FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarter period ended March 4, 1999
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission File No. 333-50981
MCMS, INC.
(Exact name of registrant as specified in its charter)
Idaho 82-0480109
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or
organization)
16399 Franklin Road, Nampa, Idaho 83687
(Address of principal executive offices, Zip Code)
(208)898-2600
(Registrant's telephone number, including area code)
(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 filing
requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13 or
15(d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court.
Yes No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Shares of Class A Common Stock outstanding at March 4, 1999: 3,261,177
Shares of Class B Common Stock outstanding at March 4, 1999: 863,823
Shares of Class C Common Stock outstanding at March 4, 1999: 874,999
MCMS,INC.
INDEX
Part I. Page
----
Item 1 Financial Information
Unaudited Consolidated Balance Sheets -
March 4, 1999 and September 3, 1998 3
Unaudited Consolidated Statements of Operations -
Three and Six Months Ended March 4, 1999 and
February 26, 1998 4
Unaudited Consolidated Statements of Cash Flows -
Six Months Ended March 4, 1999 and February 26, 1998 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Certain Factors 14
Item 3 Quantitative and Qualitative Disclosures about Market
Risk 19
Part II. Other Information
Item 6 Exhibits 19
Signatures 20
2
PART I FINANCIAL INFORMATION
- ----------------------------
ITEM 1. FINANCIAL STATEMENTS
MCMS, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
March 4, September 3,
As of 1999 1998
- --------------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ - $ 7,542
Trade account receivable, net of allowances for
doubtful accounts of $442 and $97 48,060 34,231
Receivable from affiliates 1,951 2,096
Inventories 38,527 29,816
Deferred income taxes 1,356 1,255
Other current assets 921 356
--------- ---------
Total current assets 90,815 75,296
Property, plant and equipment, net 66,996 62,106
Deferred income taxes 2,488 -
Other assets 7,658 7,650
--------- ---------
Total assets $ 167,957 $ 145,052
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Current portion of long-term debt $ 571 $ 420
Accounts payable and accrued expenses 56,871 44,433
Payable to affiliates 423 775
Interest payable 217 197
--------- ---------
Total current liabilities 58,082 45,825
Long-term debt, net of current portion 203,225 184,737
Deferred income taxes - 1,286
Other liabilities 646 580
--------- ---------
Total liabilities 261,953 232,428
Redeemable preferred stock, no par value,
750,000 shares authorized; issued and
outstanding 283,217 and 266,313 shares,
respectively; mandatory redemption value of
$28.3 million and $26.6 million, respectively 27,407 25,675
SHAREHOLDERS' DEFICIT
Series A convertible preferred stock, par value
$0.001 per share, 6,000,000 shares
authorized; issued and outstanding 3,261,177;
aggregate liquidation preference of $36,949,135 3 3
Series B convertible preferred stock, par value
$0.001 per share, 6,000,000 shares authorized;
issued and outstanding 863,823 shares;
aggregate liquidation preference of $9,787,115 1 1
Series C convertible preferred stock, par value
$0.001 per share, 1,000,000 shares authorized;
issued and outstanding 874,999 shares;
aggregate liquidation preference of $9,913,739 1 1
Class A common stock, par value $0.001 per share,
30,000,000 shares authorized; issued and
outstanding 3,261,177 3 3
Class B common stock, par value $0.001 per share,
12,000,000 shares authorized; issued and
outstanding 863,823 shares 1 1
Class C common stock, par value $0.001 per share,
2,000,000 shares authorized; issued and
outstanding 874,999 shares 1 1
Additional paid-in capital 61,586 63,318
Accumulated other comprehensive loss (2,219) (2,270)
Retained deficit (180,730) (174,109)
Less treasury stock at cost:
Series A convertible preferred stock, 3,676
shares outstanding (42) -
Class A common stock, 3,676 shares outstanding (8) -
--------- ---------
Total shareholders' deficit (121,403) (113,051)
--------- ---------
Commitments and contingencies - -
Total liabilities and shareholders'
deficit $ 167,957 $ 145,052
========= =========
The accompanying notes are an integral part of the financial statements.
3
MCMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Three months ended Six months ended
------------------------------- -------------------------------
March 4, February 26, March 4, February 26,
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Net sales $ 116,348 $ 74,680 $ 207,591 $ 145,681
Cost of goods sold 110,337 67,182 196,393 128,091
--------- --------- --------- ---------
Gross profit 6,011 7,498 11,198 17,590
Selling, general and
administrative 6,790 3,805 11,009 6,927
--------- --------- --------- ---------
Income (loss) from
operations (779) 3,693 189 10,663
Other expense (income):
Interest expense(income), net 4,925 (194) 9,646 (329)
Transaction expenses - 8,312 45 8,312
--------- --------- --------- ---------
Income (loss) before taxes
and extraordinary item (5,704) (4,425) (9,502) 2,680
Income tax provision
(benefit) (1,722) (562) (3,497) 2,067
--------- --------- --------- ---------
Income (loss) before
extraordinary item (3,982) (3,863) (6,005) 613
Extraordinary item - loss
on early extinguishment
of debt, net of income
tax benefit of $403 (617) - (617) -
--------- --------- --------- ---------
Net income (loss) (4,599) (3,863) (6,622) 613
Redeemable preferred
stock dividends and
accretion of preferred
stock discount (918) (9) (1,772) (9)
--------- --------- --------- ---------
Net income (loss) to
common stockholders $ (5,517) $ (3,872) $ (8,394) $ 604
========= ========= ========= =========
Net income (loss) per
common share - basic:
Income (loss) before
extraordinary item $ (0.98) $ (69.21) $ (1.56) $ 21.23
Extraordinary item (0.12) - (0.12) -
--------- --------- --------- ---------
Net income (loss) per
share $ (1.10) $ (69.21) $ (1.68) $ 21.23
========= ========= ========= =========
Net income (loss) per
common share - assuming
dilution:
Income (loss) before
extraordinary item $ (0.98) $ (69.21) $ (1.56) $ 10.80
Extraordinary item (0.12) - (0.12) -
--------- --------- --------- ---------
Net income (loss) per
share $ (1.10) $ (69.21) $ (1.68) $ 10.80
========= ========= ========= =========
The accompanying notes are an integral part of the financial statements.
4
MCMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Six months ended
-------------------------------
March 4, February 26,
1999 1998
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (6,622) $ 613
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Loss on extinguishment of debt 617 -
Depreciation and amortization 7,441 5,458
Loss (gain) on sale of property, plant and equipment 25 (2)
Write-off of deferred loan costs - 206
Changes in operating assets and liabilities:
Receivables (13,857) (5,933)
Inventories (8,722) (5,879)
Other assets (699) (217)
Accounts payable and accrued expenses 8,261 12,453
Deferred income taxes (3,472) (917)
Other liabilities 52 156
--------- ---------
Net cash provided by (used for) operating activities (16,976) 5,938
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for property, plant and equipment (7,544) (10,763)
Proceeds from sales of property, plant and equipment - 219
--------- ---------
Net cash used for investing activities (7,544) (10,544)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contributions - 1,786
Repurchase of common stock and recapitalization - (249,147)
Proceeds from issuance of common stock - 10,200
Proceeds from issuance of convertible preferred stock - 51,000
Proceeds from and issuance of redeemable preferred
stock - 24,000
Proceeds from borrowings 28,094 175,000
Repayments of debt (9,832) (916)
Payment of deferred debt issuance costs (1,239) (7,489)
Purchase of treasury stock (50) -
--------- ---------
Net cash provided by financing activities 16,973 4,434
--------- ---------
Effect of exchange rate changes on cash and cash
equivalents 5 (201)
--------- ---------
Net decrease in cash and cash equivalents (7,542) (373)
Cash and cash equivalents at beginning of period 7,542 13,636
--------- ---------
Cash and cash equivalents at end of period $ - $ 13,263
========= =========
The accompanying notes are an integral part of the financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(TABULAR DOLLAR AMOUNTS IN THOUSANDS)
1. General
The information included in the accompanying
consolidated interim financial statements is unaudited and
should be read in conjunction with the annual audited
financial statements and notes thereto contained in the
Company's Report on Form 10-K for the fiscal year ended
September 3, 1998. In the opinion of management, all
adjustments, consisting of normal recurring accruals,
necessary for a fair presentation of the results of
operations for the interim periods presented have been
reflected herein. The results of operations for the interim
periods presented are not necessarily indicative of the
results to be expected for the entire fiscal year.
2. Effect of Recently Issued Accounting Standards
During the first quarter of fiscal 1999, the Company
adopted Statement of Financial Accounting Standards ("SFAS")
No. 130, Reporting Comprehensive Income. SFAS No. 130
establishes standards for the presentation of comprehensive
income or loss in financial statements. Comprehensive income
or loss includes income and loss components which are
otherwise recorded directly to shareholders' equity under
generally accepted accounting principles. The Company's
comprehensive loss for the second quarter and first six
months of fiscal 1999 was $4,481,000 and $6,570,000,
respectively. The Company's comprehensive loss was
$4,453,000 and $1,271,000 for the corresponding periods of
fiscal 1998. The accumulated balance of foreign currency
translation adjustments, excluded from net income or loss, is
presented in the consolidated balance sheet as "Accumulated
other comprehensive loss."
In June 1997, the Financial Accounting Standards Board
issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." Under SFAS No. 131,
publicly held companies are required to report financial and
other information about key revenue-producing segments of the
entity for which such information is available and utilized
by the chief operating decision-maker. Specific information
to be reported for individual segments includes profit or
loss, certain revenue and expense items and total assets. A
reconciliation of segment financial information to amounts
reported in the financial statements must also be provided.
SFAS No. 131 is effective for the Company in fiscal 1999 and
the form of the presentation in the Company's financial
statements has not yet been determined.
In March 1998, the AICPA issued Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." Under SOP 98-1,
companies are required to capitalize certain costs of
computer software developed or obtained for internal use,
provided that those costs are not research and development.
The Company is required to implement SOP 98-1 in fiscal 2000
and adoption is not expected to have a material effect on the
Company's results of operations or financial position.
3. Inventories
March 4, September 3,
1999 1998
-------------- --------------
Raw materials and supplies $ 20,257 $ 18,126
Work in process 17,238 11,020
Finished goods 1,032 670
--------- ---------
$ 38,527 $ 29,816
========= =========
4. Accounts payable and accrued expenses
March 4, September 3,
1999 1998
-------------- --------------
Trade accounts payable $ 46,080 $ 39,152
Short-term equipment contracts 4,745 543
Salaries, wages, and benefits 4,766 3,619
Other 1,280 1,119
--------- ---------
$ 56,871 $ 44,433
========= =========
6
5. Long-term Debt
March 4, September 3,
1999 1998
-------------- --------------
Revolving loan, principal payments at the
Company's option to February 26, 2003,
interest due quarterly, interest rates
ranging from 8.38% to 10.75% (8.38%
September 3, 1998) $ - $ 9,500
Revolving loan, principal payments at the
Company's option to February 26, 2004,
interest due monthly, interest rate of
7.75% since inception and as of March 4,
1999 28,094 -
Senior subordinated notes (the "Fixed
Rate Notes"), unsecured, interest at
9.75% due semiannually, mature on March
1, 2008 145,000 145,000
Floating interest rate subordinated term
securities, (the "Floating Rate Notes"),
unsecured, interest due semiannually,
mature on March 1, 2008, variable
interest rate equal to LIBOR plus 4.63%
(9.75% and 10.22% at March 4, 1999 and
September 3, 1998, respectively) 30,000 30,000
Note payable, matures on October 8, 1998,
interest due at maturity, weighted
average interest rate equal to interest
earned on the Company's cash investments
(5.24% at September 3, 1998) - 212
Note payable, quarterly installments
through October 1, 2000,
interest rate of 3.51% 326 445
Note payable, monthly installments
through December 26, 1999, interest rate
of 5.95% 376 -
--------- ---------
Total debt 203,796 185,157
Less current portion (571) (420)
--------- ---------
Long-term debt, net of current portion $ 203,225 $ 184,737
========= =========
On February 26, 1999, the Company entered into a $60
million Senior Credit Facility (the "Credit Facility") which
matures on February 26, 2004. The Credit Facility includes
both a $10 million facility restricted to the purchase of
qualifying equipment and a $50 million revolving credit
facility. Amounts outstanding under the equipment loan
facility bear interest at the lesser of the applicable
Alternate Base Rate plus 0.25% or the Eurodollar Rate plus
2.50%, as defined in the agreement, and borrowings are
limited to the first three loan years. Amounts outstanding
under the revolving credit facility bear interest at the
lower of the applicable Alternate Base Rate or Eurodollar
Rate plus 2.25%. Amounts available under the revolving credit
facility vary depending on Eligible Receivable and Eligible
Inventory balances, as defined in the agreement. The Credit
Facility includes a quarterly commitment fee of 0.375% per
annum based upon the average unused portion and is
collateralized by substantially all the assets of the
Company. The Credit Facility contains customary covenants
such as restrictions on capital expenditures, additional
indebtedness and on the payment of dividends. In particular,
the Credit Facility contains a covenant requiring that the
Company maintain a fixed charge ratio of not less than 1.0 to
1.0, provided, however, that this fixed charge ratio covenant
will not be applied to any fiscal quarter during the term as
long as the Company maintains at all times during such fiscal
quarter undrawn availability of more than $5 million for any
such fiscal quarter during the ninety days following the
closing date of the Credit Facility and $10 million for any
month thereafter. As of March 4, 1999, the Company would not
have satisfied the requirements of this fixed charge ratio
covenant. The Credit Facility contains customary events of
default. Any default under the Credit Facility could result
in default of the Notes and Redeemable Preferred Stock, as
defined below. As of March 4, 1999, the Company had a $28.1
million outstanding balance under the revolving credit
facility and no outstanding balance on the equipment loan
facility. As of March 4, 1999, the Company had $14.1 million,
after adjustments required by the fixed charge ratio
covenant, and $10 million available to borrow under the
revolving credit facility and the equipment loan facility,
respectively. The Credit Facility replaced the $40 million
revolving credit facility the company had previously entered
into with various lending institutions.
7
On February 26, 1998, the Company issued $25.0 million
in 12-1/2% Redeemable Preferred Stock due on March 1, 2010
with a liquidation preference of $100 per share. Dividends
are payable in cash or in-kind quarterly beginning June 1,
1998 at a rate equal to 12-1/2% per annum. To-date, the
Company has paid all dividends in-kind.
6. Net Income (Loss) Per Share
Basic earnings per share is computed using net income
(loss) reduced (increased) by dividends on the Redeemable
Preferred Stock divided by the weighted average number of
common shares outstanding. Diluted earnings per share is
computed using the weighted average number of common and
common stock equivalent shares outstanding. Common
equivalent shares include shares issuable upon the exercise
of outstanding stock options and shares issuable upon the
conversion of outstanding convertible securities, and affect
earnings per share only when they have a dilutive effect.
Loss before extraordinary item per share and net loss per
share for the three and six months ended March 4, 1999 and
the three months ended February 26, 1998 is computed based on
the weighted average number of common shares outstanding
during each period of 5,000,000, 5,000,000 and 55,934,
respectively. The Company's basic earnings per share and its
fully diluted earnings per share were the same for the three
and six months ended March 4, 1999 and three months ended
February 26, 1998 because of the antidilutive effect of
outstanding convertible securities and stock options. The
following table presents a reconciliation of the numerators
and denominators of basic earnings per share and fully
diluted earnings per share for the six months ending February
26, 1998:
Weighted
Average Number Per Share
Income Of Shares Amount
--------- ---------------- ------------
Basic earnings per share:
Net income to common stockholders $ 604,000 28,467 $ 21.23
=========
Add dilutive effect of
convertible securities - 27,473
--------- ---------
Earnings per share - assuming
dilution:
Net income to common stockholders $ 604,000 55,940 $ 10.80
========= =========
7. Income Taxes
The effective rate of the tax benefit for the three and
six months ended March 4, 1999 was 31.6% and 37.1%,
respectively. The effective rate for the benefit and the
provision of income taxes was 12.7% and 77.1% for the
corresponding periods of fiscal 1998. The effective tax rate
for fiscal 1999 primarily reflects the statutory corporate
income tax rate, the net effect of state taxation and the
effect of a tax holiday granted to the Company's Malaysian
operation. The increases in the effective rate of the tax
benefit in the three and six months ended March 4, 1999
relative to the corresponding periods of fiscal 1998 were
primarily due to nondeductible transaction costs related to
the Recapitalization, as defined below, in fiscal 1998,
offset in part by a decrease in the proportion of lower taxed
income generated by the Company's international operations
and an increase in a valuation allowance established during
fiscal 1999. The Company does not provide for U.S. tax on
the earnings of its foreign subsidiaries and, therefore, the
effective rate may vary significantly from period to period.
During the three months ended March 4, 1999, the Company
set up a valuation allowance of $0.5 million for the amount
of the deferred tax asset which would not be realized through
either carrying back its net operating losses or through
future income generated by reversal of deferred tax
liabilities during the loss carryforward period.
8. Recapitalization
On February 26, 1998 the Company completed a
recapitalization (the "Recapitalization"). Prior to the
closing of the Recapitalization, the Company was a wholly
owned subsidiary of MEI California, Inc. ("MEIC"), a wholly
owned subsidiary of Micron Electronics, Inc. ("MEI"). Under
the terms of the amended and restated Recapitalization
Agreement between the Company, MEIC, MEI and certain other
parties, pursuant to which the Company effected the
Recapitalization, certain unrelated investors (the
"Investors") acquired an equity interest in the Company. In
order to complete the Recapitalization, the Company arranged
for additional financing in the form of notes and redeemable
preferred stock totaling $200.0 million. The Company used the
proceeds from the Investors' equity investment and the
issuance of notes and redeemable preferred stock to redeem a
portion of MEIC's outstanding equity interest for
approximately $249.2 million. As of the date of this report
and at all times since the date of the Recapitalization, MEIC
holds and has held a 10% equity interest in the Company.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Statements contained in this Form 10-Q that are not
purely historical are forward-looking statements and are
being provided in reliance upon the "safe harbor" provisions
of the Private Securities Litigation Reform Act of 1995. All
forward-looking statements are made as of the date hereof and
are based on current management expectations and information
available to the Company as of such date. The Company assumes
no obligation to update any forward-looking statement. It is
important to note that actual results could differ materially
from historical results or those contemplated in the forward-
looking statements. Forward-looking statements involve a
number of risks and uncertainties, and include trend
information. Factors that could cause actual results to
differ materially include, but are not limited to, those
identified herein under "Certain Factors" and in other
Company filings with the Securities and Exchange Commission.
All quarterly references are to the Company's fiscal periods
ended March 4, 1999, September 3, 1998 or February 26, 1998,
unless otherwise indicated.
MCMS, Inc. ("MCMS" or the "Company") is a leading
electronics manufacturing services ("EMS") provider serving
original equipment manufacturers ("OEMs") in the networking,
telecommunications, computer systems and other sectors of the
electronics industry. The Company offers a broad range of
capabilities and manufacturing management services, including
product design and prototype manufacturing; materials
procurement and inventory management; manufacturing and
testing of printed circuit board assemblies ("PCBAs"); memory
modules and systems; quality assurance; and end-order
fulfillment.
MCMS provides services on both a turnkey and consignment
basis. Under a consignment arrangement, the OEM procures the
components and the Company assembles and tests them in
exchange for a processing fee. Under a turnkey arrangement,
the Company assumes responsibility for both the procurement
of components and their assembly and test. Turnkey
manufacturing generates higher net sales than consignment
manufacturing due to the generation of revenue from materials
as well as labor and manufacturing overhead, but also
typically results in lower gross margins than consignment
manufacturing because the Company generally realizes lower
gross margins on material-based revenue than on manufacturing-
based revenue. The Company also provides services on a
partial consignment basis, whereby the OEM procures certain
materials and the Company procures the remaining materials.
Consignment revenues, excluding partial consignment revenues,
accounted for 5.8% and 5.3% of the Company's net sales for
the three and six months ended March 4, 1999, respectively.
Results of Operations
Three months ended Six months ended
------------------------------ --------------------------------
March 4, February 26, March 4, February 26,
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Net sales 100.0% 100.0% 100.0% 100.0%
Costs of sales 94.8 90.0 94.6 87.9
------- ------- ------- -------
Gross margin 5.2 10.0 5.4 12.1
Selling, general and
administrative expenses 5.9 5.1 5.3 4.8
------- ------- ------- -------
Income (loss) from operations (0.7) 4.9 0.1 7.3
Interest expense (income), net 4.2 (0.3) 4.6 (0.2)
Transaction expenses - 11.1 0.1 5.7
------- ------- ------- -------
Income (loss) before taxes (4.9) (5.9) (4.6) 1.8
Income tax provision (benefit) (1.5) (0.7) (1.7) 1.4
Extraordinary loss (0.5) - (0.3) -
------- ------- ------- -------
Net income (loss) (3.9)% (5.2)% (3.2)% 0.4%
======= ======= ======= =======
Depreciation and amortization (1) 3.1% 3.8% 3.4% 3.7%
======= ======= ======= =======
(1) For the three and six months ended March 4, 1999, the depreciation and amortization amount
excludes $233,000 and $466,000, respectively, of deferred loan amortization that was expensed as
interest.
9
Three Months Ended March 4, 1999 Compared to Three Months Ended
February 26, 1998
Net Sales. Net sales for the three months ended March
4, 1999 increased by $41.7 million, or 55.8%, to $116.3
million from $74.7 million for the three months ended
February 26, 1998. The increase in net sales is primarily
the result of higher volumes of complex PCBA and system level
shipments to customers in the networking and
telecommunications industries. These increases were partially
offset by lower complex PCBA prices, lower volumes and prices
on custom turnkey memory modules and lower prices on
consigned memory modules.
Net sales attributable to foreign subsidiaries totaled
$7.1 million for the three months ended March 4, 1999,
compared to $3.6 million for the corresponding period of
fiscal 1998. The growth in foreign subsidiary net sales is
primarily the result of higher volumes of complex PCBA's in
both Malaysia and Belgium. This increase was negatively
impacted by a shift from a turnkey to consignment model at
the Belgian facility early in the second quarter of fiscal
1999.
Gross Profit. Gross profit for the three months ended
March 4, 1999 decreased by $1.5 million, or 19.8%, to $6.0
million from $7.5 million for the three months ended February
26, 1998. Gross margin for the three months ended March 4,
1999 decreased to 5.2% of net sales from 10.0% for the
comparable period ended February 26, 1998. The decrease in
gross profit resulted from lower margins realized on less
mature programs, continued pricing pressure on existing
programs, reduced capacity utilization as manufacturing lines
and personnel were added to support anticipated growth in the
Idaho and Malaysia facilities and lower prices on consigned
memory modules.
Selling, General and Administrative Expenses. Selling,
general and administrative expenses ("SG&A") for the three
months ended March 4, 1999 increased by $3.0 million, or
78.4%, to $6.8 million from $3.8 million for the three months
ended February 26, 1998. This increase for the three months
ended March 4, 1999 was primarily the result of expenses
associated with additional senior management to support
future growth, additional program management personnel, sales
commissions associated with increased sales volume and
additional expenses and headcount associated with the Company
operating as a standalone entity following the
Recapitalization. SG&A expenses included a non-cash foreign
currency expense of $0.8 million for the three months ended
March 4, 1999 primarily related to an intercompany loan
between the Company and its Belgian subsidiary.
Interest Expense. Interest expense for the three months
ended March 4, 1999 increased to $4.9 million due principally
to the addition of $175 million in long-term debt issued or
incurred in conjunction with the Recapitalizaton.
Provision for Income Taxes. Income taxes for the three
months ended March 4, 1999 decreased by $1.6 million, to a
benefit of $2.1 million from a benefit of $0.6 million for
the three months ended February 26, 1998. The effective rate
of the tax benefit for the three months ended March 4, 1999
was 31.6%, as compared to 12.7% for the corresponding period
of fiscal 1998. The increase in the effective rate of the tax
benefit during the three months ended March 4, 1999 relative
to the corresponding period of fiscal 1998 was primarily due
to nondeductible transaction costs related to the
Recapitalization in the three months ended February 26, 1998,
offset in part by a decrease in the proportion of lower taxed
income generated by the Company's international operations
and an increase in a valuation allowance established during
the three months ended March 4, 1999. The Company does not
provide for U.S. tax on the earnings of its foreign
subsidiaries and, therefore, the effective rate may vary
significantly from period to period.
During the three months ended March 4, 1999, the Company
set up a valuation allowance of $0.5 million for the amount
of the deferred tax asset which would not be realized through
either carrying back its net operating losses or through
future income generated by reversal of deferred tax
liabilities during the loss carryforward period.
Extraordinary loss. The extraordinary after tax loss of
the $0.6 million for the three months ended March 4, 1999
resulted from the write-off of deferred financing costs
related to the early retirement of the Company's Revolving
Credit Facility.
Net Loss. For the reasons stated above, the net loss
for the three months ended March 4, 1999 increased by $0.7
million to $4.6 million from $3.9 million for the three
months ended February 26, 1998. As a percentage of net
sales, net loss for the three months ended March 4, 1999 was
3.9% compared to 5.2% for the three months ended February 26,
1998.
10
Six Months Ended March 4, 1999 Compared to Six Months Ended
February 26, 1998
Net Sales. Net sales for the six months ended March 4,
1999 increased by $61.9 million, or 42.5%, to $207.6 million
from $145.7 million for the six months ended February 26,
1998. The increase in net sales is primarily the result of
higher volumes of complex PCBA and system level shipments to
customers in the networking and telecommunications
industries. These increases were partially offset by lower
complex PCBA prices, lower volumes of custom turnkey memory
modules, and both lower volumes and prices on consigned
memory modules.
Net sales attributable to foreign subsidiaries totaled
$14.2 million for the six months ended March 4, 1999,
compared to $9.0 million for the corresponding period of
fiscal 1998. The growth in foreign subsidiary net sales is
primarily the result of additional sales at the Company's
Belgian operation, which began operations in November of
1997. This increase was negatively impacted by a shift from a
turnkey to consignment model at the Belgian facility early in
the second quarter of fiscal 1999.
Gross Profit. Gross profit for the six months ended
March 4, 1999 decreased by $6.4 million, or 36.3%, to $11.2
million from $17.6 million for the six months ended February
26, 1998. Gross margin for the six months ended March 4,
1999 decreased to 5.4% of net sales from 12.1% for the
comparable period ended February 26, 1998. The decrease in
gross profit resulted from lower prices on existing programs,
lower margins on startup programs with new customers,
lower volumes of turnkey custom memory modules and both lower
volumes and prices on consigned memory modules.
Selling, General and Administrative Expenses. SG&A
expenses for the six months ended March 4, 1999 increased by
$4.1 million, or 58.9%, to $11.0 million from $6.9 million
for the six months ended February 26, 1998. This increase
for the six months ended March 4, 1999 was primarily the
result of additional senior management to support future
growth and additional expenses and headcount associated with
operating the Company as a standalone entity following the
Recapitalization. SG&A expenses included a non-cash foreign
currency expense of $0.3 million related to an intercompany
loan between the Company and its Belgian subsidiary
Interest Expense. Interest expense for the six months
ended March 4, 1999 increased to $9.6 million due primarily
to the addition of $175 million in long-term debt issued or
incurred in conjunction with the Recapitalizaton.
Provision for Income Taxes. Income taxes for the six
months ended March 4, 1999 decreased by $6.0 million to a
benefit of $3.9 million from an expense of $2.1 million for
the six months ended February 26, 1998. The Company's
effective income tax rate for its benefit for the first six
months of fiscal 1999 decreased to 37.1% from a provision of
77.1% for the comparable period in fiscal 1998 principally as
a result of certain transaction expenses for which no tax
deduction was allowed in fiscal 1998, offset in part by both
a decrease in the proportion of lower taxed income generated
by the Company's international operations and an increase in
a valuation allowance established in fiscal 1999.
During the six months ended March 4, 1999 the Company
set up a valuation allowance of $0.5 million for the amount
of the deferred tax assets which would not be realized
through either carrying back its net operating losses or
through future income generated by reversal of deferred tax
liabilities during the loss carryforward period.
Extraordinary loss. The extraordinary after tax loss of
the $0.6 million for the six months ended March 4, 1999
resulted from the write-off of deferred financing costs
related to the early retirement of the Company's Revolving
Credit Facility.
Net Income. For the reasons stated above, net income
for the six months ended March 4, 1999 decreased by $7.2
million to a loss of $6.6 million from income of $0.6 million
for the six months ended February 26, 1998. As a percentage
of net sales, net loss for the six months ended March 4, 1999
was 3.2% compared to net income of 0.4% for the six months
ended February 26, 1998.
11
Liquidity and Capital Resources
During the first six months of fiscal 1999, the
Company's cash and cash equivalents decreased by $7.5
million. Net cash consumed by operating activities was $17.0
million. Net cash used by investing activities was $7.5
million and net cash provided by financing activities was
$17.0 million. Net cash used by investing activities during
the first six months of fiscal 1999 primarily consisted of
capital expenditures for additional manufacturing capacity
primarily in the U.S and implementation of the Company's new
enterprise resource planning ("ERP") system. Net cash
generated from financing activities principally resulted from
net borrowings under the Company's existing credit facility.
The $17.0 million of cash consumed by operations was
primarily due to an increase in accounts receivables of $13.9
million and an increase in inventory of $8.7 million during the
six months ended March 4, 1999. The growth in accounts receivables
and inventory related primarily to increased sales. The average
collection period for accounts receivable and the average
inventory turns were 37.2 days and 10.0 turns, respectively,
for the six months ended March 4, 1999 compared to 46.8 days
and 12.4 turns, respectively, for the corresponding period in
fiscal 1998. The average collection period for accounts
receivable and the average inventory turns were 35.6 days and
10.0 turns, respectively, for the three months ended March 4,
1999 compared to 38.5 days and 8.7 turns, respectively, for
the three months ended December 3, 1998. The average
collection period and average inventory turn levels vary,
among other things, as a function of sales volume, sales
volatility, product mix, payment terms with customers and
suppliers and the mix of consigned and turnkey business.
Capital expenditures during the first six months of
fiscal 1999 were $7.5 million, including $5.1 million for
additional manufacturing capacity primarily in the U.S. and
$2.4 million toward the implementation of the ERP system.
The Company anticipates additional capital expenditures of
$1.7 million in fiscal 1999 to complete the ERP system
implementation. See "Year 2000 Readiness Disclosure" and
"Certain Factors-ERP System Implementation."
On February 26, 1999, the Company entered into a $60
million Senior Credit Facility (the "Credit Facility"). The
Credit Facility includes both a $50 million revolving credit
facility and a $10 million facility restricted to the
purchase of qualifying equipment. Amounts available to
borrow under the revolving credit facility vary depending on
accounts receivable and inventory balances, which serve as
collateral along with substantially all of the other assets
of the Company. The Credit Facility contains a covenant
requiring that the Company maintain a fixed charge ratio of
not less than 1.0 to 1.0, provided, however, that this fixed
charge ratio covenant will not be applied to any fiscal
quarter during the term as long as the Company maintains at
all times during such fiscal quarter undrawn availability of
more than $5 million for any such fiscal quarter during the
ninety days following the closing date of the Credit Facility
and $10 million for any month thereafter. As of March 4,
1999, the Company would not have satisfied the requirements
of this fixed charge ratio covenant. As of March 4, 1999,
the Company had $14.1 million, after adjustments required by
the fixed charge ratio covenant, and $10 million available to
borrow under the revolving credit facility and the equipment
loan facility, respectively. As of March 4, 1999, the
Company had a $28.1 million outstanding balance under the
revolving credit facility and no outstanding balance on the
equipment loan facility. See "Notes to Consolidated
Financial Statement--5. Long-term Debt" and "Certain Factors-
- -Restrictions Imposed by Terms of Indebtedness and Redeemable
Preferred Stock".
The Company's principal sources of future liquidity are
cash flows from operating activities and borrowings under the
Credit Facility. The Company is highly leveraged and believes
that these sources should provide sufficient liquidity and
capital resources to meet its current and future interest
payments, working capital and capital expenditures
obligations. No assurance can be given, however, that this
will be the case. See "Certain Factors--High Level of
Indebtedness; Ability to Service Indebtedness and Satisfy
Preferred Stock Dividend Requirements."
Year 2000 Readiness Disclosure
State of Readiness
The Year 2000 presents many issues for the Company
because many computer hardware and software systems use only
the last two digits to refer to a calendar year.
Consequently, these systems may fail to process dates
correctly after December 31, 1999, which may cause system
failures. In October 1997, the Company established a cross
functional team chartered with the specific task of
evaluating all of the Company's software, equipment and
processes for Year 2000 compliance. This team determined
that a substantial portion of the Company's systems,
including its company-wide ERP system, were not Year 2000
compliant and, therefore, developed a plan to resolve this
12
issue which includes, among other things, implementing a new
ERP system. The new ERP system is being implemented across
all of the Company's sites with targeted completion scheduled
in late fiscal 1999. In addition, the Company retained the
services of outside consulting firms to review and assess the
Company's evaluation and implementation plan. The Company
believes that the new ERP system will make all "mission
critical" company information systems Year 2000 compliant.
As part of the Company's Year 2000 compliance
evaluation, the Company recently began contacting key
suppliers and significant customers to determine the extent
to which the Company is exposed to third party failure to
remedy their Year 2000 compliance issues. In order to assist
in these efforts, the Company recently joined a Year 2000
high tech consortium comprised of a number of companies in
the electronics industry. The mission of the consortium is
to provide a framework to facilitate the sharing of
information and practices concerning the Year 2000 readiness
of suppliers as well as develop and utilize standardized
tools and methods to assess, mitigate and plan for potential
Year 2000 disruptions. The Company believes that its efforts
and membership in the high tech consortium will significantly
assist in the Year 2000 assessment of key suppliers and
customers. However, there can be no assurance that such
efforts and membership will adequately protect the Company
from disruptions caused by the failure of some or all of the
Company's key suppliers and customers to be Year 2000
compliant, which could have a material adverse effect on the
Company's business, financial condition and results of
operations.
Costs
The total costs, whether capitalized or expensed,
associated with implementation and system modification
relating to the Year 2000 problem is anticipated to be
approximately $10.1 million, excluding internal programming
time on existing systems. The total amount spent during the
first six months of fiscal 1999 and since inception on this
implementation was $2.4 million and $8.4 million,
respectively, with anticipated expenditures of approximately
$1.7 million during the remainder of fiscal 1999. This
amount includes the costs associated with new systems that
will be Year 2000 compliant even though such compliance was
not the primary reason for installation.
Contingency Plan
Although the Company has no formal contingency plan
related to the ERP implementation at the present time, the
implementation is on schedule with key implementation dates
established and completion is slated for late fiscal 1999.
If the ERP implementation is significantly delayed at any key
implementation date, the Company will develop appropriate
contingency plans. However, there can be no assurance that
the Company will be able to develop contingency plans on a
timely basis, or at all, which could have a material adverse
effect on the Company's business, financial condition and
results of operations.
The Company will be attempting to develop a contingency
plan designed to address problems which might arise from the
failure of the Company's key suppliers and customers to
timely and adequately address Year 2000 issues, which may
include, among other things, duel sourcing the supply of
materials or changing suppliers.
Risks Associated with the Company's Year 2000 Issues
The Company presently believes that by modifying
existing software and converting to new software, such as the
ERP system, the Year 2000 problem will not pose significant
operational problems for the Company's information systems.
However, if such modifications and conversions are not timely
or properly implemented, the Year 2000 problem could affect
the ability of the Company, among other things, to
manufacture product, procure and manage materials, and
administer functions and processes, which could have a
material adverse effect on the Company's business, financial
condition and results of operations. Additionally, failure
of third party suppliers to become Year 2000 compliant on a
timely basis could create a need for the Company to change
suppliers and otherwise impair the sourcing of components,
raw materials or services to the Company, or the
functionality of such components or raw materials, any of
which could have a material adverse effect on the Company's
business, financial condition and results of operations.
In addition, the Company's Year 2000 compliance efforts
have caused significant strain on the Company's information
technology resources and, as a result, could cause the
deferral or cancellation of other important Company projects.
There can be no assurance that the delay or cancellation of
such projects will not have a material adverse effect on the
Company's business, financial condition and results of
operations.
13
CERTAIN FACTORS
In addition to factors discussed elsewhere in this Form
10-Q and in other Company filings with the Securities and
Exchange Commission, the following are important factors
which could cause actual results or events to differ
materially from the historical results of the Company's
operations or those results or events contemplated in any
forward-looking statements made by or on behalf of the
Company.
High Level of Indebtedness; Ability to Service Indebtedness
and Satisfy Preferred Stock Dividend Requirements
The Company is highly leveraged. At March 4, 1999, the
Company had approximately $203.8 million of total
indebtedness outstanding (exclusive of unused commitments of
$24.1 million, after adjustments required by the fixed charge
ratio covenant, under the Credit Facility), and Series
B 12-1/2% Senior Preferred Stock (the "Redeemable Preferred Stock")
outstanding with an aggregate liquidation preference of $28.3
million. The Company may incur additional indebtedness from
time to time to provide for working capital or capital
expenditures or for other purposes, subject to certain
restrictions in (i) the Credit Facility (ii) the
Indenture (the "Indenture") governing the Company's Series B
9-3/4% Senior Subordinated Notes due 2008 and the Series B
Floating Interest Rate Subordinated Term Securities due 2008
(collectively, the "Notes"), (iii) the Certificate of
Designation relating to the Redeemable Preferred Stock (the
"Certificate of Designation") and (iv) the Indenture (the
"Exchange Indenture") governing the 12-1/2% Subordinated
Exchange Debentures (the "Exchange Debentures") due 2010
issuable in exchange for the Redeemable Preferred Stock.
The level of the Company's indebtedness could have
important consequences to the Company and the holders of the
Company's securities, including, but not limited to, the
following: (i) a substantial portion of the Company's cash
flow from operations must be dedicated to debt service and
will not be available for other purposes; (ii) the Company's
ability to obtain additional financing in the future, as
needed, may be limited; (iii) the Company's leveraged
position and covenants contained in the Indenture, the
Certificate of Designation, the Exchange Indenture and the
Credit Facility may limit its ability to grow and make
capital improvements and acquisitions; (iv) the Company's
level of indebtedness may make it more vulnerable to economic
downturns; and (v) the Company may be at a competitive
disadvantage because some of the Company's competitors are
less financially leveraged, resulting in greater operational
and financial flexibility for such competitors.
The ability of the Company to pay cash dividends on, and
to satisfy the redemption obligations in respect of, the
Redeemable Preferred Stock and to satisfy its debt
obligations, including the Notes, will be primarily dependent
upon the future financial and operating performance of the
Company. Such performance is dependent upon the Company's
rate of growth and profitability and the ability of the
Company to manage its working capital effectively, including
its inventory turns and accounts receivable collection
period. The Company may require additional equity or debt
financing to meet its interest payments, working capital
requirements and capital equipment needs. There can be no
assurance that additional financing will be available when
required or, if available, will be on terms satisfactory to
the Company. The Company's future operating performance and
ability to service or refinance the Notes and to repay,
extend or refinance the Credit Facility will be subject to
future economic conditions and to financial, business and
other factors, many of which are beyond the Company's
control. If the Company is unable to generate sufficient cash
flow to meet its debt service obligations or provide adequate
long-term liquidity, it will have to pursue one or more
alternatives, such as reducing or delaying capital
expenditures, refinancing debt, selling assets or raising
equity capital. There can be no assurance that such
alternatives could be accomplished on satisfactory terms, if
at all, or in a timely manner.
Restrictions Imposed by Terms of Indebtedness and Redeemable
Preferred Stock
The Indenture, the Certificate of Designation, the
Exchange Indenture and the Credit Facility contain certain
covenants that restrict, among other things, the ability of
the Company and its subsidiaries to incur additional
indebtedness, consummate certain assets sales and purchases,
issue preferred stock, incur liens, pay dividends or make
certain other restricted payments, enter into certain
transactions with affiliates, merge or consolidate with any
other person or sell, assign, transfer, lease, convey or
otherwise dispose of all or substantially all of the assets
of the Company and its subsidiaries, none of which impaired
the Company's ability to conduct business in the first six
months of fiscal 1999. A breach of any of these covenants
could result in a default under the Credit Facility, the
Indenture and the Exchange Indenture and would violate
certain provisions of the Certificate of Designation. The
Credit Facility contains a covenant requiring that the
Company maintain a fixed charge ratio of not less than 1.0 to
1.0, provided, however, that this fixed charge ratio covenant
will not be applied to any fiscal quarter during the term as
long as the Company maintains at all times during such fiscal
quarter undrawn availability of more than $5 million for any
such fiscal quarter during the ninety days following the
closing date of the Credit Facility and $10 million for any
month thereafter. As of March 4, 1999, the Company would not
have satisfied the requirements of this fixed charge ratio
covenant.
14
In the event the Company is unable to satisfy the
requirements of this fixed charge ratio, the availability of
capital from bank borrowings, including but not limited to
the ability to access the Credit Facility, could be adversely
affected. The inability to borrow under the Credit Facility
could have a material adverse effect on the Company's
business, financial condition and results of operations.
Upon an event of default under the Credit Facility, the
Indenture or the Exchange Indenture, the lenders thereunder
could elect to declare all amounts outstanding thereunder,
together with accrued interest, to be immediately due and
payable. In the case of the Credit Facility, if the Company
were unable to repay those amounts, the lenders thereunder
could proceed against the collateral granted to them to
secure that indebtedness. Such collateral is comprised of
substantially all of the tangible and intangible assets of
the Company, including the capital stock and membership
interests of its subsidiary stock.
Customer Concentration; Dependence on Certain Industries
Certain customers account for significant portions of
the Company's net sales. For the first six months of fiscal
1999 approximately 84.2% of net sales were derived from
networking and telecommunications customers. In addition,
for the second quarter and first six months of fiscal 1999,
the Company's ten largest customers accounted for
approximately 86.1% and 87.2%, respectively, of net sales.
The Company's top two customers accounted for approximately
43.5% and 21.6%, respectively, of net sales in the first six
months of fiscal 1999. In addition, the Company has another
major customer that operates under a consignment manufacturing
model and, while sales are less than 10% of total revenue, the
customer makes an important contribution to the Company's overall
financial performance. Moreover, the Company has significant
customer concentration at a site level. Volatility in demand from
these customers may lead to reduced site capacity utilization
and have a negative effect on the Company's gross margin.
Decreases in sales to or margins with these or any other key
customers could have a material adverse effect on the
Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of
Operations."
The Company expects to continue to depend upon a
relatively small number of customers for a significant
percentage of its net sales. There can be no assurance that
the Company's principal customers will continue to purchase
services at current levels, if at all. The percentage of the
Company's sales to these customers may fluctuate from period-
to-period. Significant reductions in sales to any of the
Company's major customers as well as period-to-period
fluctuations in sales and changes in product mix ordered by
such customers could have a material adverse effect on the
Company's business, financial condition and results of
operations. In addition, in the event the Company were to
lose a key customer at a specific site, the Company may be
forced to reduce its workforce at such site, reallocate
manufacturing demand or close the site, any of which could
have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the Company is dependent upon the continued
growth, viability and financial stability of its OEM
customers, which are in turn substantially dependent on the
growth of the networking, telecommunications, computer
systems and other industries. These industries are subject to
rapid technological change, product obsolescence and price
competition. Many of the Company's customers in these
industries are affected by general economic conditions.
Recent currency devaluations and economic slowdowns in
various Asian economies may have an adverse effect on the
results of operations of certain of the Company's OEM
customers, and in turn, their orders from the Company. These
and other competitive factors affecting the networking,
telecommunications and computer system industries in general,
and the Company's OEM customers in particular, could have a
material adverse effect on the Company's business, financial
condition and results of operations. Moreover, any further
volatility in the market for DRAM components caused by, among
other things, the turmoil in the Asian economies, could have
a material adverse effect on MTI, which has historically been
one of the Company's major customers, and consequently the
Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of
Operations."
15
Variability of Results of Operations
The Company's operations may be affected by a number of
factors including economic conditions, price competition, the
level of volume and the timing of customer orders, product
mix, management of manufacturing processes, materials
procurement and inventory management, fixed asset
utilization, foreign currency fluctuations, the level of
experience in manufacturing a particular product, customer
product delivery requirements, availability and pricing of
components, availability of experienced labor and failure to
introduce, or lack of market acceptance, new processes,
services, technologies and products. In addition, the level
of net sales and gross margin can vary significantly based on
whether certain projects are contracted on a turnkey basis,
where the Company purchases materials, versus on a
consignment basis, where materials are provided by the
customer (turnkey manufacturing tends to result in higher net
sales and lower gross margins than consignment
manufacturing). An adverse change in one or more of these
factors could have a material adverse effect on the Company's
business, financial condition and results of operations.
In addition, customer orders can be canceled and volume
levels can be changed or delayed. From time to time, some of
the Company's customers have terminated their manufacturing
arrangements with the Company, and other customers have
reduced or delayed the volume of design and manufacturing
services performed by the Company. Resolving customer
obligations due to program or relationship termination and
the replacement of canceled, delayed or reduced contracts
with new business cannot be assured. Termination of a
manufacturing relationship or changes, reductions or delays
in orders could have a material adverse effect on the
Company's business, financial condition and results of
operations.
Management of Growth
Expansion has caused, and is expected to cause, strain
on the Company's infrastructure, including its managerial,
technical, financial, information systems and other
resources. To manage further growth, the Company must
continue to enhance financial and operational controls,
develop or hire additional executive officers and other
qualified personnel. Continued growth will also require
increased investments to add manufacturing capacity and to
enhance management information systems. See "Certain
Factors-ERP System Implementation." There can be no
assurance that the Company will be able to scale its internal
infrastructure and other resources to effectively manage
growth and the failure to do so could have a material adverse
effect on the Company's business, financial condition and
results of operations.
The markets served by the Company are characterized by
short product life cycles and rapid technology changes. The
Company's ability to successfully support new product
introductions is critical to the Company's customers. New
product introductions have caused, and are expected to
continue to cause, certain inefficiencies and strain on the
Company's resources. Any such inefficiencies could have a
material adverse effect on the Company's business, financial
condition and results of operations.
New operations, whether foreign or domestic, can require
significant start-up costs and capital expenditures. In the
event that the Company continues to expand its domestic or
international operations, there can be no assurance that the
Company will be successful in generating revenue to recover
start-up and operating costs. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-
- -Results of Operations."
ERP System Implementation
In fiscal 1997, the Company finalized selection of a
company-wide ERP software solution to, among other things,
accommodate the future growth and requirements of the Company
and, in early fiscal 1998, the Company began implementation
of the ERP system. The Company based its selection criteria
on a number of items it deemed critical, and included among
other things, multi-site and foreign currency capabilities,
7x24 hour system availability, enhanced customer
communications, end-order fulfillment and other mix mode
manufacturing support and year 2000 compliance. The Company
began to implement this software in early fiscal 1998 with
completion scheduled in fiscal 1999. There can be no
assurance that the Company will be successful and timely in
its implementation efforts and any delay of such
implementation could have a material adverse affect on the
Company's business, financial condition and results of
operations.
16
Competition
The electronics manufacturing services industry is
intensely competitive and subject to rapid change, and
includes numerous regional, national and international
companies, a number of which have achieved substantial market
share. The Company believes that the primary competitive
factors in its targeted markets are manufacturing technology,
product quality, responsiveness and flexibility, consistency
of performance, range of services provided, the location of
facilities and price. To be competitive, the Company must
provide technologically advanced manufacturing services, high
quality products, flexible production schedules and reliable
delivery of finished products on a timely and price
competitive basis. Failure to satisfy any of the foregoing
requirements could materially and adversely affect the
Company's competitive position. The Company competes directly
with a number of EMS firms, including Celestica International
Holdings Inc., Flextronics International, Ltd., Jabil
Circuits, Inc., SCI Systems, Inc., Sanmina Corporation and
Solectron Corporation. The Company also faces indirect
competition from the captive manufacturing operations of its
current and prospective customers, which continually evaluate
the merits of manufacturing products internally rather than
using the services of EMS providers. Many of the Company's
competitors have more geographically diversified
manufacturing facilities, international procurement
capabilities, research and development and capital and
marketing resources than the Company. In addition, the
Company may be at a competitive disadvantage because some of
the Company's competitors are less financially leveraged,
resulting in, among other things, greater operational and
financial flexibility for such competitors. See "Certain
Factors--High Level of Indebtedness; Ability to Service
Indebtedness and Satisfy Preferred Stock Dividend
Requirements." In recent years, the EMS industry has
attracted new entrants, including large OEMs with excess
manufacturing capacity, and many existing participants have
substantially expanded their manufacturing capacity by
expanding their facilities through both internal expansion
and acquisitions. In the event of a decrease in overall
demand for EMS services, this increased capacity could result
in substantial pricing pressures, which could have a material
adverse effect on the Company's business, financial condition
and results of operations.
Capital Requirements
The Company believes that, in order to achieve its
long-term expansion objectives and maintain and enhance its
competitive position, it will need significant financial
resources over the next several years for capital
expenditures, including investments in manufacturing
capabilities and management information systems, working
capital and debt service. The Company has added significant
manufacturing capacity and increased capital expenditures
since 1995. In April 1995, it opened its Durham, North
Carolina facility. In October 1996, it opened its first
international facility in Penang, Malaysia and moved from its
former Boise, Idaho facility to a new facility in Nampa,
Idaho. In November 1997, it purchased its first European
facility in Colfontaine, Belgium from Alcatel. The Company
anticipates that its capital expenditures will continue to
increase as the Company expands its facilities in Asia and
Europe, invests in necessary equipment to continue new
product production, and continues to invest in new
technologies and equipment to increase the performance and
the cost efficiency of its manufacturing operations. The
precise amount and timing of the Company's future funding
needs cannot be determined at this time and will depend upon
a number of factors, including the demand for the Company's
services and the Company's management of its working capital.
The Company may not be able to obtain additional financing on
acceptable terms or at all. If the Company is unable to
obtain sufficient capital, it could be required to reduce or
delay its capital expenditures and facilities expansion,
which could materially adversely affect the Company's
business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
International Operations
The Company currently offers EMS capabilities in North
America, Asia and Europe. In the second quarter of fiscal
1999, net sales attributable to foreign operations totaled
$7.1 million or 6.1% of total net sales. During the three
months ended March 4, 1999, sales to the Belgian operation's
largest customer shifted from a turnkey to consignment model
and the Malaysian operation continued to have a significant
portion of revenue derived from consignment programs. The
Company may be affected by economic and political conditions
in each of the countries in which it operates and certain
other risks of doing business abroad, including fluctuations
in the value of currencies, import duties, changes to import
and export regulations (including quotas), possible
restrictions on the transfer of funds, employee turnover,
labor or civil unrest, inadequate law enforcement, long
payment cycles, greater difficulty in collecting accounts
receivable, the burdens, cost and risk of compliance with a
variety of foreign laws, and, in certain parts of the world,
political and economic instability. In addition, the
attractiveness of the Company's services to its United States
customers is affected by United States trade policies, such
as "most favored nation" status and trade preferences, which
are reviewed periodically by the United States government.
Changes in policies by the United States or foreign
governments could result in, for example, increased duties,
higher taxation, currency conversion limitations, hostility
toward United States-owned operations, limitations on imports
or exports, or the expropriation of private enterprises, any
of which could have a material adverse effect on the
Company's business, financial condition or results of
operations. The Company's Belgian operations are subject to
labor union agreements covering managerial, supervisory and
production employees, which set standards for, among other
things, the maximum number of working hours and minimum
compensation levels. In addition, economic considerations may
make it difficult for the Company to compete effectively
compared to other lower cost European locations. The
Company's Malaysian operations and assets are subject to
significant political, economic, legal and other
uncertainties customary for businesses located in Southeast
Asia.
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The Company's international operations are based in
Belgium and Malaysia. The functional currencies of the
Company's international operations are the Belgian Franc and
the Malaysian Ringgit. The Company's financial performance
may be adversely impacted by changes in exchange rates
between these currencies and the U.S. dollar. Fixed assets
for the Belgian and Malaysian operations are denominated in
each entity's functional currency and translation gains or
losses will occur as the exchange rate between the local
functional currency and the U.S. dollar fluctuates on each
balance sheet reporting date. The Company's investments in
fixed assets as of March 4, 1999 were $6.1 million (9.1% of
total fixed assets) and $2.8 million (4.1% of total fixed
assets) in Belgium and Malaysia, respectively. The Company's
cumulative translation losses as of March 4, 1999, were $0
million and $2.2 million for the Belgian and Malaysian
operations, respectively. The Company's equity investments in
Belgium and Malaysia are long-term in nature and, therefore,
the translations adjustments are shown as a separate
component of shareholders' equity and do not effect the
Company's net income. An additional risk is that certain
working capital accounts such as accounts receivable and
accounts payable are denominated in currencies other than the
functional currency and may give rise to exchange gains or
losses upon settlement or at the end of any financial
reporting period. Sales in currencies other than the
functional currency were approximately 1.8% and 3.7% of
consolidated sales for the quarter ended March 4, 1999 for
Belgium and Malaysia, respectively. The Company experienced a
non cash transaction loss of $0.8 million for the three
months ended March 4, 1999 primarily related to an
intercompany loan between the Company and its Belgian
subsidiary. During fiscal 1998, the exchange rate between
the Malaysian Ringgit and U.S. dollar was extremely volatile.
In September 1998, the Malaysian government imposed currency
control measures which, among other things, fixed the
exchange rate between the United States dollar and the
Malaysian Ringgit and make it more difficult to repatriate
the Company's investments. In January 1999, the Euro became
the official currency of eleven countries, including Belgium,
and a fixed conversion rate between the Belgium Franc and the
Euro was established. For three years after the introduction
of the Euro, the participating countries can perform
financial transactions in either the Euro or their original
local currencies. This will result in a fixed exchange rate
among the participating countries, whereas the Euro (and the
participating countries' currencies in tandem) will continue
to float freely against the U.S. dollar and other currencies
of non-participating countries. The Company is currently
evaluating the timing of changing the functional currency of
its Belgium operation from the Belgium Franc to the Euro and
is required to finalize this change no later than January
2002. The Company attempts to minimize the impact of
exchange rate volatility by entering into U.S. dollar
denominated transactions whenever possible for purchases of
raw materials and capital equipment and by keeping minimal
cash balances of foreign currencies. Direct labor,
manufacturing overhead, and selling, general and
administrative costs of the international operations are also
denominated in the local currencies. Transaction losses are
reflected in the Company's net income. As exchange rates
fluctuate, the Company will continue to experience
translation and transaction adjustments related to its
investments in Belgium and Malaysia which could have a
material and adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Key Personnel
The Company's continued success depends to a large
extent upon the efforts and abilities of key managerial and
technical employees. The Company's business will also depend
upon its ability to continue to attract and retain qualified
employees. Although the Company has been successful in
attracting and retaining key managerial and technical
employees to date, the loss of services of certain key
employees, in particular, any of its executive officers, or
the Company's failure to continue to attract and retain other
key managerial and technical employees could have a material
adverse effect on the Company's business, financial condition
and results of operations.
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Environmental Regulations
The Company is subject to a variety of environmental
laws and regulations governing, among other things, air
emissions, waste water discharge, waste storage, treatment
and disposal, and remediation of releases of hazardous
materials. While the Company believes that it is currently in
material compliance with all such environmental requirements,
any failure to comply with present and future requirements
could have a material adverse effect on the Company's
business, financial conditions and results of operations.
Such requirements could require the Company to acquire costly
equipment or to incur other significant expenses to comply
with environmental regulations. The imposition of additional
or more stringent environmental requirements, the results of
future testing at the Company's facilities, or a
determination that the Company is potentially responsible for
remediation at other sites where problems are not presently
known, could result in expenditures in excess of amounts
currently estimated to be required for such matters.
Concentration of Ownership
Cornerstone Equity Investors and certain other investors
beneficially own, in the aggregate, approximately 90.0% of
the outstanding capital stock (other than the Redeemable
Preferred Stock) of the Company. As a result, although no
single investor has more than 49.0% of the voting power of
the Company's outstanding securities or the ability to
appoint a majority of the directors, the aggregate votes of
these investors could determine the composition of a majority
of the board of directors and, therefore, influence the
management and policies of the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The Company uses the U.S. dollar as its functional
currency, except for its operations in Belgium and Malaysia.
The Company has evaluated the potential costs and benefits of
hedging potential adverse changes in the exchange rates
between U.S. dollar, Belgian Franc and Malaysian Ringgit.
Currently, the Company does not enter into derivative
financial instruments because a substantial portion of the
Company's sales in these foreign operations are in U.S
dollars. The assets and liabilities of these two operations
are translated into U.S. dollars at an exchange rates in
effect at the period end date. Income and expense items are
translated at the year-to-date average rate. Aggregate
transaction losses included in net income for the second
quarter and first six months of fiscal 1999 were $0.8 million
and $0.3 million, respectively, for the Belgian operation.
There were no transaction losses for the Malaysian operation in
either period.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS
(a): The following are filed as part of this report:
Exhibit Description
10.4 (b) Credit Agreement, dated as of February 26, 1999,
between MCMS, Inc. and PNC Bank, as agent.
27 Financial Data Schedules.
(b): Reports on Form 8-K:
During the second quarter of Fiscal 1999, no reports on Form
8-K were filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed on behalf of the
registrant by the following duly authorized person.
MCMS, Inc.
(Registrant)
Date: April 15, 1999 By: /s/ Chris J. Anton
Vice President, Finance and Chief
Financial Officer (Principal Financial
Officer and Accounting Officer)
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