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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended July 3, 1999
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
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Commission File Number: 0-26472
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SMARTFLEX SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 33-0581151
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14312 Franklin Avenue, Tustin, California 92781-2085
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(Address of principal executive offices) (Zip Code)
(714) 838-8737
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes [X} No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Common Stock, $.0025 par value; 6,493,994 shares as of August 9, 1999
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Page 1 of 21
Exhibit Index on Page 21
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SMARTFLEX SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
Page
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 1999 (Unaudited)
and December 31, 1998 3-4
Condensed Consolidated Statements of Operations (Unaudited) for the
three months and six months ended June 30, 1999 and June 30, 1998 5
Condensed Consolidated Statements of Cash Flows (Unaudited) for the
six months ended June 30, 1999 and June 30, 1998 6
Notes to Unaudited Condensed Consolidated Financial Statements 7-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
INDEX TO EXHIBITS 21
</TABLE>
The Company's fiscal year is 52 or 53 weeks, ending on the Saturday
nearest December 31 each year, and follows a four-four-five week quarterly
cycle. For clarity of presentation, the Company has presented its fiscal years
as ending December 31, and its fiscal quarters as ending on March 31, June 30,
September 30 and December 31.
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PART I --- FINANCIAL INFORMATION
Item 1. Financial Statements
SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Balance Sheets
(Dollars in thousands except share and amounts)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash $ 3,052 $ 2,613
Short-term investments 18,662 24,743
Accounts receivable, net of allowance for doubtful accounts
of $767 at June 30, 1999 and $957 at December 31, 1998 14,969 11,209
Inventories:
Raw materials 6,234 1,329
Work-in-process 4,074 1,352
Finished goods 159 1,246
-------- --------
Total inventories 10,467 3,927
Deferred income taxes 3,613 3,613
Income tax receivable 1,735 --
Prepaid expenses and other current assets 2,821 2,360
-------- --------
Total current assets 55,319 48,465
Property and equipment, at cost:
Machinery and equipment 30,831 25,718
Office furniture and equipment 5,374 4,242
Leasehold improvements 5,298 5,474
-------- --------
41,502 35,434
Less accumulated depreciation and amortization (20,701) (16,959)
-------- --------
Total property and equipment 20,801 18,475
Goodwill, net of accumulated amortization of
$398 at June 30, 1999 and $49 at December 31, 1998 14,327 4,089
Other assets 1,167 1,262
-------- --------
Total assets $ 91,614 $ 72,291
======== ========
</TABLE>
See accompanying notes.
3
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LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------- ------------
(Unaudited)
<S> <C> <C>
Current liabilities:
Accounts payable $14,885 $ 7,050
Accrued compensation and related costs 2,423 1,627
Accrued restructuring liabilities 1,229 650
Other accrued liabilities 3,392 5,269
Current portion of notes payable to bank 1,150 1,150
Current portion of other notes payable 4,523 --
------- -------
Total current liabilities 27,602 15,746
Deferred tax liability 324 323
Line of credit 15,233 1,146
Long-term portion of notes payable to bank 2,833 3,317
Long-term portion of other notes payable -- 740
Stockholders' equity:
Preferred stock, $.001 par value:
Authorized shares -- 5,000,000
Issued and outstanding - none -- --
Common stock, $.0025 par value:
Authorized shares -- 25,000,000
Issued and outstanding shares - 6,492,140 at June 30, 1999
and 6,453,541 at December 31, 1998, respectively 16 16
Additional paid-in capital 36,534 36,532
Retained earnings 9,072 14,471
------- -------
Total stockholders' equity 45,622 51,019
------- -------
Total liabilities and stockholder's equity $91,614 $72,291
======= =======
</TABLE>
See accompanying notes.
4
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SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Statements of Operations
(In thousands except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30 June 30
----------------------- -----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues $ 30,339 $ 27,037 $ 53,491 $ 64,042
Cost of revenues 27,082 24,054 48,143 56,914
-------- -------- -------- --------
Gross margin 3,257 2,983 5,348 7,128
Costs and expenses:
Marketing and sales expense 687 886 1,844 1,816
General and administrative expense 3,178 1,886 6,032 3,967
Goodwill expense 202 -- 398 --
Restructuring expense -- -- 3,847 --
-------- -------- -------- --------
Operating (loss) income (810) 211 (6,773) 1,345
Interest income 174 221 489 484
Interest expense (342) (25) (652) (87)
Other income 151 171 188 98
-------- -------- -------- --------
Income before income taxes (827) 578 (6,748) 1,840
Income tax (benefit) provision (281) 191 (1,348) 625
======== ======== ======== ========
Net (loss) income $ (546) $ 387 $ (5,400) $ 1,215
======== ======== ======== ========
Net (loss) income per share:
Basic $ (0.08) $ 0.06 $ (0.84) $ 0.19
======== ======== ======== ========
Diluted $ (0.08) $ 0.06 $ (0.83) $ 0.19
======== ======== ======== ========
Shares used in computing net (loss)
income per share:
Basic 6,481 6,422 6,467 6,397
======== ======== ======== ========
Diluted 6,508 6,476 6,500 6,469
======== ======== ======== ========
</TABLE>
See accompanying notes.
5
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SMARTFLEX SYSTEMS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
June 30
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net cash flow from operating activities:
Net (loss) income $ (5,400) $ 1,215
Adjustments to reconcile net income to cash provided by
(used in) operating activities:
Depreciation 3,578 1,965
Amortization of goodwill 398 --
Provision for doubtful accounts (105) 165
Provision for inventory obsolescence (1,251) 1,941
Other changes in operating assets and liabilities:
Receivables (3,655) 5,308
Inventories (1,789) 4,418
Prepaid expenses and other assets (2,100) 97
Accounts payable to related parties -- (396)
Accrued restructuring cost 579 (1,406)
Accounts payable and accrued expenses 6,755 (7,125)
-------- --------
Net cash (used in) provided by operating activities (2,990) 6,182
Cash flow from investing activities:
Capital expenditures (4,654) (3,358)
Purchase of short-term investments 36 (2,590)
Acquisitions (11,604) --
Proceeds from the sale of short-term investments 6,045 --
-------- --------
Net cash used in investing activities: (10,177) (5,948)
Cash flow from financing activities:
Net proceeds from sale of common stock 3 282
Net borrowings on revolving line of credit 14,087 --
Repayments on term loan (483) (888)
-------- --------
Net cash provided by (used in) financing activities 13,607 (606)
Net decrease in cash (1,016) (372)
Cash at beginning of period 2,613 2,069
======== ========
Cash at end of period $ 1,597 $ 1,697
======== ========
Supplemental disclosures of cash flow information:
Interest paid $ 652 $ 87
Taxes paid 53 960
</TABLE>
See accompanying notes.
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SMARTFLEX SYSTEMS, INC.
Notes to Unaudited Condensed Consolidated Financial Statements
June 30, 1999
Note (A) -- Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Smartflex Systems, Inc. and its wholly owned
subsidiaries ("Smartflex" or the "Company"), and have been prepared in
accordance with generally accepted accounting principles for interim financial
information, and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the six-month period ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999.
Note (B) -- Fiscal Year
The Company's fiscal year is 52 or 53 weeks, ending on the Saturday
nearest December 31 each year, and follows a four-four-five week quarterly
cycle. For clarity of presentation, the Company has presented its fiscal years
as ending December 31, and its fiscal quarters as ending on March 31, June 30,
September 30 and December 31.
Note (C) -- Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
Note (D) -- Credit Facility
The Company amended its bank credit facility (the "facility") on March
30, 1999 and April 20, 1999 to provide for aggregate unsecured borrowings of $25
million under a revolving line of credit (the "credit line"). Borrowings under
the credit line, which expires in September 2000, include a sub-limit 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 June 30, 1999. Outstanding balances on the credit line bear interest at the
bank's prime rate or, at the Company's option, a sliding rate of LIBOR plus
1.50% to 2.25%, and unused portions of the credit line bear interest at .125%
per annum. At June 30, 1999 there was $15.2 million 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, a
sliding rate of LIBOR plus 1.75% to 2.50%. Principal and interest are payable
monthly, and this term loan matures on March 30, 2001. At June 30, 1999, the
outstanding balance on this term loan was $1.3 million. The facility
additionally provides for a second unsecured term loan (the "second term loan")
totaling $3.0 million to be used for general corporate purposes. The second term
loan bears interest at the bank's reference rate, or at the Company's option, a
sliding rate of LIBOR plus 1.75% to 2.50%. At June 30, 1999, the outstanding
balance on the second term loan was $2.7 million. The facility contains certain
financing and operating covenants relating to net worth, liquidity, leverage,
profitability, fixed charge coverage and a prohibition on payment of cash
dividends. At June 30, 1999, the Company was in compliance with all of the
covenants, except those that relate to the quick ratio, for which the Company
has received a waiver.
Note (E) -- Impact of newly issued pronouncement by the Financial Accounting
Standards Board
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative instruments and Hedging Activities." This
statement provides a comprehensive and consistent standard for the recognition
and measurement of derivatives and hedging activities. This statement requires
all derivatives to be recorded on the balance sheet at fair value and
establishes accounting for several types of hedges, resulting in the recognition
of offsetting changes in value or cash flows of the hedge and hedged items in
earnings in the same period. The provisions of this statement are effective for
years beginning after June 15, 1999. The Company will adopt this statement for
fiscal year 2000. The adoption of SFAS No. 133 will not materially impact the
Company's results of operations or financial position.
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Note (F) -- Tanon Acquisition
On February 1, 1999, the Company, through its wholly-owned
subsidiaries, Smartflex Fremont, Inc. and Smartflex New Jersey, Inc., acquired
certain assets from Tanon Manufacturing, Inc., the principal operating
subsidiary of EA Industries, Inc. ("Tanon"). On December 3, 1998, Tanon had
filed a voluntary proceeding under Chapter 11 of the Bankruptcy Code in the
United States Bankruptcy Court for Northern District of California. The
acquisition of the assets was subject to approval of the Bankruptcy Court, which
was granted on January 29, 1999. The assets acquired include certain specified
contracts, equipment and inventory used in connection with Tanon's contract
manufacturing electronic assembly business at facilities in Fremont, California
and West Long Branch, New Jersey. The aggregate purchase price paid was $14.9
million, $2.5 million of which is due in April of 2000 and the Company has
delivered a non-interest-bearing promissory note to guarantee this additional
payment.
Note (G) -- Tender offer from Saturn
On July 7, 1999 the Company announced that it has entered into a
definitive agreement pursuant to which all outstanding shares of common stock
will be acquired by SSI Acquisition Corp. ("SSI") a subsidiary of Saturn
Electronics and Engineering, Inc. ("Saturn"). Under the agreement, Saturn
commenced a tender offer for all outstanding shares of common stock of Smartflex
for $10.50 per share in cash. A successful completion of the tender offer will
be followed by a merger in which any shares not acquired by Saturn in the tender
offer will be acquired for the same amount of cash in the merger. The tender
offer commenced on July 14, 1999, and is conditioned on a majority of the
outstanding shares being tendered as well as other customary conditions.
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SMARTFLEX SYSTEMS, INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following information includes forward-looking statements, such as
all plans, intentions, projections, and beliefs, the realization of which may be
impacted materially by certain important factors discussed in "Risk Factors,"
below, and the other information in this Form 10-Q. Therefore, investors are
cautioned not to place undue reliance thereon or on historic information as an
indication of future performance.
OVERVIEW
Smartflex is a technology leader in electronics manufacturing services.
The Company provides a diverse range of services for customers to achieve their
product realization needs. These services include product, Application Specific
Integrated Circuit ("ASIC"), software and Radio Frequency ("RF") design;
modeling, and package/enclosure management; and the precision assembly of
comprehensive advanced interconnect solutions, utilizing precision surface mount
and Direct-Chip-Attach ("DCA") technologies. Prototype through high volume
manufacturing of electronic circuit board and box build services is provided
through nine facilities worldwide for customers in the Americas, Europe and
Asia.
Results for the first half of 1999 compared to the first half of 1998
were mixed. While revenue is down for the entire six-month period, revenue
results for the second quarter of 1999 were up compared to the second quarter of
1998. Revenue has also improved in the second quarter of 1999 compared to the
first quarter of 1999. While the Company continues to experience competitive
pressures, demand is firming in the data storage segment. The data storage
segments of hard disk drive ("HDD"), removable, and array products increased
this quarter from last quarter, with tape products remaining relatively
unchanged.
The Company's recent acquisitions of Logical Services and Smartflex New
England contributed to results for the full six months of 1999. Smartflex
Fremont and Smartflex New Jersey contributed to 1999 results for the months of
February through June. None of the acquisitions are contained in results for the
first six months of 1998. The acquisitions have enabled the Company to
accelerate its diversification into additional markets by providing a platform
into the automotive, RF communications, and medical marketplaces. These
acquisitions are 100% non-data storage related.
Net revenues for the second quarter of 1999 increased 12% from the same
period in the prior year and increased 31% from the previous quarter. During the
second quarter ended June 30, 1999, HDD shipments were 25% of total net revenues
compared to 52% in the comparable quarter of the prior year.
On July 7, 1999 the Company announced that it has entered into a
definitive agreement pursuant to which all outstanding shares of common stock
will be acquired by SSI Acquisition Corporation ("SSI") a subsidiary of Saturn
Electronics and Engineering, Inc. ("Saturn"). Under the agreement, Saturn
commenced a tender offer for all outstanding shares of common stock of Smartflex
for $10.50 per share in cash. A successful completion of the tender offer will
be followed by a merger in which any shares not acquired by Saturn in the tender
offer will be acquired for the same amount of cash in the merger. The tender
offer commenced on July 14, 1999, and is conditioned on a majority of the
outstanding shares being tendered as well as other customary conditions.
RESULTS OF OPERATIONS
Net Revenues
Net revenues for the quarter ended June 30, 1999 increased 12% from the
comparable period in 1998. The increase is largely due to the inclusion of the
Company's wholly-owned subsidiaries, Smartflex Fremont Inc. and Smartflex New
Jersey Inc.
HDD net revenues for the second quarter of 1999 decreased 46% when
compared to the second quarter of 1998. Total data storage revenue in the second
quarter of 1999 decreased 49%, compared to the second quarter of
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1998. This revenue decrease was more than offset by revenue from the Company's
acquisitions, which were not present in the second quarter of 1998.
Net revenues for the first half of 1999 decreased 16% when compared to
the first half of 1998, due to weakness in the data storage market.
Export sales arise primarily from the shipment of assembled products to
international operations of U.S.-based customers as well as shipments to
intermediary companies that also service these accounts. Total export sales
accounted for 50% in the second quarter of 1999 compared to 88% in the
comparable quarter in 1998. Net revenues from the Company's acquisitions are
from domestic customers only.
Restructuring
During the first quarter of 1999 the Company streamlined its worldwide
operations. As a result of this restructuring, certain support services have
been transferred from the Tustin and Singapore facilities to the Company's
locations in Monterrey, Mexico and Cebu, Philippines. Additionally the Monterrey
facility was sized to match resources to current production demand. The
restructuring also addressed unutilized space within the facilities and the
write-down of non-current assets. As part of this restructuring, the Company
provided for the following charges in the first quarter of 1999: $700,000 for
severance and other employee-related costs associated with the reduction in work
force, $2.2 million for the write-down of non-current assets and other expenses,
and $1.4 million which addresses unutilized facilities and associated costs.
Gross Margins
Gross margin as a percentage of net revenues in the second quarter of
1999 were 10.7% compared to 11.0% for the second quarter of 1998, and 9.0% for
the first quarter of 1999. Gross margins for the six months ended June 30, 1999
and 1998 were 9.9% and 11.1% respectively. The slight gross margin percentage
decrease in the second quarter of 1999 from the same quarter of 1998 is a result
of the Company's acquisitions, which changed the cost structure of the Company.
Improvement in gross margins in the current quarter from the previous quarter
were a result of increased revenues which more than offset cost increases during
the same period.
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 decreased 40.6%
for the quarter ended June 30, 1999, compared to the same period in fiscal 1998.
The decrease in expenses is primarily due to the implementation of a lower
commission structure in the current year.
General and Administrative Expenses
General and administrative ("G&A") expenses increased both as a
percentage of net revenues, and in absolute dollars, for the quarter ended June
30, 1999 compared to the same period in 1998. In absolute dollars G&A expenses
were $3.2 million in the second quarter of fiscal 1999, an increase of
approximately $1.3 from the G&A expenses in the same quarter of fiscal 1998. As
a percentage of net revenues, G&A expenses were 10.5% for the current year's
second quarter, compared to 7.0% for the quarter ended June 30, 1998. These
increases were due to incremental expenses associated with the Company's
acquisitions, which were not present during the same period in 1998.
Interest Income/Expense
Interest income decreased in the second quarter of 1999, compared to
the same quarter in 1998 due to a lower amount of short-term investments.
Interest expense increased $317,000 in the second quarter of 1999 from the
comparable quarter in the prior year as a result of working capital needs
supporting the Company's revenue growth.
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Income Taxes
The Company booked a benefit for income tax of $281,000 in the quarter
ended June 30, 1999, compared to a provision of $191,000 in the same quarter of
the prior year.
Liquidity and Capital Resources
At June 30, 1999, the Company's principal sources of liquidity included
$21.7 million in cash and short-term investments, and $9.8 million in available
borrowings under its bank credit facility (the "facility"). The Company amended
its facility on March 30, 1999 and April 20, 1999 to provide for aggregate
unsecured borrowings of $25 million under a revolving line of credit (the
"credit line"). Borrowings under the credit line, which expires in September
2000, include a sub-limit 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 June 30, 1999. Outstanding balances on the
credit line bear interest at the bank's prime rate or, at the Company's option,
a sliding rate of LIBOR plus 1.50% to 2.25%, and unused portions of the credit
line bear interest at .125% per annum. At June 30, 1999 there was $15.2 million
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, a sliding rate of LIBOR plus 1.75% to 2.50%. Principal
and interest are payable monthly, and this term loan matures on March 30, 2001.
At June 30, 1999, the outstanding balance on this term loan was $1.3 million.
The facility additionally provides for a second unsecured term loan (the "second
term loan") totaling $3.0 million to be used for general corporate purposes. The
second term loan bears interest at the bank's reference rate or, at the
Company's option, a sliding rate of LIBOR plus 1.75% to 2.50%. At June 30, 1999,
the outstanding balance on the second term loan was $2.7 million.
Short-term investments at June 30, 1999 totaled $18.7 million, and
consisted primarily of holdings in municipal bonds and money market instruments
in accordance with the Company's investment policy, which is designed to
maintain a highly liquid portfolio with minimal risk. The Company's short-term
investments, which are classified as available-for-sale, decreased by
$6.1 million during the six month period ended June 30, 1999 due primarily to
acquisitions made by the Company.
Over the six months ended June 30, 1999, inventory levels increased
$6.5 million in connection with the Company's acquisitions. (see cashflow
- -"acquisitions") Inventory levels fluctuate directly with the volume of the
Company's manufacturing; and changes or significant fluctuations in market
demand can cause fluctuations in inventory levels which may result in changes in
levels of inventory turns and liquidity. See "Risk Factors."
During the six months ended June 30, 1999, the Company acquired $4.7
million in capital equipment and leasehold improvements, primarily supporting
the Fremont and New Jersey locations.
The Company may require additional capital to finance enhancements to,
and/or expansion of, its manufacturing capacity in accordance with its business
strategy. The Company may also utilize capital for the purpose of acquiring
other businesses 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 credit line will be sufficient to permit the Company to
meet its expansion plans and liquidity requirements in fiscal 1999, with the
exception of external acquisitions, where size would determine if additional
capital is needed over the Company's then current availability. See "Risk
Factors".
RISK FACTORS
Important Factors Related to Forward-Looking Statements and Associated Risks
This Quarterly Report on Form 10-Q contains forward-looking statements
that are based on current expectations and involve a number of risks and
uncertainties. All information herein, which is not historic, and any inference
from historic information concerning future periods, is a forward-looking
statement. Factors that may materially affect revenues, expenses and operating
results include, without limitation, the impact of competitive
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products and pricing, dependence upon a small number of customers and upon
customers predominantly in the data storage industry, dependence upon export
sales, the impact of conducting international operations, international currency
fluctuations, the transition of volume manufacturing operations from Singapore
to the Philippines, efficient utilization of manufacturing facilities and
financial resources, qualification of manufacturing processes, potential
interruption of the flow of components from a limited number of suppliers,
subsequent changes in business strategy or plan, the ability to retain and
attract qualified personnel, timely completion of the business systems
implementation, and structural and strategic changes affecting certain of the
Company's existing customers, suppliers and competitors, the future financial,
economic, competitive and market conditions and their potential direct or
indirect effect, including cancellations of orders included in backlog, the
integration and management of newly acquired entities or businesses, the ability
to effectively identify, investigate, conclude, integrate and manage
acquisitions and large scale projects, and all of the other material factors
discussed above, under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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 that may affect the Company's
operating results, and financial position, investors should not overly rely upon
forward looking statements or historical trends to anticipate results or trends
in future periods.
Tender Offering and Conditions to Closing
We are currently subject to a tender offer made by SSI Acquisition
Corp., a Delaware corporation and a wholly-owned subsidiary of Saturn
Electronics & Engineering, Inc., a Michigan corporation, to purchase all of our
outstanding shares at $10.50 per share, net to the selling shareholder, in cash.
The tender offer is being made by SSI pursuant to an Agreement and Plan of
Merger, dated as of July 6, 1999, under which it is contemplated that SSI will
ultimately be merged with and into us. There can be no assurance that the
conditions of the tender offer will be met, or that the merger will ever be
consummated. In the event that the tender offer is terminated prior to the
completion of the merger, all costs and expenses incurred by Smartflex in
connection with the Agreement and Plan of Merger and the tender offer shall be
paid by Smartflex. Failure to complete the tender offer and merger could have a
material adverse effect on our financial and operating results, and could
adversely affect Smartflex's current relationships with customers, suppliers,
and other persons with whom we and our subsidiaries have significant business
relationships.
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
12
<PAGE> 13
Company operated profitably from 1990 through 1996 and in 1998, it experienced
operating losses in fiscal 1997 and thus far in fiscal 1999. There can be no
assurance that the Company will be able to achieve or improve its profitability
in future periods.
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.
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 the Data Storage Market
The Company's principal market is the data storage industry, which is
characterized by intense competition, relatively short product life cycles,
rapid technological change, significant fluctuations in product demand and
significant pressure on vendors to reduce or minimize costs. The storage
industry is also highly cyclical and has experienced periods of increased demand
and rapid growth followed by periods of oversupply and contraction. The impact
of cyclical trends on suppliers to this industry has been exacerbated by the
tendency of manufacturers of data storage products to order components in excess
of their needs during growth periods, followed by a sharp reduction in demand
for components during periods of contraction. The Company's operating results
have been adversely affected from time to time during storage industry slowdowns
and could be materially adversely affected in the event of further slowdowns in
this industry now or in the future. Although the Company is attempting to reduce
its dependence on the storage industry, revenues attributable to this market
have historically represented a majority of its revenues, and the Company's
dependence on the data storage industry is expected to continue or increase in
the foreseeable future.
Customer Concentration
The Company's customer base is highly concentrated. During fiscal 1998
and 1997, the Company's five largest customers (which include, in some cases,
multiple divisions) accounted for approximately 68.0% and 80.0% of net revenue,
respectively. The Company expects that sales to a relatively small number of
OEMs will continue to account for a substantial portion of net revenues for the
foreseeable future, and the loss of, or a decline in orders from, one of the
Company's key customers would have a material adverse effect on the Company's
financial and operating results.
13
<PAGE> 14
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), and VTC, Inc. ADFlex is also one the Company's
competitors. During fiscal 1998, 1997 and 1996, the Company purchased a majority
of its flex components from either ADFlex or Mektec, and 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. There can be no
assurance that such shortages will not recur in the future. Any such shortages
could have a material adverse effect on the Company's operating results.
International Operations
The Company maintains international operations in Singapore, Mexico,
and the Philippines. In light of the continued relocating to offshore facilities
on the part of the Company's customers, Smartflex anticipates that it will be
required to increase its presence overseas. Manufacturing and sales operations
outside the United States are accompanied by a number of risks inherent in
international operations, including but not limited to imposition of
governmental controls, compliance with a wide variety of foreign and United
States export laws, currency fluctuations, unexpected changes in trade
restrictions, tariffs and barriers, political and economic instability, longer
payment cycles typically associated with foreign sales, difficulties in
administering business overseas, labor union issues and potentially adverse tax
consequences. The Company historically has denominated all export sales in
United States dollars, and accordingly, if the relative value of the U.S. dollar
in comparison to the currency of the Company's foreign customers or competitors
should increase, the resulting effective price increase of the Company's
products to such foreign customers could result in decreased sales. The
Company's production employees at the Monterrey, 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 2000. While the Company believes that it has established
good relationships with its labor force in Monterrey, 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
14
<PAGE> 15
and deferrals have had an adverse effect on the Company's operating results in
the past, and there can be no assurance that the Company will not experience
such effects in the future. In addition, the Company incurs significant accounts
receivable in connection with providing manufacturing services to its customers.
If one or more of the Company's principal customers were to become insolvent, or
otherwise were to fail to pay for the services and materials provided by the
Company, the Company's operating results and financial condition would be
adversely affected.
Rapid Technological Change
The Company and the Company's customer base competes in markets that
are characterized by rapid technological change and short product life cycles.
In particular, the HDD, computer and communications markets are prone to rapid
product obsolescence by new technologies. The flexible interconnect industry
could experience future competition from new or emerging technologies that
render existing technology less competitive or obsolete. The inability of the
Company to develop technologies to meet the evolving market requirements of its
customer base could have a material adverse effect on the Company's business,
financial condition and results of operations, including the Company's ability
to maintain its revenue base.
Management of Growth
The Company has experienced certain periods of rapid growth which has
placed, and is expected to continue to place, a significant strain on the
Company's management, operational and financial resources. The Company expects
that continued growth would require the addition of new management personnel and
the development of additional expertise by existing management personnel. The
Company's ability to manage growth effectively, particularly given the
increasingly international scope of its operations, will require it to continue
to implement and improve its operational, financial and management information
systems as well as to develop the management skills of its managers and
supervisors and to train, motivate and manage its employees. The Company's
failure to effectively manage growth could have a material adverse effect on the
Company's results of operations.
Integration of Acquisitions
Effective October 1998, the Company made its first acquisition, and has
since made a total of three acquisitions through March 1999. The Company
believes that these acquisitions are an integral part of its diversification
strategy for both markets and customers. The Company's ability to effectively
integrate these acquisitions and control the costs associated with the
integration will be key to its future success. The Company's failure in regard
to selection of acquisitions and due diligence or to effectively manage these
acquisitions could have a material adverse effect on the Company's results of
operations.
Dependence on Key Employees
The Company is highly dependent on its Chief Executive Officer, William
L. Healey, and other principal members of its management team, the loss of whose
services could have a material adverse effect upon the business and financial
condition of the Company, as well as the ability of the Company to achieve its
development objectives. None of such persons has an employment contract with the
Company. The Company is also dependent on other key personnel, and on its
ability to continue to attract, retain and motivate highly skilled personnel.
The competition for such employees is intense, and there can be no assurance
that the Company will be successful in attracting, retaining or motivating key
personnel or that personnel cost increases will not have an adverse effect on
the Company's net income or results of operations.
The Year 2000 issue
The "Year 2000 issue," also known as "Y2K issue" or the "Millennium
Bug," arises out of the fact that many existing computer programs and other
devices use only two digits to identify a year in the date field and, if
uncorrected, would fail or create erroneous results as a result of the Year
2000.
Early in 1997, the Company evaluated the Y2K issue and its impact on
the Company's operations. Currently, the Company uses certain IBM AS400
applications, which are not Y2K compliant, and various desktop applications,
15
<PAGE> 16
which are Y2K compliant. So-called "embedded systems," that control certain
manufacturing equipment and other fixtures and equipment, have been identified
and have been determined to be Y2K compliant.
A project to implement the latest versions of the IBM AS400
applications was launched in late 1997. This project also addresses the Y2K
issue. The project team consists of both dedicated resources and key functional
participants. The project consists of five main steps or phases: the first phase
consisting of an assessment of viable alternatives from commercially available
applications; the second phase being the decision process as for which
applications to obtain; the third phase consisting of configuring the system to
run the Company's business; phase four being training, testing and piloting of
all applications; and the final phase consisting of Company-wide implementation.
The team has identified, and the Company has committed to implement, an
enterprise application that is Y2K compliant. 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 Company has
implemented and is using the new software. Costs incurred at the end of June
1999 totaled $870,000.
The Company has contacted its major external suppliers, customers and
other business partners to estimate their compliance with the Y2K issue and is
presently evaluating inputs received from these external relationships. Failure
of any of the Company's major external suppliers and customers to appropriately
and timely address the Y2K issue could cause material disruption of the
Company's business and have material adverse impacts on the Company's results of
operations.
Environmental Compliance
The Company is subject to a variety of environmental regulations
relating to the use, storage, discharge and disposal of hazardous chemicals and
substances used in its manufacturing process. While the Company believes that it
is in material compliance with all existing applicable environmental statutes
and regulations, any failure by the Company to comply with statutes and
regulations presently existing or enacted in the future could subject it to
liabilities or the suspension of production. In addition, compliance with such
statutes and regulations could restrict the Company's ability to expand its
facilities or require the Company to acquire costly equipment or to incur other
significant expenses.
Control by Existing Stockholders
The Company's officers, directors and existing holders of more than
5.0% of the Company's Common Stock, in the aggregate, own beneficially
approximately 54.0% of the outstanding Common Stock as of March 18, 1999
including shares subject to presently exercisable options or options that become
exercisable within 60 days of March 18, 1999. 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 and have
collectively signed agreements with SSI to tender their shares to SSI in
connection with the offer and merger. Approximately 18.0% 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
16
<PAGE> 17
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.
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.
On July 6, 1999, the Board of Directors approved an Amendment to the
Rights Agreement which provided that the current offer by SSI will not trigger
the Provisions of the Shareholder Rights Plan.
17
<PAGE> 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in foreign exchange
and interest rates. The Company does not use derivative financial instruments
for speculative or trading purposes. The Company's earnings are affected by
fluctuations in the value of the U. S. dollar against foreign currencies, in
Singapore, the Philippines and Mexico.
The Company's earnings are affected by changes in short-term interest
rates as a result of its borrowings under the credit line, and the unsecured
term loans, all of which are based on variable interest rates. If market
interest rates for such borrowings average 1.0% higher during the fiscal year
ending January 1, 2000 than they did during the fiscal year ended January 2,
1999 the Company's interest expense would increase and income before income
taxes would decrease by approximately $19,000. This analysis does not consider
the effects of the reduced level of overall economic activity that could exist
in such an environment. Further, in the event of a change of such magnitude,
management could take actions to further mitigate its exposure to the change.
However, due to the uncertainty of the specific actions that would take and
their possible effects, the sensitivity analysis assumes no changes in the
Company's financial structure.
18
<PAGE> 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits -- See exhibits index, incorporated herein by reference
(b) Reports on Form 8-K: None
19
<PAGE> 20
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
SMARTFLEX SYSTEMS, INC.
(Registrant)
August 18, 1999 By: /s/ John W. Hohener
- --------------- --------------------------------
Date John W. Hohener
Vice President, Chief Financial
Officer, and Duly Authorized
Officer (Principal financial and
accounting officer)
20
<PAGE> 21
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
2.1 Agreement and Plan of Merger dated as of July 6, 1999 by and
among Parent, Purchaser and the Company (1)
2.2 Form of Stock Tender and Voting Agreement dated as of July 6,
1999 by and among Parent, Purchaser and each of William L.
Healey, William E. Bendush, Alan V. King, William A. Klein, Gary
E. Liebl, Anthony R. W. Richardson, John W. Hohener, Richard D.
Bell, James Cogan, Christopher Rollison and Cheryl Moreno. (1)
27 Financial Data Schedule (filed electronically).
- -------------
(1) Incorporated herein by reference to the Registrant's Amendment No. 2 to
Solicitation/Recommendation Statement on Schedule 14D-9/A, dated July 27,
1999.
21
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