, miniaturization and increased performance,
will increasingly affect other markets, creating additional opportunities for
providers of advanced SMT and DCA services. Also see "Risk Factors." The Company
is in various stages of developing prototype assemblies for applications in the
following markets:
Communications--Demand for communications products such as cellular
phones, paging systems and other mobile communications devices, and satellite
communication applications has increased significantly in recent years.
Increasingly, flex substrates are replacing rigid printed circuit boards,
connectors and cables in these products in order to reduce space, weight and
cost. For example, the Company anticipates that flex assemblies will be used in
smart batteries in order to increase battery life and reduce weight.
Computers--Portable computers, such as notebooks and personal digital
assistants, are other applications where the Company anticipates growth in
demand for flex assemblies. In addition to growth in the number and types of
portable computers, the Company believes that the number of flex-based
interconnects per notebook is increasing.
PCMCIA Peripherals--Communications and computer peripheral devices that
adhere to the PCMCIA (Personal Computer Memory Card Industry Association) format
can take advantage of advanced assembly techniques such as DCA to increase
package densities and conform to difficult size constraints. The Company
anticipates that demand for portable computers utilizing the PCMCIA format will
continue to experience significant growth.
Other Emerging Markets--Significant opportunities for flex assemblies
may also exist in other computer products, such as CD-ROMs and virtual reality
headsets and in medical electronics, such as inter-dermal blood gas analyzers
and drug dispensers, and inter-uterine fetal monitors.
9
<PAGE> 10
RISK FACTORS
Important Factors Related to Forward-Looking Statements and Associated Risks
This Annual Report on Form 10-K and the Company's Annual Report to
Stockholders contain 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, 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, 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. Also see "Backlog," "Patents," "Competition" and "Year
2000 Issue."
Limited Independent Operating History
The Company was incorporated in September 1993 to acquire all of the
assets and business of Smartflex Systems, which was founded in November 1985 as
a general partnership (the "Smartflex Partnership") jointly owned by Silicon
Systems, Inc. ("Silicon Systems"), a supplier of mixed signal integrated
circuits to the HDD market, and Rogers Corporation ("Rogers"), a supplier of
flex circuits to the HDD market. Until its acquisition by the Company, the
Smartflex Partnership was provided with financial assistance and significant
support in sales and personnel functions by Silicon Systems and Rogers. Although
the business of the Company has been in existence since November 1985, the
Company has only a limited history as an independent operating company, and
there can be no assurance that the Company will not experience problems
associated with young, growing companies. Although the Company operated
profitably from 1990 through 1996, it experienced operating losses in fiscal
1997. There can be no assurance that the Company will be able to achieve and
improve its profitability in future periods. Also see "Management's Discussion
and Analysis of Financial Condition and Results of Operations" on pages 13
through 17 of the Company's Annual Report to Stockholders for the fiscal year
ended December 31, 1997.
10
<PAGE> 11
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. Also see "Management's Discussion and Analysis
of Financial Condition and Results of Operations" on pages 13 through 17 of the
Company's Annual Report to Stockholders for the fiscal year ended December 31,
1997. Also see "Competition."
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 now or
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 a majority of its revenues for the foreseeable future.
Also see "Management's Discussion and Analysis of Financial Condition and
Results of Operations" on pages 13 through 17 of the Company's Annual Report to
Stockholders for the fiscal year ended December 31, 1997 and "Markets."
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%
11
<PAGE> 12
and 89% of net revenue, 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 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 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. Also see "Manufacturing Services" and "Competition."
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
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, and accordingly, if the relative value of the U.S. dollar
in comparison to
12
<PAGE> 13
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. Also see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" on pages 13 through 27 of the Company's
Annual Report to Stockholders for the fiscal year ended December 31, 1997.
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. Also see "Competition," " Industry Background,"
"Manufacturing Services" and "Markets."
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. Also see "Management."
13
<PAGE> 14
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 or that personnel cost increases will not have an adverse effect on
the Company's net income or results of operatins. Also see "Management."
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."
Control by Existing Stockholders
The Company's officers, directors and existing holders of more than 5%
of the Company's Common Stock, in the aggregate, own beneficially approximately
48% of the outstanding Common Stock. As a result, any substantial portion of
these stockholders, acting together, are able to effectively control most
matters requiring approval by the stockholders of the Company. Approximately 18%
of the Company's Common Stock is held by TDK U.S.A. Corporation ("TDK"), which
holds the shares formerly owned by Silicon Systems, Inc.
Anti-Takeover Provisions
On July 17, 1996, the Board of Directors approved the adoption of a
Shareholder Rights Plan for the Company, which is intended to protect
stockholder interests in the event of an unsolicited attempt to acquire the
Company on terms that the Board of Directors determines are not in the best
interests of the stockholders. The Plan provides for a dividend of one Right for
each share of outstanding common stock. Each Right entitles the holder, on the
occurrence of certain events, to purchase shares of a newly created class of the
Company's preferred stock. The Company may redeem each Right, on terms spelled
out in the Plan, if approved by the Board of Directors.
The Board of Directors has the authority to issue up to 5,000,000 shares
of Preferred Stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of those shares without any future vote
or action by the stockholders. The rights of the holders of the Common Stock
will be subject to, and may be adversely affected by, the rights of the holders
of any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting stock of the Company,
thereby delaying, deferring or preventing a change in control of the Company.
Furthermore, such Preferred Stock may have other rights senior to the Common
Stock, which could have a material adverse effect on the market value of the
Common Stock. The Company has no present plans to issue shares of Preferred
Stock other than pursuant to the Rights Plan. In addition, Section 203 of the
General Corporation Law of Delaware restricts the Company from engaging in
certain business combinations with interested stockholders, as defined by
statute.
14
<PAGE> 15
These provisions may have the effect of delaying or preventing a change
in control of the Company and therefore could adversely affect the price of the
Company's Common Stock, or the ability of stockholders to receive a premium
price for their shares upon an acquisition.
SALES AND CUSTOMER SUPPORT
The Company uses both field sales personnel and internal customer
service and marketing support personnel to facilitate its sales efforts. As of
December 31, 1997, the Company employed 28 sales, support and marketing
personnel. In addition, the Company has agreements with 18 sales representatives
who are assigned geographic territories within North America. The sales
activities of these representatives are managed by the Company's regional sales
managers, who also have some key direct account responsibilities. The Company
also uses sales representatives in Japan, Singapore, Malaysia, Thailand, Hong
Kong and Korea, whose activities are managed from the Company's Tustin
headquarters. The Company presently has no sales personnel in Europe.
The Company's customer support function consists of both customer
service and program management. Employees in these functions form the nucleus of
customer account teams that deal with specific customer technical and order
activities. The customer account teams are multi-functional teams from program
management, customer service, materials planning, manufacturing engineering and
quality engineering, which provide focused attention to the key activities
concerning the customer's account. These teams are responsible for addressing
all customer issues to ensure continuity from program development through
distribution. This focused attention is designed to enable the Company to
respond rapidly and efficiently to each customer's specialized precision
manufacturing needs. Also see "Risk Factors."
BACKLOG
The Company's backlog was approximately $53 million and $52 million at
December 31, 1997 and 1996, respectively. The Company does not have any
long-term agreements with its customers which require the customers to purchase
products. Backlog consists of purchase orders received by the Company for
shipment within up to 180 days. Because customer orders generally require
shipment within the following 90 days and may be rescheduled or canceled by the
customer, the Company does not believe that backlog is a meaningful predictor of
future revenue performance.
PATENTS
The Company does not have, nor does it generally intend to apply for,
patent protection on any aspect of its technology. The Company believes that
patents require public disclosure of information which may otherwise be subject
to trade secret protection. The Company's reliance upon protection of some of
its technology as "trade secrets" will not necessarily protect the Company from
the use by other persons of its technology. No assurances can be made that the
Company will be able to maintain the confidentiality of its technology,
dissemination of which could have a materially adverse effect on the Company's
business. Also see "Risk Factors."
ENVIRONMENTAL CONCERNS
In the past, electronic assembly specialists have typically used
chlorofluorocarbon ("CFC") cleaners, which are believed to contribute to
depletion of the ozone layer in the atmosphere. In 1992 the Company developed an
internal aqueous cleaning process which has completely eliminated the use of
CFC-based chemicals in its facilities worldwide.
The Company uses various hazardous chemicals and substances in its
manufacturing processes. Although the amounts of these materials used by the
Company are not substantial, procedures have nevertheless been implemented to
facilitate compliance with all environmental laws and regulations relating to
the use, storage, discharge and disposal of these materials. The Company
believes that it is in material
15
<PAGE> 16
compliance with all environmental laws and regulations to which it is subject.
Also see "Risk Factors--Environmental Compliance."
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. 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, who primarily assemble products that attach to flex
assemblies. 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
trend toward increasingly shorter product life cycles, particularly in the HDD
industry, is expected to result in more intense competition as each new customer
program is 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, ensure 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.
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 before 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 and
various desktop applications in its operations, which are commercially
available, and are utilized for the most part with little modification or
customization. The applications are Y2K compliant with the exception of one,
which expects to be Y2K compliant by early 1998.
A project to implement the latest versions of the above-mentioned
applications was approved in 1997 and launched in late 1997. 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 estimated to take between twelve and eighteen months to
complete at a cost of approximately $750,000 (also see "Cash Flow").
PERSONNEL
As of December 31, 1997 the Company had a total of 1,169 employees,
including 1,011 in manufacturing and operations support, 67 in engineering, 28
in marketing, sales and program management and 63 in administration. The Company
considers its relations with employees to be good. The Company's
16
<PAGE> 17
employees at its Monterrey facility are represented by a labor union and are
covered by a collective bargaining agreement that is subject to annual revision
under Mexican law.
MANAGEMENT
The executive officers and key employees of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
EXECUTIVE OFFICERS
William L. Healey 53 President, Chief Executive Officer and Chairman of the Board of Directors
Anthony R.W. Richardson 53 Executive Vice President and Chief Operating Officer
Richard D. Bell 53 Vice President of Marketing and Sales
John W. Hohener 42 Vice President, Chief Financial Officer and Treasurer
Christopher J. Rollison 39 Vice President of Operations
KEY EMPLOYEES
Marilyn A. Gosz 49 Director of Strategic Marketing and Business Development
Cheryl L. Moreno 42 Director of Human Resources
Joe L. Pendergrass 43 Director of Logistics and Information Technology
Hal Schoenberg 45 Director of Quality
</TABLE>
EXECUTIVE OFFICERS
William L. Healey has served as President and Chief Executive Officer of
the Company since July 1989, as a director since its incorporation in September
1993 and was elected Chairman in January 1996. Prior to joining Smartflex, Mr.
Healey worked at Silicon Systems, where he was responsible for all manufacturing
operations in California and Singapore and held several senior executive
positions, including Senior Vice President of Operations, Vice President of
Manufacturing and Director of Wafer Fabrication Operations. Mr. Healey also sits
on the Board of privately held Bell Technologies, Inc., a leading provider of
electronics products and services to the high technology segment of the
electronics industry.
Anthony R.W. Richardson joined Smartflex in February 1998 as Executive
Vice President and Chief Operating Officer. Prior to joining Smartflex, Mr.
Richardson spent twenty-four years in senior management roles at Raychem
Corporation ("Raychem"), a material sciences company. Mr. Richardson's positions
at Raychem included Director of Operations, Director of Sales and Marketing, and
General Manager for businesses in Asia, North America, South America, Europe and
the Middle East.
Richard D. Bell joined Smartflex in 1987, and has served as Vice
President of Marketing and Sales of the Company since 1993. Prior to joining
Smartflex, Mr. Bell spent nine years in senior technical marketing and sales
management positions with Scientific-Atlanta, Inc., a manufacturer of
communications and electronics equipment, and Rogers Corporation. Mr. Bell
served as a member of the Board of Directors during September and October 1993.
John W. Hohener has served as Vice President, Chief Financial Officer
and Treasurer since August 1997. From May 1988 through July 1997, Mr. Hohener
served as the Company's Corporate Controller and Treasurer. Prior to joining
Smartflex, Mr. Hohener spent eight years with Silicon Systems, where he held
numerous financial management positions, including Director of Corporate
Accounting. Mr. Hohener served as a member of the Board of Directors during
September and October 1993.
17
<PAGE> 18
Christopher J. Rollison has served as Vice President of Operations since
July 1995 and served as Director of Operations of the Company from October 1992
to July 1995. Mr. Rollison joined Smartflex at its inception in August 1985 as a
senior process engineer. Subsequently, he held a series of positions of
increasing responsibility culminating in his current role as Vice President of
Operations.
KEY EMPLOYEES
Marilyn A. Gosz joined Smartflex as Director of Strategic Marketing and
Business Development in June 1996. Prior to joining the Company, Ms. Gosz
performed technology management and business planning projects on a contract
basis for technology clients for six years. From 1982 to 1989, Ms. Gosz held
various management positions in product marketing, program management and new
business development with Unisys Corporation, Burroughs Corporation and Fujitsu
Corporation.
Cheryl L. Moreno, joined Smartflex in November 1997 as Director of Human
Resources. Prior to joining Smartflex, Ms. Moreno held senior level human
resources positions at Beckman Instruments, MAI Systems Corporation, and
divisions of Ball Corporation and Alps Electric, Ltd.
Joe L. Pendergrass joined Smartflex as Director of Materials in May 1995
and was promoted to Director of Logistics and Information Technology in 1998.
From October 1993 until May 1995, Mr. Pendergrass was self employed as a
materials logistics consultant. From January 1992 until October 1993, he was
Director of Materials at International Rectifier Corporation, a semiconductor
manufacturer. Prior to January 1992, Mr. Pendergrass held a variety of materials
management positions at Rockwell International Corporation for over twelve
years.
Hal Schoenberg has served as Director of Quality Assurance of the
Company since June 1997. Prior to joining the Company, Mr. Schoenberg was a
quality management consultant and educator. Prior to 1995, Mr. Schoenberg was
Director of Quality and Customer Satisfaction for International Rectifier
Corporation, and Region Quality Manager for Hewlett-Packard Company.
18
<PAGE> 19
ITEM 2. PROPERTIES
The Company's Tustin, California facility comprises approximately 44,000
square feet, and is held under operating lease arrangements extending through
2002. The Company's Singapore facility comprises approximately 21,000 square
feet. The Mexico facility comprises approximately 65,000 square feet, which was
completed in 1997. The Singapore and Mexico facilities are held under lease
arrangements extending through 2000 and 2004, respectively. The Company's
manufacturing line in Cebu, the Philippines, comprises approximately 35,000
square feet and is held under a lease agreement extending through 1999.
The description under "Business - International Manufacturing
Capability" is incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year covered by this report.
19
<PAGE> 20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The information required by Item 5 of Form 10-K is incorporated herein
by reference to the information contained in the section captioned "Common Stock
Data" on the inside back cover of the Company's Annual Report to Stockholders
for the fiscal year ended December 31, 1997.
ITEM 6. SELECTED FINANCIAL DATA
The information required by Item 6 of Form 10-K is incorporated herein
by reference to the information contained in the section captioned "Financial
Highlights" on page 1 of the Company's Annual Report to Stockholders for the
fiscal year ended December 31, 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by Item 7 of Form 10-K is incorporated herein
by reference to the information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" on
pages 13 through 17 of the Company's Annual Report to Stockholders for the
fiscal year ended December 31, 1997.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 of Form 10-K is incorporated herein
by reference to the Company's consolidated financial statements and related
notes thereto, and the report of the independent auditors, presented on pages 18
through 30 of the Company's Annual Report to Stockholders for the fiscal year
ended December 31, 1997.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
20
<PAGE> 21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information appearing in the "Information Concerning Nominees"
section of the Company's Proxy Statement to be filed in connection with the
Annual Meeting of Stockholders to be held on or about May 20, 1998, is hereby
incorporated by reference. Information concerning the current executive officers
of the Company is contained in Item 1 of this Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing in the "Executive Compensation," "Summary
Compensation Table," "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements," "Option Grants in Last Fiscal Year," "Aggregate
Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values,"
sections of the Company's Proxy Statement to be filed in connection with the
Annual Meeting of Stockholders to be held on or about May 20, 1998, is hereby
incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information appearing in the "Security Ownership of Management and
Certain Beneficial Owners" section of the Company's Proxy Statement to be filed
in connection with the Annual Meeting of Stockholders to be held on or about May
20, 1998, is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing in the "Compensation Committee Interlocks and
Insider Participation" and "Certain Transactions" sections of the Company's
Proxy Statement to be filed in connection with the Annual Meeting of
Stockholders to be held on or about May 20, 1998, is hereby incorporated by
reference.
21
<PAGE> 22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) 1. FINANCIAL STATEMENTS.
The financial statements listed in the accompanying Index to
Consolidated Financial Statements are filed as part of this
Annual Report on Form 10-K.
2. FINANCIAL STATEMENT SCHEDULES.
The financial statement schedules listed in the accompanying
Index to Consolidated Financial Statement Schedules are filed as
part of this Annual Report on Form 10-K.
3. EXHIBITS.
The exhibits listed in the accompanying Index to Exhibits are
filed as part of this Annual Report on Form 10-K.
(B) CURRENT REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the quarter ended
December 31, 1997.
A current report on Form 8-K, announcing under Item 5 the
appointment of Anthony R.W. Richardson as the Executive Vice
President and Chief Operating Officer was filed in the first
quarter of fiscal 1998.
22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized in the City of Tustin,
State of California, on the 26th day of March, 1998.
SMARTFLEX SYSTEMS, INC.
(Registrant)
By: /s/ William L. Healey
--------------------------------
William L. Healey President,
Chief Executive Officer and
Chairman of the Board
POWER OF ATTORNEY
We, the undersigned directors and officers of Smartflex Systems, Inc. do
hereby constitute and appoint William L. Healey and John W. Hohener, or either
of them, our true and lawful attorneys and agents, to do any and all acts and
things in our name and behalf in our capacities as directors and officers and to
execute any and all instruments for us and in our names in the capacities
indicated below, which said attorneys and agents, or either of them, may deem
necessary or advisable to enable said corporation to comply with the Securities
Exchange Act of 1934, and any rules, regulations, and requirements of the
Securities and Exchange Commission, in connection with this Report, including
specifically, but without limitation, power and authority to sign any and all
amendments hereto; and we do hereby ratify and confirm all that the said
attorneys and agents, or either of them, shall do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ William L. Healey President, Chief Executive March 27, 1998
- ---------------------------- Officer and Chairman of the Board
William L. Healey (Principal Executive Officer)
/s/ John W. Hohener Vice President, Chief Financial March 27, 1998
- ---------------------------- Officer, Treasurer (Principal Financial
John W. Hohener and Accounting Officer)
/s/ William E. Bendush Director March 27, 1998
- ----------------------------
William E.Bendush
/s/ Alan V. King Director March 27, 1998
- ----------------------------
Alan V. King
/s/ William A. Klein Director March 27, 1998
- ----------------------------
William A. Klein
/s/ Gary E. Liebl Director March 27, 1998
- ----------------------------
Gary E. Liebl
</TABLE>
23
<PAGE> 24
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statements of Smartflex Systems,
Inc., included in the Company's Annual Report to Stockholders for the fiscal
year ended December 31, 1997, are incorporated by reference:
<TABLE>
<CAPTION>
Annual Report
Description Page Reference
----------- --------------
<S> <C>
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995 18
Consolidated Balance Sheets as of December 31, 1997 and 1996 19
Consolidated Statements of Stockholders' Equity
for the years ended December 31, 1997, 1996 and 1995 20
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 21
Notes to Consolidated Financial Statements 22-29
Report of Independent Auditors 30
</TABLE>
The following consolidated financial statement schedule of Smartflex
Systems, Inc. and the Consent of Independent Auditors are included herein:
<TABLE>
<CAPTION>
Description Page Reference
----------- --------------
<S> <C>
Schedule II - Valuation and Qualifying Accounts 28
</TABLE>
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
<TABLE>
<S> <C>
Consent of Independent Auditors Exhibit 23.2
</TABLE>
24
<PAGE> 25
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<C> <S>
3.3 Restated Certificate of Incorporation of the Registrant. (1)
3.4 Bylaws of the Registrant. (1)
4.1 Form of Founders Restricted Stock Purchase Agreement dated as of
September 28, 1993, entered into between the Registrant and each of
William L. Healey, John W. Hohener, Richard D. Bell, Christopher J.
Rollison and Merle J. Ihrman. (1)
4.2 Stock Purchase Agreement dated as of March 30, 1994, between the
Registrant and AMP Incorporated. (1)
4.3 Registration Rights Agreement dated as of March 30, 1994 among the
Registrant, J.V. Acquisition Corporation, Silicon Systems, Inc. and
AMP Incorporated. (1)
4.4 Rights Agreement dated as of July 17, 1996 between the Registrant and
The First National Bank of Boston, which includes as Exhibit A thereto
a form of Certificate of Designation for the Preferred stock, as
exhibit B thereto the Form of Rights Certificate and as Exhibit C
thereto a Summary of Terms of Shareholders Rights Plan. (6)
10.1+ Smartflex Systems, Inc. 1993 Equity Incentive Plan, as amended. (1)
10.2+ Smartflex Systems, Inc. 1994 Equity Incentive Plan for Officers,
Directors and Consultants. (1)
10.3+ Smartflex Systems, Inc. 1995 Equity Incentive Plan. (1)
10.4+ Smartflex Systems, Inc. 1995 Employee Stock Purchase Plan. (1)
10.5+ Smartflex Systems, Inc. Amended and Restated Profit Sharing Bonus
Plan. (2)
10.9 Master Lease Agreement dated as of March 9, 1994 between the
Registrant and General Electric Capital Corporation, and Addendum No.
1 thereto dated as of March 9, 1994. (1)
10.10 Volume Purchase Agreement dated August 16, 1989 between Registrant and
Silicon Systems, Inc. (1)
10.13 Facilities and Services Agreement dated October 1, 1995, between
Smartflex Systems Singapore Pte, Ltd. ("Smartflex Singapore") and
Silicon Systems Singapore Pte, Ltd. (2)
10.14 Tenancy of Flatted Factory Unit made November 29, 1994, between
Smartflex Singapore and Jurong Town Corporation. (1)
10.15 Standard Industrial Lease - Net, and addendum thereto, dated February
1, 1996 between the Registrant and Roy G.G. Harris and Patricia S.
Harris, as co-trustees of the Harris Family Trust dated November 2,
1979 and Glyn P. Harris and Ginger M. Harris, Husband and Wife (14312
Franklin). (2)
10.16 Standard Industrial Lease - Net, and addendum thereto, dated February
1, 1996 between the Registrant and Roy G.G. Harris and Patricia S.
Harris, as co-trustees of the Harris Family Trust dated November 2,
1979 and Glyn P. Harris and Ginger M. Harris, Husband and Wife (14312
Franklin - parking lot). (2)
10.17 Facilities and Services Agreement entered into on April 5, 1995
between the Registrant and Silicon Systems, Inc. (1)
10.18 Reorganization Agreement dated July 31, 1995 between the Registrant
and J.V. Acquisition Corporation. (1)
10.19+ Form of Indemnification Agreement for Officers and Directors of the
Registrant. (1)
10.20 Loan Agreement dated December 29, 1995 between Smartflex Singapore and
GE Capital Services Pte. Ltd. (2)
10.21 Promissory Note dated October 11, 1996, from the Registrant in favor
of Union Bank of California, N.A. (term loan). (4)
</TABLE>
25
<PAGE> 26
INDEX TO EXHIBITS (continued)
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<C> <S>
10.22 Debenture dated March 13, 1996 between Smartflex Singapore and GE
Capital Services Pte. Ltd. (2)
10.23+ First Amendment to Smartflex Systems, Inc. 1995 Employee Stock
Purchase Plan (2)
10.24+ Executive Involuntary Termination Policy of the Registrant. (2)
10.25 Corporate Guaranty dated December 29, 1995 between the Registrant and
GE Capital Services Pte. Ltd. (2)
10.26 Contract of Lease dated May 24, 1996, between Smartflex Systems
Philippines, Inc. ("Smartflex Philippines") and Joe & Larry Active
Wears Co., Inc. (3)
10.27 Registration Agreement dated May 25, 1996 between Smartflex
Philippines and Philippine Economic Zone Authority. (3)
10.29 Lease Agreement entered into on November 17, 1996 between Inmobiliaria
Nuevo Aeropuerto, S.A. de C.V. and Smartflex Systems de Mexico, S.A.
de C.V. (5)
10.30 Amendment to the Facilities and Services Agreement dated February 28,
1997, between the Registrant and Silicon Systems, Inc. (5)
10.32+ Second Amendment to Smartflex Systems, Inc. 1995 Employee Stock
Purchase Plan (8)
10.33 Restated Loan Agreement, dated September 26, 1997, amending and
restating the Loan Agreement dated September 29, 1995 between the
Registrant and Union Bank of California, N.A. (9)
10.34 Promissory note dated September 18, 1997, made by the Registrant in
favor of Union Bank of California, N.A. (9)
10.35 Notice of Waiver dated January 26, 1998, addressed to the Registrant
from Union Bank of California (10)
13 Portions of the Company's Annual Report to Stockholders for the year
ended December 31, 1997 (10)
21.1 Subsidiaries of the Registrant. (10)
23.2 Consent of Independent Auditors. (10)
27.1 Financial Data Schedule (Filed electronically)
27.2 Restated Financial Data Schedule (Filed electronically)
27.3 Restated Financial Data Schedule (Filed electronically)
</TABLE>
- ----------------
+ A management contract or compensatory plan or arrangement required to be
filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.
(1) Incorporated herein by reference to the referenced exhibit number to the
Registrant's Form S-1 Registration Statement Number 33-93426, dated July
27, 1995.
(2) Incorporated herein by reference to the referenced exhibit number to the
Registrant's Annual Report on Form 10-K for the Year Ended December 31,
1995.
(3) Incorporated herein by reference to the Registrant's Quarterly Report on
Form 10-Q for the Quarter Ended June 29, 1996
(4) Incorporated herein by reference to the Registrant's Quarterly Report on
Form 10-Q for the Quarter Ended September 28, 1996
(5) Incorporated herein by reference to the referenced exhibit number to the
Registrant's Annual Report on Form 10-K for the Year Ended December 31,
1996
26
<PAGE> 27
(6) Incorporated herein by reference to exhibit 1 to Registrant's Registration
Statement on Form 8-4, dated July 24, 1996
(7) Incorporated herein by reference to the Registrant's Quarterly report on
Form 10-Q for the Quarter Ended March 29, 1997
(8) Incorporated herein by reference to the Registrant's Quarterly report on
Form 10-Q for the Quarter Ended June 28, 1997
(9) Incorporated herein by reference to the Registrant's Quarterly report on
Form 10-Q for the Quarter Ended September 27, 1997
(10) Filed with this Form 10-K.
27
<PAGE> 28
SMARTFLEX SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
----------------------
Balance at Charged to Charged to Balance at
beginning of costs and other end of
Description period expenses accounts Deductions period
----------- ---------- ---------- ---------- ----------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1995:
Allowance for doubtful accounts $ 285 $ 721 $ 35 (1) $ 116 (2) $ 925
Reserve for excess and obsolete
inventory 670 628 - 127 (3) 1,171
-------- -------- ------ ------ --------
Total $ 955 $ 1,349 $ 35 $ 243 2,096
======== ======== ====== ====== ========
Year ended December 31, 1996:
Allowance for doubtful accounts $ 925 $ - $ - $ 5 (2) $ 920
Reserve for excess and obsolete
inventory 1,171 (115) - 190 (3) 866
-------- -------- ------ ------ --------
Total $ 2,096 $ (115) $ - $ 195 1,786
======== ======== ====== ====== ========
Year ended December 31, 1997:
Allowance for doubtful accounts $ 920 $ 11 $ 477 $ 24 (2) 1,384
Reserve for excess and obsolete
inventory 866 910 - 160 (3) 1,616
-------- -------- ------ ------ --------
Total $ 1,786 $ 921 $ 477 $ 184 $ 3,000
======== ======== ====== ====== ========
</TABLE>
- ---------------------
(1) Write off of credit balances in accounts receivable.
(2) Uncollectible accounts written off, net of recoveries.
(3) Inventory written off.
28
<PAGE> 1
EXHIBIT 10.35
[UNION BANK OF CALIFORNIA LETTERHEAD]
Date
January 26, 1998
John Hohener, CFO
SMARTFLEX SYSTEMS INCORPORATED
14312 Franklin Avenue
Tustin, CA 92781-2085
NOTICE OF WAIVER
Re: Loan Agreement
Dated: September 26, 1997
Dear Mr. Hohener:
You have requested the following waiver(s) in reference to the Loan
Agreement ("Agreement") between Union Bank of California, N.A. ("Bank") and
Smartflex Systems Incorporated ("Borrower") referred to above.
Bank hereby waives Borrower's breach of Section 4.8 Profit From Operations
and Section 4.9 Cash Flow of the Agreement occurring prior to January 1, 1998.
Any further breach of these sections is not waived.
Except as waived hereby, the Agreement, as the same may have previously
been waived, shall remain unaltered and in full force and effect. This letter
shall not be a waiver of any existing default or breach of a covenant unless
specified herein.
If you agree with the foregoing, please sign the enclosed acknowledgment
copy and return it on or before February 15, 1998.
UNION BANK OF CALIFORNIA, N.A.
By [SIG]
-------------------------------------
Title Vice President
-----------------------------------
By [SIG]
-------------------------------------
Title Vice President
-----------------------------------
SMARTFLEX SYSTEMS INCORPORATED hereby
agree to and acknowledge this waiver
this 30th day of January, 1998.
By [SIG]
--------------------------------------
Title VP, CFO
-----------------------------------
By
--------------------------------------
Title
-----------------------------------
-1-
<PAGE> 1
PAGE 1
EXHIBIT 13
This exhibit contains portions of the Company's Annual Report to Stockholders
for the year ended December 31, 1997. Page number references made in this
exhibit are to the page numbers on the said Annual Report.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Dollars in thousands except per share data
Fiscal year ended December 31 1997 1996 1995 1994 1993
--------- --------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Net Revenue $ 133,347 $ 146,100 $ 125,258 $ 76,045 $ 69,116
Gross margin(1) 10,734 18,791 17,109 9,490 8,023
Operating income(1)(2) (295) 10,446 8,795 4,305 3,096
Net income(1)(2)(3) 362 7,157 5,513 2,534 3,564
Pro forma net income (unaudited)(3) N/A N/A N/A N/A 1,746
Basic earnings per common share(4) $ 0.06 $ 1.14 $ 1.09 $ 0.60 N/A
YEAR-END POSITION
Working capital $ 33,640 $ 41,713 $ 40,519 $ 17,338 $ 7,684
Total assets 81,906 72,132 69,414 31,345 18,411
Long-term debt, excluding current portion 1,689 722 398 5,026 -
Stockholders' equity 49,089 52,749 44,923 17,864 10,473
NUMBER OF EMPLOYEES 1,169 1,006 868 701 596
</TABLE>
- ----------
(1) Gross margin, operating loss, and net-income in fiscal 1997 excludes
one-time pre-tax inventory write-off of $1.4 million (related to
restructuring) in cost of revenues.
(2) Operating loss and net income in fiscal 1997 excludes a one-time pre-tax
restructuring charge of $5.1 million.
(3) Smartflex was a joint venture and did not recognize income tax expense
prior to October 4, 1993. Taxes on its income were payable by the joint
venture partners. Pro forma net income is unaudited and reflects
provisions for federal and state income taxes using an effective tax rate
of 40% for the period ended December 31, 1993, as if the Company had
operated as a corporation during the period.
(4) Earnings per share for fiscal 1994 was computed using the weighted
average number of shares and common stock equivalents (when dilutive)
outstanding during the period, and assuming the conversion of all
outstanding shares of Series A Preferred Stock into Common Stock at the
beginning of the period.
<TABLE>
<CAPTION>
For the year ended December 31, 1997
- -------------------------------------
<S> <C>
Closing stock price $9.50
Earnings per share - basic (excluding restructuring) $0.06
Common stockholders' equity per share $7.72
Common shares outstanding 6,362,477
</TABLE>
1
<PAGE> 2
PAGES 13 THROUGH 17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information is comprised of forward-looking statements,
the realization of which may be impacted by certain important factors discussed
in the Company's Annual Report on Form 10-K under "Risk Factors -- Important
Factors Related to Forward-Looking Statements and Associated Risks."
OVERVIEW
Smartflex Systems, Inc. ("Smartflex" or "the Company") is a technology
leader in electronics manufacturing services. The Company specializes in
developing and automating the precision assembly of comprehensive interconnect
solutions, utilizing precision surface mount and Direct-Chip-Attach ("DCA")
technologies on multiple circuit substrates. DCA solutions include Chip-On-Flex
("COF"), Flip-Chip-On-Flex ("FCOF"), and Chip-On-Ceramic ("COC") assembly
technologies. The Company was founded as a joint-venture in 1985 and
incorporated in 1993. On July 31, 1995, the Company completed an initial public
offering ("IPO") of 3,220,000 shares of common stock, of which 2,000,000 shares
were sold by the Company.
The Company's markets include hard disk drive ("HDD") and non-HDD
industries. The non-HDD industries include medical electronics, optical and tape
storage, removable storage, communications, computers and peripherals. Sales to
the HDD and non-HDD industries have generally been concentrated among a few
large customers. The Company's predominant market has been the HDD industry,
accounting for approximately 54.8%, 50.0%, and 65.1% of net revenues in fiscal
1997, 1996 and 1995, respectively. Customers in the HDD market include
International Business Machines Corporation and Seagate Technology, Inc.
Customers in the non-HDD market include Iomega Corporation, Quantum Corporation,
and Hewlett Packard Company. Sales to both segments of the market are made
directly to various divisions of these companies or to intermediary companies
that also service these accounts. Demand swings from any of the aforementioned
customers due to a number of factors, including significant slowdowns in their
respective industries, could have a materially adverse effect on the Company's
operating results.
By mid-1992 the Company had developed the methodology to begin
high-volume production of assemblies using the COF process. In 1996, the Company
developed the technique to produce assemblies utilizing the FCOF process. In
early 1997, the Company developed and began shipping volume production of
assemblies incorporating the COC process. Even though sales-to-date of
assemblies incorporating these process technologies have largely been in the HDD
applications, these technologies support both HDD and non-HDD applications. In
fiscal 1997, 1996 and 1995, these process technologies have accounted for
approximately 50.0%, 43.5% and 50.6% of net revenues, respectively.
During fiscal 1997 the Company streamlined its worldwide manufacturing
operations. The Company's Monterrey, Mexico ("Monterrey") operations were moved
to a new facility with approximately 65,000 square feet of manufacturing and
support space for high-volume precision assembly, effectively doubling the floor
space of the operations. In the Company's facility in Cebu, Philippines
("Cebu"), several milestones were achieved. The facility began volume
manufacturing of surface mount assemblies in late 1996. Automated COF process
was implemented in 1997. Manufacturing capability in the Cebu plant increased
three-fold during 1997 compared to 1996. In 1997, the Company announced the
realignment of its Singapore operations to function as the Regional Services and
Technology Center for all of Asia (see "Restructuring").
The Company's revenue growth is, and historically has been, a function
of unit shipment growth, offset in part by reductions in the average selling
prices of products shipped. The Company's recent revenue growth has been
positive except in fiscal 1997 when revenues declined 8.7% compared to 1996. The
Company believes that its ability to again achieve growth will depend primarily
on growth in sales to existing customers for their current and future product
generations and its ability to attract new markets and new customers. The
Company has no firm long-term volume commitments from its customers; customer
contracts can be canceled and volume levels can be changed or delayed. The
timely replacement of delayed, canceled, or reduced orders with new business
cannot be assured. Because of these factors, there can be no assurance that the
Company's historical rate of growth in revenues will resume.
The Company currently serves the electronics industry, which is subject
to rapid technological change, product obsolescence and price competition. These
and other factors affecting the electronics industry, or any of the Company's
major customers in particular, could have a materially adverse effect on the
Company's results of operations.
2
<PAGE> 3
RESULTS OF OPERATIONS
The following table sets forth consolidated statements of operations
data of the Company expressed as a percentage of net revenues for the periods
indicated:
<TABLE>
<CAPTION>
Fiscal Years Ended
December 31
-------------------------------------------
1997 1996 1995
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------
Net revenues 100.0 % 100.0 100.0 %
Cost of revenues 93.0 87.1 86.3
- -----------------------------------------------------------------------------------------
Gross margin 7.0 12.9 13.7
Costs and expenses:
Marketing and sales expense 2.7 1.9 2.1
General and administrative expense 5.5 3.8 4.6
Restructuring expense 3.9 - -
- -----------------------------------------------------------------------------------------
Operating (loss) income (5.1) 7.2 7.0
Interest income 0.7 0.7 0.5
Interest expense (0.4) (0.2) (0.3)
Other income (expense) 0.1 - (0.1)
- -----------------------------------------------------------------------------------------
(Loss) income before income taxes (4.7) 7.7 7.1
Income tax (benefit) provision (1.6) 2.8 2.7
- -----------------------------------------------------------------------------------------
Net (loss) income (3.1)% 4.9 % 4.4 %
=========================================================================================
</TABLE>
Net Revenues
In 1997, revenues declined due to flat demand in the HDD market, as well
as reduced demand in the non-HDD market. Revenue growth in 1996 and 1995 was
primarily due to growth in the overall HDD market, and in particular, in the
higher-capacity HDD segment, as well as due to expansion of the Company's
presence in other markets. The impact of the increase in unit shipments on
revenues has been partially offset by decreases in aggregate average selling
prices ("ASP"). The ASP's have generally declined during these periods primarily
due to decreases in component costs (which are generally passed through to
customers), competitive pricing pressures, and fluctuations in product mix. The
relative impact of any one of these factors varies from period to period.
Net revenues in fiscal 1997 declined $12.8 million, or 8.7% compared to
fiscal 1996, primarily due to reduced demand in the Company's scanner business,
which was offset by slight increases in the removable storage business. The HDD
business was flat in 1997 as compared to 1996. Net revenues in fiscal 1996 rose
$20.8 million or 16.6% from fiscal 1995 levels. Fiscal 1996 net revenues
reflected an increase in aggregate shipment volumes as a result of increased
capacity, partially offset by price reductions reflecting component cost
decreases.
Net revenues derived from non-HDD programs were 45.2% of total net
revenues in fiscal 1997 as compared to 50.0% in fiscal 1996, and 34.9% in fiscal
1995. Reduced demand in 1997 resulted in the decline in net revenues from this
business. The growth in 1996 was primarily due to increased unit sales and
manufacture of a high-cost program, which was previously handled on a
consignment basis.
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 who also service these accounts. Total export sales were
82.6%, 70.9%, and 49.5% of total revenues in fiscal 1997, 1996, and 1995,
respectively. The fiscal 1997 and 1996 increases were due largely to transferred
production to these international operations by the Company's U.S.-based
customers. The Company anticipates that export sales will continue to account
for a significant portion of net revenues for the foreseeable future.
Restructuring
In order to address the imbalance between demand and capacity, as well
as to position the Company's operations for future cost advantages, the Company
accelerated the streamlining of its worldwide operations in the third quarter
of 1997. As part of this restructuring, volume manufacturing is being moved 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, which is included in cost of revenues,
$3.5 million for the write-down of non-current
3
<PAGE> 4
assets and other expenses, $1.1 million for severance and other employee-related
costs associated with the reduction in force, and approximately $500,000 toward
a potential Singapore tax liability. At the end of 1997, the Company had used
approximately $1.8 million for the write-down of non-current assets and other
expenses and has paid approximately $530,000 in severance and other
employee-related costs. The Company expects to utilize the remaining portion of
the restructuring expense provision in 1998.
Gross Margin
Gross Margins as a percentage of net revenues were 7.0%, 12.9% and 13.7%
in fiscal 1997, 1996 and 1995, respectively. The decrease in fiscal 1997 was
primarily due to decreased revenue coupled with increased costs associated with
the expansion of the Company's manufacturing space. The cost of the expansion
will be offset to some degree in 1998 as a result of the restructuring of the
manufacturing facilities described above.
The fiscal 1996 decrease compared to 1995 resulted primarily from the
conversion of a high-cost component for a non-HDD program from consignment to a
turnkey basis, resulting generally in a pass-through of costs, effecting a
decrease in the program's gross margin percentage. This was compounded by the
rapid growth of the program in fiscal 1996, offsetting gross margins overall.
The Company's gross margin, as a percentage of revenues, historically
has not been materially affected by declines in average selling prices because
price reductions generally have been offset by reductions in component costs and
improved operating efficiencies. However, there can be no assurance that future
declines in average selling prices will not negatively impact the Company's
gross margin. The Company's gross margin has been, and will continue to be,
affected by a variety of factors, including the costs associated with
implementing and ramping new production capacity to full utilization, sales
volumes, fluctuations in material costs and the mix of materials for particular
products, price competition, the timing of expenditures in anticipation of
increased sales, changes in product delivery schedules and the range of services
provided. Gross margins for new products are typically lower than those of
mature products due to the inefficiencies associated with the start-up of
manufacturing operations for new products.
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. As a percentage of net revenues, these expenses were 2.7%, 1.9%
and 2.1% in fiscal 1997, 1996 and 1995, respectively. The increase in marketing
and sales expense in fiscal 1997 was attributable generally to increases in
commissions, staffing, advertising and other administrative costs. In fiscal
1996, although sales volume increased, changes in the product mix resulted in
lower average sales commission rates, which was offset somewhat by increases in
other marketing and selling expenses.
General and Administrative Expense
General and administrative ("G & A") expenses increased to $7.5 million
or 5.6% of net revenues in fiscal 1997 as compared to $5.6 million or 3.8% of
net revenues in fiscal 1996, and $5.7 million or 4.6% of net revenues in fiscal
1995. The increase in 1997 was largely due to increases in administrative
personnel in the Monterrey and Cebu locations, and due to increases in program
management. The decrease in 1996 was largely the result of the absence of
significant legal, accounting and insurance costs related to a proposed
acquisition of the Company, which was subsequently abandoned.
The Company expects that G & A expenses will increase in absolute
amounts in the future due, in part, to program management and other staffing
additions needed to support higher business volumes, added profit sharing costs
based on increased profits, if any, and incremental spending on process
development activities in all of its facilities.
Interest Income/Expense
In fiscal 1997, interest income decreased by $48,000 from fiscal 1996
largely due to a slight decrease in investments held during the year. The fiscal
1996 increase in interest income totaling $454,000 was largely due to the
investment of most of the proceeds from the Company's IPO for an entire year
versus five months during fiscal 1995. Interest expense is incurred through the
use of the Company's line of credit facilities, the balances of which vary daily
depending upon operating cash flows.
Income Taxes
Income tax expense decreased $6.2 million in fiscal 1997 compared to
fiscal 1996 due to operating losses and charges related to the restructuring
(see "Restructuring"). Income tax expense increased $691,000 in fiscal 1996
compared to 1995. The Company's effective tax rate was 34.4% in fiscal 1997
compared to 36.3% in fiscal 1996, and 38.1% in fiscal 1995. Changes in the
effective tax
4
<PAGE> 5
rate reflect changes in incremental volume contributions from the company's
offshore manufacturing facilities, which have foreign income tax obligations, if
any, that are generally less than U.S. income tax obligations.
FINANCIAL CONDITION
Summary
The company has financed its growth and operations through proceeds from
the sale of its common stock, bank financing and funds generated from
operations. At December 31, 1997, cash and short-term investments totaled $28.1
million, an increase of $2.2 million from fiscal 1996 year-end balances. This
increase was primarily due to the effect of increases in accounts payable levels
partially offset by the expenditures related to capital purchases and the
restructuring. Uses of the net proceeds from the IPO included increases in
working capital, funding of manufacturing capacity expansion and repayment of
debt.
Sale of Common Stock
On July 31, 1995, the Company completed an IPO of 3,220,000 shares of
common stock, of which 2,000,000 shares were sold by the Company. Net proceeds
from the offering, after underwriting discounts and offering costs, totaled
$21.5 million.
Bank Financing
The company amended its bank credit facility ("facility") on September
26, 1997 to provide for aggregate unsecured borrowings of $25 million under a
revolving line of credit ("credit line"). Borrowings under the credit line,
which expires in September 1999, include a sublimit for the issuance of up to $2
million in commercial or standby letters of credit for the importation or
purchase of inventory. No such letters of credit were outstanding at December
31, 1997. Outstanding balances on the credit line bear interest at the bank's
prime rate or, at the Company's option, LIBOR plus 1.5%, and unused portions of
the credit line bear interest at .125% per annum. At December 31, 1997 there
were no borrowings outstanding under the credit line. The facility additionally
provides for an unsecured term loan totaling $2.2 million for the purchase of
equipment. This unsecured term loan will bear 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 December 31,
1997, the outstanding balnce on the term loan was $2.1 million. The facility
contains certain financing and operating covenants relating to net worth,
liquidity, leverage, profitability, debt coverage and a prohibition on payment
of cash dividends. At December 31, 1997, the Company was in compliance with all
of the covenants, except those related to annual profitability, for which the
Company has obtained a waiver.
In December 1995, the Company's Singapore subsidiary entered into a $1.1
million secured term loan agreement. This loan, guaranteed by the Company, was
used primarily to purchase manufacturing equipment for the Company's Singapore
facility. This loan bears interest at a variable rate, based on SIBOR plus
3.93%, and is secured by the equipment purchased. At December 31, 1997, the
outstanding balance on this note was $416,000.
Cash Flow
At December 31, 1997, the Company's principal sources of liquidity
included $28.1 million in cash and short-term investments and $25.0 million in
available borrowings under its bank credit facility. Short-term investments at
December 31, 1997 totaled $26.1 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 interest-rate risk.
Total cash provided by operations decreased $1.5 million in fiscal 1997,
compared to fiscal 1996, due largely to the effects of accruing for the
Company's restructuring and an increase in inventories. In fiscal 1997,
approximately $11.2 million was used in investing activities, which included
manufacturing and other equipment purchases of $9.9 million and net short-term
investments of $1.3 million. Fiscal 1997 financing activities provided $1.8
million in cash primarily through borrowings on the term loan feature of the
Company's credit facility.
Total cash provided by operations increased $9.3 million in fiscal 1996,
compared to fiscal 1995, due largely to improved operating results and
reductions in receivables and inventories in fiscal 1996. Cash totaling $9.3
million was used in fiscal 1996 investing activities, which included
manufacturing and other equipment purchases of $6.4 million, and net purchases
of $3.0 million in short-term investments. Fiscal 1996 financing activities
absorbed $2.6 million in cash through repayments on the revolving line of
credit.
5
<PAGE> 6
The Company presently expects to purchase approximately $9.2 million of
capital equipment in fiscal 1998, primarily for (a) manufacturing enhancements
and new technology, (b) computer and information systems improvements including
Year 2000 upgrades ("see The Year 2000 Issue"), and (c) quality control
equipment and general improvements.
The Company may require additional capital to finance enhancements to,
or acquisitions and expansion of, its manufacturing capacity in accordance with
its business strategy. Although no assurance can be given that future financing
will be available on terms acceptable to the Company, the Company may seek
additional funds from time to time through public or private debt or equity
offerings or through bank borrowings. Management believes, however, that
existing cash balances, funds generated from operations and borrowings under the
line of credit will be sufficient to permit the Company to meet its expansion
plans and liquidity requirements in fiscal 1998.
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 before 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 and
various desktop applications in its operations, which are commercially
available, and are utilized for the most part with little modification or
customization. The applications are Y2K compliant with the exception of one,
which expects to be Y2K compliant by early 1998.
A project to implement the latest versions of the above-mentioned
applications was approved in 1997 and launched in late 1997. 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 estimated to take between twelve and eighteen months to
complete at a cost of approximately $750,000 (also see "Cash Flow").
6
<PAGE> 7
PAGE 18
CONSOLIDATED STATEMENTS OF OPERATIONS
In thousands, except per share data
<TABLE>
<CAPTION>
Years ended December 31
---------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net revenues $133,347 $146,100 $125,258
Cost of revenues 123,963 127,309 108,149
----------- ---------- ----------
Gross margin 9,384 18,791 17,109
Costs and expenses:
Marketing and sales expense 3,537 2,755 2,594
General and administrative expense 7,492 5,590 5,720
Restructuring expense 5,150 - -
----------- ---------- ----------
Operating (loss) income (6,795) 10,446 8,795
Interest income 967 1,015 561
Interest expense (486) (214) (392)
Other income (expense) 25 (4) (56)
----------- ----------- -----------
(Loss) income before income taxes (6,289) 11,243 8,908
Income tax (benefit) provision (2,160) 4,086 3,395
------------ ---------- ----------
Net (loss) income $ (4,129) $ 7,157 $ 5,513
============ ========== ==========
Net (loss) income per share (basic) $ (0.65) $ 1.14 $ 1.09
============ ========== ==========
Net (loss) income per share (diluted) $ (0.65) $ 1.12 $ 1.06
============ ========== ==========
Number of shares used in computing
net (loss) income per share (basic) 6,333 6,271 5,057
====== ===== =====
Number of shares used in computing
net (loss) income per share (diluted) 6,333 6,395 5,220
====== ===== =====
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 8
PAGE 19
CONSOLIDATED BALANCE SHEETS
In thousands, except share data
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash $ 2,069 $ 1,164
Short-term investments 26,051 24,796
Accounts receivable, less allowance of $1,384
in 1997 and $920 in 1996 19,252 18,837
Inventories 12,100 11,090
Deferred income taxes 3,541 1,634
Prepaid expenses and other current assets 1,755 1,944
------- -------
Total current assets 64,768 59,465
Property and equipment, net 16,278 12,667
Deferred income taxes 350 --
Other assets 510 --
------- -------
$81,906 $72,132
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable to related parties $ 533 $ 2,041
Accounts payable 18,990 11,457
Other accrued liabilities 10,542 3,667
Current portion of notes payable 1,063 587
------- -------
Total current liabilities 31,128 17,752
Deferred income taxes -- 909
Long-term portion of notes payable 1,689 722
Commitments
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares--5,000,000
None issued and outstanding -- --
Common stock, $.0025 par value:
Authorized shares--25,000,000
Issued and outstanding shares--6,362,477 in
1997 and 6,301,313 in 1996 16 16
Additional paid-in capital 36,118 35,649
Retained earnings 12,955 17,084
------- -------
Total stockholders' equity 49,089 52,749
------- -------
$81,906 $72,132
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
8
<PAGE> 9
PAGE 20
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK ADDITIONAL
----------------- ------------------ PAID-IN RETAINED
In thousands SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS TOTAL
- ------------ ------ ------ ------ ------ ------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1994 8,500 $ 9 809 $ 2 $ 13,439 $ 4,414 $ 17,864
Proceeds from public offering, net -- -- 2,000 5 21,489 -- 21,494
Conversion of preferred stock to
common stock (8,500) (9) 3,400 9 -- -- --
Exercise of stock options -- -- 14 -- 15 -- 15
Tax benefit associated with exercise
of stock options -- -- -- -- 37 -- 37
Net income -- -- -- -- -- 5,513 5,513
------ -------- ------ -------- -------- --------
Balances at December 31, 1995 -- -- 6,223 16 34,980 9,927 44,923
Exercise of stock options -- -- 21 -- 61 -- 61
Employee stock purchase plan -- -- 57 -- 570 -- 570
Tax benefit associated with exercise
of stock options -- -- -- -- 38 -- 38
Net income -- -- -- -- -- 7,157 7,157
------ -------- ------ -------- -------- --------
Balances at December 31, 1996 -- -- 6,301 16 35,649 17,084 52,749
Exercise of stock options -- -- 22 -- 59 -- 59
Employee stock purchase plan -- -- 39 -- 343 -- 343
Tax benefit associated with exercise
of stock options -- -- -- -- 67 -- 67
Net loss -- -- -- -- -- (4,129) (4,129)
------ -------- ------ -------- -------- --------
Balances at December 31, 1997 -- $ -- 6,362 $ 16 $ 36,118 $ 12,955 $ 49,089
======= ====== ======== ====== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
9
<PAGE> 10
PAGE 21
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
<TABLE>
<CAPTION>
Years ended December 31
------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
NET CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (4,129) $ 7,157 $ 5,513
Adjustments to reconcile net (loss) income
to cash provided by (used in) operating
activities:
Depreciation and amortization 5,776 2,905 1,919
Provision for doubtful accounts 11 -- 721
Provision for inventory obsolescence 910 (115) 628
Deferred income taxes (3,166) 686 (573)
Tax benefit from exercise of stock options 67 38 37
Changes in operating assets and liabilities:
Receivables (426) (1,441) (6,019)
Inventories (1,920) 6,350 (11,413)
Prepaid expenses and other assets 218 (1,616) (198)
Accounts payable to related parties (1,508) (1,376) 1,750
Accrued restructuring cost 6,500 - -
Accounts payable and accrued liabilities 7,908 (877) 10,085
-------- -------- --------
Net cash provided by
operating activities 10,241 11,711 2,450
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (9,918) (6,414) (5,085)
Proceeds from sales of capital assets -- 85 --
Purchases of short-term investments (20,868) (19,043) (67,893)
Proceeds from the sale of short-term investments 19,604 16,056 50,830
-------- -------- --------
Net cash used in investing activities (11,182) (9,316) (22,148)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 402 631 21,509
Line of credit, net -- (2,505) (1,615)
Borrowings on term loan 2,200 -- 1,132
Payments on term loan (756) (755) (281)
-------- -------- --------
Net cash provided by (used in)
financing activities 1,846 (2,629) 20,745
-------- -------- --------
Net increase (decrease) in cash 905 (234) 1,047
Cash at beginning of period 1,164 1,398 351
-------- -------- --------
Cash at end of period $ 2,069 $ 1,164 $ 1,398
======== ======== ========
Supplemental disclosures of cash flow
information:
Interest paid $ 428 $ 190 $ 347
Taxes paid (refunded) (79) 3,530 3,185
Non-cash transactions:
Conversion of preferred stock to common
stock -- -- (9)
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 11
PAGES 22 THROUGH 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENT OF OPERATIONS
NOTE 1 SIGNIFICANT ACCOUNTING POLICIES
Description of business
Smartflex Systems is a technology leader in electronic manufacturing
services. The Company specializes in developing and automating the precision
assembly of comprehensive interconnect solutions, utilizing precision surface
mount and DCA technologies on multiple circuit substrates. DCA solutions include
COF, FCOF, and COC assembly technologies. The Company serves customers in the
Americas, Europe and Asia.
Basis of Presentation and Fiscal Year
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries, Smartflex Systems Singapore,
Pte. Ltd., Smartflex Systems Philippines, Inc., and Smartflex Systems de Mexico,
S.A. de C.V. All significant intercompany accounts and transactions have been
eliminated in consolidation.
The Company operates and reports financial results on a 52- or 53-week
year, ending on the Saturday nearest December 31 each year, and follows a
four-four-five week quarterly cycle. Fiscal years 1997, 1996 and 1995 each
included 52 weeks of operations. For clarity of presentation, all periods are
described as if the fiscal year ended December 31.
Short-Term Investments
The Company's short-term investments are composed primarily of municipal
bonds and money market instruments. The Company's short-term investments at
December 31, 1997 and 1996, are classified as available-for-sale and are carried
at fair value with the net unrealized gains or losses reported as a separate
component of stockholders' equity, net of their related tax effects. Fair values
are based on quoted market prices where available. Amortization of premiums or
discounts, if any, associated with marketable debt securities is included in
investment income. Realized gains and losses, and declines in value judged to be
other-than-temporary, as well as interest and dividends on available-for-sale
securities, are included in investment income.
Inventories
Inventories are stated at the lower of standard cost (which approximates
actual cost on a first-in, first-out basis) or market (estimated net realizable
value).
Revenue Recognition
The Company recognizes revenue from product sales at the time of
shipment and provides an appropriate allowance for estimated sales returns and
warranties based on historical experience and other known factors.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization of property and equipment is
computed using the straight-line method over the estimated useful lives of the
assets, which is usually three to five years.
3
<PAGE> 12
Foreign Currency
The Company uses the United States dollar as the functional currency for
its wholly owned subsidiaries in Singapore, the Philippines and Mexico.
Remeasurement gains and losses, resulting from the process of remeasuring the
financial statements of these foreign subsidiaries into U.S. dollars, are
included in operations. To date, the effect on income of remeasurement gains and
losses has not been significant.
Income Taxes
The Company uses the liability method of accounting for income taxes,
whereby, deferred taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
Deferred tax assets are recognized and measured based on the likelihood of
realization of the related tax benefit in the future.
Stock-based Compensation
The Company accounts for employee stock options under Accounting
Principles Board opinion No. 25 and related interpretations (APB 25) and has
made certain pro forma disclosures for options granted at fair market value in
accordance with Financial Accounting Standards Board No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation".
Earnings Per Share
Net (loss) income per share for the years ended December 31, 1997, 1996
and 1995 was computed in accordance with Statement of Financial Accounting
Standard No. 128 ("SFAS 128"), "Earnings Per Share." Earnings per common share
("Basic EPS") was computed by dividing net income by the weighted-average number
of common shares outstanding during the periods. Earnings per common
share--assuming dilution ("Diluted EPS") was calculated by dividing net income
by the weighted-average number of common and common share equivalents (when the
effect is dilutive) outstanding during the periods presented. Common share
equivalents result from outstanding options to purchase common stock.
The following table sets forth the computation of Basic and Diluted earnings per
share (in thousands except per share data):
<TABLE>
<CAPTION>
Years ended December 31
------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Numerator:
Net (loss) income - numerator for basic
and diluted earnings per share $(4,129) $7,157 $5,513
======= ====== ======
Denominator:
Denominator for basic earnings per
share--weighted-average shares 6,333 6,271 5,057
Effect of dilutive securities --
Employee stock options -- 124 163
------- ------ ------
Denominator for diluted earnings per
share -- adjusted weighted-average
shares and assumed conversions 6,333 6,395 5,220
======= ====== ======
Basic earnings per share $ (0.65) $ 1.14 $ 1.09
======= ====== ======
Diluted earnings per share $ (0.65) $ 1.12 $ 1.06
======= ====== ======
</TABLE>
4
<PAGE> 13
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.
Reclassifications
Certain prior year amounts in the accompanying consolidated financial
statements have been reclassified to conform to the 1997 presentation.
New Accounting Pronouncements
In June 1997, the Financial Accounting standards Board issued SFAS No.
130, "Reporting Comprehensive Income" and SFAS No. 131, "Segment Information".
Both of these standards are effective for fiscal years beginning after December
15, 1997. SFAS No. 130 requires that all components of comprehensive income,
including net income, be reported in the financial statements in the period in
which they are recognized. Comprehensive income is defined as the change in
equity during a period from transactions and other events and circumstances from
non-owner sources. Net income and other comprehensive income, including foreign
currency translation adjustments, and unrealized gains and losses on
investments, shall be reported, net of their related tax effect, to arrive at
comprehensive income. The Company does not believe that comprehensive income or
loss will be materially different than net income or loss. SFAS No. 131 amends
the requirements for public enterprises to report financial and descriptive
information about its reportable operating segments. Operating segments, as
defined in SFAS No. 131, are components of an enterprise for which separate
financial information is available and is evaluated regularly by the Company in
deciding how to allocate resources and in assessing performance. The financial
information is required to be reported on the basis that is used internally for
evaluating the segment performance. The Company believes it operates in one
business and operating segment and does not believe the adoption of this
standard will have a material impact on the Company's financial statements.
NOTE 2 SHORT-TERM INVESTMENTS
Short-term investments, for which cost approximated fair value, were as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
---- ----
<S> <C> <C>
Municipal bonds $13,283 $15,663
Money market preferred stock 5,000 6,000
Money market funds 7,740 2,954
Other 28 179
------- -------
$26,051 $24,796
======= =======
</TABLE>
Certain of the Company's municipal bond investments include instruments
that have original maturities at various dates through 2025. As a result of the
Company's ability and intent to redeem these investments at their stated
principal values at various dates throughout 1998, the Company has classified
these investments as maturing within one year. Realized gains and losses from
securities transactions are determined on a specific identification basis.
Realized or unrealized gains or losses for the years ended December 31, 1997,
1996 and 1995 were not material.
5
<PAGE> 14
NOTE 3 INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
---- ----
<S> <C> <C>
Raw materials $ 6,943 $ 7,722
Work-in-process 2,725 2,968
Finished goods 2,432 400
------------ ----------
$12,100 $11,090
============ ==========
</TABLE>
NOTE 4 PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
---- ----
<S> <C> <C>
Machinery and equipment $20,930 $ 13,415
Office furniture and equipment 3,148 2,622
Leasehold improvements 4,460 2,581
--------- ---------
28,538 18,618
Less: Accumulated depreciation (12,260) (6,492)
--------- ---------
$16,278 $ 12,126
========= =========
</TABLE>
NOTE 5 OTHER ACCRUED LIABILITIES
Other accrued liabilities consisted of the following:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
---- ----
<S> <C> <C>
Accrued compensation and related costs $1,569 $1,452
Income tax payable 1,248 310
Restructuring liabilities 3,923 --
Other accrued liabilities 3,802 1,905
------- -------
$10,542 $3,667
======= =======
</TABLE>
In order to address the imbalance between demand and capacity, the
Company restructured its worldwide operations in the third quarter of 1997.
Included in the restructuring was the write-down of non-current assets of $3.5
million, severance related expenses of $1.1 million and inventory write-off of
$1.4 million which is included in cost of revenues.
The Company's restructuring plan included a reduction of approximately
195 employees, primarily in manufacturing. Of the approximately 165 employees in
the Singapore operation, 140 employees had been terminated at December 31, 1997.
Additionally, 30 employees from the Tustin, California facility had also been
terminated at December 31, 1997 as part of the restructuring plan.
During the fourth quarter of 1997, the Company utilized $1.8 million
for the write-down of non-current assets and has paid approximately $530,000 in
severance and other employee related costs. The Company expects to complete the
restructuring in 1998.
6
<PAGE> 15
NOTE 6 CREDIT FACILITY AND LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
---- ----
<S> <C> <C>
Revolving line of credit $ -- $ --
Unsecured term loan (LIBOR) 2,108 --
Note payable, secured by equipment, principal
payments in equal monthly installments through
December 1999, interest is payable monthly at
variable interest rates averaging 6.87% in 199 7 416 711
Note payable to bank, secured by equipment,
principal payments in equal monthly
installments through June 1998, interest at 9.53% 228 598
-------- -------
2,752 1,309
Less: Current portion (1,063) (587)
-------- -------
$ 1,689 $ 722
======== =======
</TABLE>
On September 26, 1997, the Company amended its bank credit facility
("facility") which provides for aggregate borrowings of $25 million under a
revolving line of credit ("credit line"). Borrowings under the credit line,
which expires in September 1999 include a sublimit for the issuance of up to $2
million in commercial or standby letters of credit for the purchase of
inventory. No such letters of credit were outstanding at December 31, 1997.
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. At December 31, 1997 there were no
borrowings outstanding under the credit line. The interest rates on any amounts
outstanding at December 31, 1997 and 1996 would have been 7.69% and 8.25%,
respectively. Interest is payable monthly and principal is payable at maturity
on September 30, 1999.
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 December 31, 1997, the outstanding balance of the term loan was $2.1
million.
The facility requires maintenance of certain financial covenants
pertaining to key financial ratios and a minimum level of net worth. In
addition, the facility restricts the Company's ability to pay cash dividends and
places restrictions on the sale of assets and the incurrence of additional debt.
At December 31, 1997, the Company was in compliance with all of the covenants,
except those related to annual profitability, for which the Company had obtained
a waiver.
The Company's Singapore subsidiary has a term loan agreement ("loan")
bearing interest at a variable rate, based on SIBOR plus 3.93%, and is secured
by equipment with a net book value of $297,000 at December 31, 1997. The loan is
guaranteed by the company and matures in December 1999.
7
<PAGE> 16
Long-term debt will mature in fiscal years after December 31, 1997 as follows:
<TABLE>
<CAPTION>
(In thousands)
Fiscal Year:
<S> <C>
1998 $ 1,063
1999 727
2000 550
2001 412
--------
$ 2,752
========
</TABLE>
NOTE 7 FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Company's cash, cash equivalents, accounts
receivable and accounts payable approximated their carrying amounts due to the
relatively short maturity of these items. The fair value of the Company's
short-term investments approximated cost and was determined based on quoted
market prices. The fair value of long-term debt approximated its carrying amount
at December 31, 1997 based on rates currently available to the Company for debt
with similar terms and remaining maturities.
NOTE 8 COMMITMENTS
The Company has entered into leases for its Tustin, California
headquarters, Monterrey, and Cebu facilities which expire at various dates
through March 15, 2004 and provide for renewal options at the then current
market rate, thereafter adjusted for changes in the Consumer Price Index. The
Company also leases certain equipment under a noncancelable operating lease
which expires in 1998. Future minimum lease payments under these noncancelable
obligations at December 31, 1997, are as follows:
<TABLE>
<CAPTION>
(In thousands)
Fiscal Year:
<S> <C>
1998 $1,084
1999 894
2000 730
2001 602
2002 322
Thereafter 389
------
$4,021
======
</TABLE>
Total rent expense was $792,000, $437,000 and $219,000 in 1997, 1996 and 1995,
respectively.
NOTE 9 STOCKHOLDERS' EQUITY
Sale of Common Stock
On July 31, 1995, the Company completed an IPO of 3,220,000 shares of
common stock, of which 2,000,000 shares were sold by the Company. The selling
price for all shares sold was $11.16 per share, net of underwriting discounts.
Series A Preferred Stock
At December 31, 1994, the Company had authorized 8,500,000 shares of
Series A convertible preferred stock (Series A Preferred Stock) with $.001 par
value. Shares of Series A Preferred Stock were converted to 3,400,000 shares of
common stock, after giving effect to the two-for-five reverse split, upon the
closing of the IPO on July 31, 1995.
8
<PAGE> 17
Authorized Preferred Stock
The Company has authorized 5,000,000 shares of preferred stock, par
value $.001, none of which is issued or outstanding. Shares of this preferred
stock can be issued in one or more series on terms and conditions, and with such
rights, preferences and privileges, as the Board of Directors may from time to
time determine. In connection with the Shareholder Rights Plan adopted July 17,
1996, there are 200,000 shares of preferred stock reserved for issuance upon
exercise of the Rights.
NOTE 10 INCOME TAXES
Income tax expense (benefit) is as follows:
<TABLE>
<CAPTION>
Years Ended December 31
------------------------------------
(In thousands) 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $ 753 $2,688 $ 3,257
State 131 622 674
Foreign 55 52 --
------- ------ ------
939 3,362 3,931
Deferred:
Federal (2,911) 576 (474)
State (255) 110 (99)
------- ------ ------
(3,166) 686 (573)
Charge in lieu of income
taxes attributable to
benefits of stock option
exercises 67 38 37
------- ------ ------
$(2,160) $4,086 $3,395
======= ====== ======
</TABLE>
Income tax expense (benefit) differed from the amounts computed by applying the
U.S. statutory federal income tax rate to pretax income as a result of the
following:
<TABLE>
<CAPTION>
Years Ended December 31
-----------------------------------
(In thousands) 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Tax at U.S. statutory rates $(2,138) $3,823 $3,118
State taxes, net of federal benefit (77) 487 384
Foreign earnings not subject to tax (45) (246) (143)
Singapore losses not benefited 205 -- --
Other (105) 22 36
------- ------ ------
$(2,160) $4,086 $3,395
======= ====== ======
</TABLE>
9
<PAGE> 18
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities were as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
---- ----
<S> <C> <C>
Deferred tax assets:
Restructuring reserve $1,821 $ --
Inventory obsolescence reserve 614 351
Reserve for returns and allowances 645 419
Inventory capitalization 17 76
Vacation accrual 152 127
Allowance for doubtful accounts 353 377
Other reserves 864 79
State taxes -- 205
AMT credits 79 --
------ ------
Total deferred tax assets 4,545 1,634
Deferred tax liabilities:
Tax over book depreciation 570 909
State taxes 84 --
------ ------
Total deferred tax liabilities 654 909
------ ------
Net deferred tax assets $3,891 $ 725
====== ======
</TABLE>
The Company has not recorded a valuation allowance against the deferred
tax assets as management believes all of the temporary differences will be
realized against taxable income in future fiscal years.
Effective March 1, 1994, the Company obtained a Pioneer Status tax
holiday in Singapore, which expires five years thereafter, assuming the Company
continues to maintain certain levels of capital expenditures and employment, and
implements certain technology development. Net income tax relief resulting from
the tax holiday was $246,000 in 1996 and $143,000 in 1995. There was no income
tax relief in 1997.
Residual income taxes of approximately $337,000 have not been provided
on approximately $992,000 of undistributed earnings of certain foreign
subsidiaries at December 31, 1997, because the Company intends to keep those
earnings reinvested indefinitely.
NOTE 11 EQUITY INCENTIVE PLANS AND STOCK PURCHASE PLAN
1995 Equity Incentive Plan
The Company's 1995 Equity Incentive Plan ("1995 Plan") provides for the
grant of stock options, performance shares, restricted stock, stock units and
other stock-based awards of the Company's common stock to employees, executive
officers, directors and consultants. Incentive stock options may be granted only
to employees and the exercise price per share may not be less than 100% of the
fair market value ("FMV") of a share of common stock on the grant date. The
exercise price per share of non-qualified stock options shall not be less than
85% of the FMV of a share of common stock on the grant date. The 1995 Plan
provides for the automatic grant of a non-qualified option to purchase 10,000
shares of common stock to each non-employee director of the Company upon his or
her initial election to the Board of Directors, and an additional automatic
grant of a non-qualified option to purchase 3,000 shares of common stock each
time such director is reelected. Automatic grants shall be at the fair market
price of the common stock on the date that such director is elected or
reelected.
10
<PAGE> 19
An aggregate of 600,000 shares of common stock was initially reserved
for issuance under the 1995 Plan. The number of shares of common stock
authorized under the 1995 Plan will increases automatically on January 1 of each
year commencing on January 1, 1997, by an amount equal to 1% of the total number
of issued and outstanding shares of common stock of the Company as of the
immediately preceding December 31; provided, however, that the number of shares
of common stock which may be issued pursuant to incentive stock options may not
exceed 600,000.
As of December 31, 1997, incentive stock options and non-qualified stock
options to purchase 421,219 shares of common stock have been granted with prices
ranging from $9.00 to $18.25 per share. All employee options vest at a rate of
25% on the first anniversary of the grant date and 6.25% per quarter thereafter.
At December 31, 1997, stock options to purchase 101,018 shares of common stock
under the 1995 Plan were exercisable.
1994 Equity Incentive Plan
The Company's 1994 Equity Incentive Plan ("1994 Plan") provided for the
grant of stock options, and other stock-based awards of the Company's common
stock, to officers, key employees, directors and consultants. The 1994 Plan
allowed for the issuance of up to 100,000 shares of common stock. Effective with
the Company's IPO, the Board of Directors resolved to cease issuance of new
awards under the 1994 Plan. As of December 31, 1997, a total of 37,200
restricted shares of common stock at $3.13 per share, and non-qualified stock
options to purchase 20,000 shares of common stock ranging in price from $3.13 to
$9.25 per share have been granted to non-employee directors of the Company. At
December 31, 1997, there were no unexercised shares of restricted common stock,
or non-qualified stock options under the 1994 Plan.
1993 Equity Incentive Plan
The Company's 1993 Equity Incentive Plan (1993 Plan) provided for the
grant of stock options and other stock-based awards of the Company's common
stock to employees, consultants and affiliates. The 1993 Plan allowed for the
issuance of up to 280,000 shares of common stock. Effective with the Company's
IPO, the Board of Directors resolved to cease issuance of new awards under the
1993 Plan. As of December 31, 1997, options to purchase 145,425 shares of common
stock have been granted with prices ranging from $.96 to $10.40 per share. All
options vest at a rate of 25% on the first anniversary of the grant date and
6.25% per quarter thereafter. At December 31, 1997, stock options to purchase
102,150 shares of common stock under the 1993 Plan were exercisable.
11
<PAGE> 20
The following is a summary of equity incentive plan activity for the periods
indicated:
<TABLE>
<CAPTION>
Shares Exercise Price
------ --------------
<S> <C> <C>
Outstanding, December 31, 1994 197,200 $ 0.96-$10.40
Granted 173,950 $ 9.25-$17.00
Exercised (14,485) $ 0.96-$ 3.13
Canceled (6,150) $ 0.96-$12.00
-------
Outstanding, December 31, 1995 350,515 $ 0.96-$17.00
Granted 42,000 $10.25-$18.25
Exercised (20,540) $ 0.96-$12.00
Canceled (12,412) $ 0.96-$14.63
-------
Outstanding, December 31, 1996 359,563 $ 0.96-$18.25
Granted 245,750 $ 9.00-$16.75
Exercised (22,432) $ 0.96-$12.00
Canceled (16,494) $ 0.96-$16.50
-------
Outstanding, December 31, 1997 566,387 $ 0.96-$18.25
</TABLE>
The weighted average exercise price per share of options granted,
exercised and canceled during 1997 and outstanding at December 31, 1997 were
$14.01, $2.62, $12.41 and $11.38, respectively. The weighted average exercise
price per share of options granted, exercised and canceled during 1996 and
outstanding at December 31, 1996 were $15.11, $2.97, $9.30 and $8.23,
respectively. The weighted average exercise price per share of options granted,
exercised and canceled during 1995 and outstanding at December 31, 1995 were
$11.77, $1.00, $2.54 and $7.14, respectively. The weighted average remaining
contractual life of stock options outstanding at December 31, 1997, 1996 and
1995 was 7.9 years, 8.1 years and 8.8 years, respectively.
The range of exercise prices, shares, weighted average remaining
contractual life and exercise price for the options outstanding as of December
31, 1997, 1996 and 1995 are:
<TABLE>
<CAPTION>
Weighted Average
Range of Number Remaining Weighted Average Number
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable
--------------- ----------- ---------------- -------------- -----------
<S> <C> <C> <C> <C>
1997:
- -----
$0.96--$ 0.96 49,850 5.7 $0.96 49,850
$3.13--$ 3.13 40,125 6.2 $3.13 37,625
$9.00--$13.25 262,712 8.3 $11.29 99,330
$13.75--$18.25 176,500 8.4 $16.34 16,363
1996:
- -----
$0.96--$0.96 61,125 6.7 $0.96 46,200
$3.13--$3.13 50,625 7.2 $3.13 37,925
$9.25--$13.25 178,738 8.6 $11.81 55,372
$13.75--$18.25 31,875 8.6 $16.19 1,268
1995:
- -----
$0.96--$0.96 72,265 7.7 $0.96 35,690
$3.13--$3.13 58,900 8.1 $3.13 35,800
$9.00--$13.25 177,400 9.5 $11.61 5,400
$13.75--$18.25 4,750 9.8 $15.25 --
</TABLE>
12
<PAGE> 21
1995 Employee Stock Purchase Plan
Under the Company's 1995 Employee Stock Purchase Plan ("ESPP"), eligible
employees may elect to contribute from 1% to 15% of their base compensation
toward the purchase of the Company's common stock through weekly payroll
deductions. The purchase price per share is the lesser of 85% of the fair market
value of the stock on the commencement date, or last business day, of each
six-month purchase period. The total number of shares of stock that may be
issued under the ESPP may not exceed 200,000 shares. As of December 31, 1997, a
total of 95,899 shares have been issued under the ESPP.
Common Stock Reserved
At December 31, 1997, the Company had reserved 1,106,641 shares of
common stock for issuance pursuant to the 1995 and 1993 Equity Incentive
Plans and the ESPP.
Accounting for Stock-Based Compensation
The Company applies APB 25 and related Interpretations in accounting for
its employee stock options because, as discussed below. The alternative fair
value accounting provided for under SFAS 123 requires use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB 25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of that Statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted average
assumptions: risk free interest rates ranging from 5.3% to 5.4% for 1997, 5.3%
to 6.5% for 1996, and 5.6% to 6.4% for 1995; volatility factors of the expected
market price of the Company's common stock of .60 for 1997, .65 for both 1996
and 1995; and a weighted-average expected life of the option of 3.9 to 5.2 years
for 1997, and 6.0 years for 1996 and 1995.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands, except for earnings per share
information):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Pro forma net (loss) income $(4,680) $6,744 $5,357
Pro forma (loss) earnings per share:
Basic $ (.74) $ 1.07 $ 1.04
Diluted (.74) 1.06 1.03
</TABLE>
The effects of applying SFAS 123 for providing pro forma disclosures are
not likely to be representative of the effects on reported net income for future
years.
13
<PAGE> 22
NOTE 12 EMPLOYEE BENEFIT PLANS
Employee Investment Plan
The Company sponsors a 401(k) employee salary deferral plan that allows
voluntary contributions by substantially all full-time employees. Under the
plan, eligible employees may contribute up to 15% of their pre-tax earnings, not
to exceed the Internal Revenue Service annual contribution limit. The Company
may make discretionary matching contributions, which vest over five years.
During 1997, 1996 and 1995, the Company matched 100% of the first 3% of each
employee's contribution, which totaled $236,000, $226,000 and $213, 000,
respectively.
Profit Sharing Bonus Plan
The Company also has a profit sharing bonus plan whereby all full-time
employees are eligible to participate in a pool of before-tax earnings of the
Company. The profit sharing pool is established annually by the Board of
Directors based on the operational performance expectations of the Company. In
1997, 1996 and 1995, the Company recognized compensation expense totaling
$56,000, $260,000 and $416,000, respectively, pursuant to the employees' profit
sharing portion of the plan.
NOTE 13 RELATED PARTY TRANSACTIONS
The Company has entered into facility and service agreements with
Silicon Systems, Inc. ("SSI") and Silicon Systems Singapore Pte. Ltd. (SSS),
both wholly owned subsidiaries of Texas Instruments. The agreements state that
SSI and SSS will provide certain administrative services and facilities to the
Company for agreed-upon fees, which are based upon actual costs. One of the
Company's board of directors is a senior executive with SSI.
A summary of such purchases and expenses with related parties is as follows:
<TABLE>
<CAPTION>
(In thousands) 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
SSI (current board member and former stockholder):
Purchases of raw materials $ 5,528 $9,679 $10,176
Administrative and facility expenses 383 499 619
TDK (stockholder):
Purchases of raw materials 193 479 --
</TABLE>
NOTE 14 BUSINESS SEGMENT INFORMATION
Historically, the Company has operated in one business segment, which is
the development, production and distribution of flexible interconnect products
for use in computers and peripheral equipment. The Company's principal market is
the HDD industry. In fiscal 1997, approximately 54.8% of the Company's net
revenues were to HDD manufacturers.
The Company sells its products primarily to U.S.-based companies that
are manufacturers or distributors of computer and computer-related products.
These products are often shipped directly to the international headstack
assemblers of these companies, as well as to the offshore facilities of these
U.S.-based companies.
The Company performs periodic credit evaluations on its customers'
financial condition and does not require collateral. Credit losses have
traditionally been minimal and such losses have been within management's
expectation.
14
<PAGE> 23
During fiscal years 1997, 1996 and 1995, net revenues to individual
customers, each of which represented over 10% of total net revenues are as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Customer A 7% 7% 16%
Customer B 12 32 30
Customer C 27 15 15
Customer D 24 24 19
Customer E 20 11 6
</TABLE>
Some of the assemblies manufactured by the Company require one or more
components that are ordered from, or which may be available from, a limited
number of suppliers. A change in suppliers could cause a delay in manufacturing
and a possible loss of sales, which would affect operating results adversely.
Total export revenues, primarily to the Far East, were $111.7 million,
$104.1 million, and $63.6 million during 1997, 1996 and 1995, respectively.
Export revenues by country in excess of 10% of total net revenues were as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Singapore 24% 33% 9%
Thailand 21 23 26
Hong Kong 29 7 9
Mexico 14 - -
</TABLE>
The Company maintains manufacturing operations in Mexico, Singapore and
the Philippines. Pre-tax (loss) income from the Company's offshore operations
totaled $(308,000), $723,000 and $422,000 for the years ended December 31, 1997,
1996 and 1995, respectively.
The Company's employees at the Mexico facility are represented by a
labor union and are covered by a collective bargaining agreement ("agreement")
that is subject to revision annually under Mexican law. These employees
represent 89% of the Company's Mexican labor force. The current agreement,
covering all employees in Mexico, 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.
15
<PAGE> 24
NOTE 15 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents summarized quarterly results:
<TABLE>
<CAPTION>
(In thousands, except per share data)
Quarter 1st 2nd 3rd 4th
--- --- --- ---
<S> <C> <C> <C> <C>
FISCAL 1997
Net revenues $ 30,272 $ 37,003 $ 28,010 $ 38,062
Gross margin 1,953 3,591 (10)(1) 3,850
Net income (loss) 234 558 (5,436)(1,2) 515
Net income (loss) per share - basic $ .04 $ .09 $ (.85)(3) $ .08
Net income (loss) per share - diluted $ .04 $ .09 $ (.85)(3) $ .08
</TABLE>
- ----------
(1) Includes one-time pre-tax inventory write-off of $1.4 million (related to
restructuring) included in cost of revenues.
(2) Includes one-time pre-tax restructuring charge of $5.1 million.
(3) Includes one-time charges totaling $(.70) per share on an after-tax basis.
<TABLE>
<S> <C> <C> <C> <C>
FISCAL 1996
Net revenues $40,025 $34,290 $35,581 $36,204
Gross margin 5,012 4,354 4,707 4,718
Net income 1,912 1,644 1,702 1,899
Net income per share -- basic $ .31 $ .26 $ .27 $ .30
Net income per share -- diluted $ .30 $ .26 $ .27 $ .30
</TABLE>
The summation of quarterly per share amounts do not equal annual per share
amounts due to the effect of stock issuance on the weighted average share
calculation.
16
<PAGE> 25
PAGE 30
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Smartflex Systems, Inc.
We have audited the accompanying consolidated balance sheets of
Smartflex Systems, Inc. as of December 31, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Smartflex Systems, Inc. at December 31, 1997 and 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Orange County, California
January 24, 1998
17
<PAGE> 26
INSIDE BACK COVER
COMMON STOCK DATA
Smartflex Systems, Inc. Common Stock has traded on the Nasdaq National Market
System (symbol SFLX) since its initial public offering on July 31, 1995. The
high and low closing prices, as reported by Nasdaq, were as follows:
<TABLE>
<CAPTION>
1997 High Low
---- ---- ---
<S> <C> <C>
First Quarter $18.00 $10.25
Second Quarter $15.25 $ 9.25
Third Quarter $12.25 $ 9.50
Fourth Quarter $12.00 $ 8.75
</TABLE>
As of January 30, 1998 there were approximately 2,040 holders of the Company's
stock, including 81 stockholders of record.
DIVIDENDS
The Company does not currently pay cash dividends on its Common Stock and
intends to retain earnings for use in the operation and expansion of its
business. In addition, the covenants of certain of the Company's debt agreements
limit payment of cash dividends on its Common Stock.
18
<PAGE> 1
EXHIBIT 21.1
SMARTFLEX SYSTEMS, INC.
LISTING OF SUBSIDIARIES
<TABLE>
<CAPTION>
Jurisdiction of
Name Organization
---- ------------
<S> <C>
Smartflex Singapore Pte. Ltd. Singapore
Smartflex Systems de Mexico, C.V. de S.A. Mexico
Smartflex Systems Philippines Inc. Philippines
</TABLE>
19
<PAGE> 1
EXHIBIT 23.2
Consent of Independent Auditors
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Smartflex systems, Inc. of our report dated January 24, 1998, included in the
1997 Annual Report to Shareholders of Smartflex Systems, Inc.
Our audits also included the financial statement schedule of Smartflex Systems,
Inc., listed in the Index at Item 14(a). This schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion based on
our audits. In our opinion, such consolidated financial statement schedule
referred to above, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
We also consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-95434) pertaining to the 1995 Equity Incentive Plan of
Smartflex Systems, Inc., the Registration statement (Form S-8 No. 33-95358)
pertaining to the 1995 Employee Stock Purchase Plan of Smartflex Systems, Inc.,
the Registration Statement (Form S-8 No. 333-32629) pertaining to the 1995
Equity Incentive Plan of Smartflex Systems, Inc. and the Registration Statement
(Form S-8 No. 33-95372) pertaining to the 1993 Equity Incentive Plan of
Smartflex Systems, Inc. of our report dated January 24, 1998 with respect to the
consolidated financial statements incorporated herein by reference, and our
report included in the preceding paragraph with respect to the financial
statement schedule included in this Annual Report (Form 10-K) of Smartflex
Systems, Inc.
/s/ Ernst & Young LLP
Orange County, California
March 27, 1998
20
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,069
<SECURITIES> 26,051
<RECEIVABLES> 20,636
<ALLOWANCES> 1,384
<INVENTORY> 12,100
<CURRENT-ASSETS> 64,768
<PP&E> 28,538
<DEPRECIATION> 12,260
<TOTAL-ASSETS> 81,906
<CURRENT-LIABILITIES> 31,128
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 49,073
<TOTAL-LIABILITY-AND-EQUITY> 81,906
<SALES> 133,347
<TOTAL-REVENUES> 133,347
<CGS> 123,963
<TOTAL-COSTS> 123,963
<OTHER-EXPENSES> 16,144
<LOSS-PROVISION> 11
<INTEREST-EXPENSE> 486
<INCOME-PRETAX> (6,289)
<INCOME-TAX> (2,160)
<INCOME-CONTINUING> (4,129)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,129)
<EPS-PRIMARY> (0.65)
<EPS-DILUTED> (0.65)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 6-MOS 9-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996 JAN-01-1996
<PERIOD-END> JUN-30-1996 SEP-30-1996 DEC-31-1996
<CASH> 2,773 917 1,164
<SECURITIES> 24,321 24,642 24,796
<RECEIVABLES> 14,084 22,440 19,757
<ALLOWANCES> 925 925 920
<INVENTORY> 11,406 10,762 11,090
<CURRENT-ASSETS> 54,139 61,344 59,465
<PP&E> 15,156 16,146 18,618
<DEPRECIATION> 5,032 5,754 6,492
<TOTAL-ASSETS> 64,809 72,576 72,132
<CURRENT-LIABILITIES> 14,121 17,228 17,752
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 16 16 16
<OTHER-SE> 48,888 50,592 52,733
<TOTAL-LIABILITY-AND-EQUITY> 64,809 72,576 72,132
<SALES> 74,315 109,896 146,100
<TOTAL-REVENUES> 74,315 109,896 146,100
<CGS> 64,949 95,823 127,309
<TOTAL-COSTS> 64,949 95,823 127,309
<OTHER-EXPENSES> 4,112 6,255 8,345
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 97 161 214
<INCOME-PRETAX> 5,638 8,387 11,243
<INCOME-TAX> 2,082 3,129 4,086
<INCOME-CONTINUING> 3,556 5,258 7,157
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 3,556 5,258 7,157
<EPS-PRIMARY> .57 .84 1.14
<EPS-DILUTED> .56 .82 1.12
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997
<PERIOD-END> JUN-30-1997 SEP-30-1997
<CASH> 1,461 2,270
<SECURITIES> 21,414 21,644
<RECEIVABLES> 21,723 15,055
<ALLOWANCES> 705 707
<INVENTORY> 14,725 12,911
<CURRENT-ASSETS> 62,679 58,089
<PP&E> 26,211 27,927
<DEPRECIATION> 8,687 9,738
<TOTAL-ASSETS> 80,233 76,358
<CURRENT-LIABILITIES> 20,441 20,146
<BONDS> 0 0
0 0
0 0
<COMMON> 16 16
<OTHER-SE> 53,754 48,321
<TOTAL-LIABILITY-AND-EQUITY> 80,223 76,358
<SALES> 67,275 95,285
<TOTAL-REVENUES> 67,275 95,285
<CGS> 61,731 88,401
<TOTAL-COSTS> 61,731 88,401
<OTHER-EXPENSES> 4,926 14,170
<LOSS-PROVISION> (189) (189)
<INTEREST-EXPENSE> 260 389
<INCOME-PRETAX> 793 (7,074)
<INCOME-TAX> 1 (2,430)
<INCOME-CONTINUING> 792 (4,644)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 792 (4,644)
<EPS-PRIMARY> .13 (0.73)
<EPS-DILUTED> .12 (0.73)
</TABLE>
