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 June 3, 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 June 3, 1999: 3,282,427
Shares of Class B Common Stock outstanding at June 3, 1999: 863,823
Shares of Class C Common Stock outstanding at June 3, 1999: 874,999
MCMS, INC.
INDEX
Part I. Page
Item 1 Financial Information
Unaudited Consolidated Balance Sheets -
June 3, 1999 and September 3, 1998 3
Unaudited Consolidated Statements of
Operations - Three and Nine Months Ended 4
June 3, 1999 and May 28, 1998
Unaudited Consolidated Statements of Cash
Flows - Nine Months Ended June 3, 1999
and May 28, 1998 5
Notes to Unaudited Consolidated Financial 6
Statements
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 20
Signatures 21
2
PART I FINANCIAL INFORMATION
- ----------------------------
ITEM 1. FINANCIAL STATEMENTS
MCMS, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
June 3, September 3,
As of 1999 1998
- -----------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,530 $ 7,542
Trade account receivable, net of
allowances for doubtful accounts
of $323 and $97 42,831 34,231
Receivable from affiliates 1,424 2,096
Inventories 45,072 29,816
Deferred income taxes 705 1,255
Other current assets 920 356
------------ ------------
Total current assets 92,482 75,296
Property, plant and equipment, net 66,094 62,106
Other assets
7,070 7,650
------------ ------------
Total assets $ 165,646 $ 145,052
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Current portion of long-term debt $ 448 $ 420
Accounts payable and accrued expenses 55,025 44,433
Payable to affiliates 235 775
Interest payable 4,684 197
------------ ------------
Total current liabilities 60,392 45,825
Long-term debt, net of current portion 202,973 184,737
Deferred income taxes 18 1,286
Other liabilities 618 580
------------ ------------
Total liabilities 264,001 232,428
Redeemable preferred stock, no par value,
750,000 shares authorized; issued and
outstanding 292,060 and 266,313 shares,
respectively; mandatory redemption value
of $29.2 million and $26.6 million,
respectively 28,352 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
3,282,427 and 3,261,177, respectively 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 60,689 63,318
Accumulated other comprehensive loss (2,144) (2,270)
Retained deficit (185,212) (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 (126,707) (113,051)
------------ ------------
Commitments and contingencies - -
Total liabilities and
shareholders' deficit $ 165,646 $ 145,052
============ ============
The accompanying notes are an integral part of the financial statement.
3
MCMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Three months ended Nine months ended
--------------------- ---------------------
June 3, May 28, June 3, May 28,
1999 1999 1999 1998
Net sales $ 110,305 $ 88,565 $ 317,896 $ 234,246
Cost of goods sold 103,917 82,689 300,310 210,781
-------- --------- --------- ---------
Gross profit 6,388 5,876 17,586 23,465
Selling, general
and administrative 5,846 4,405 16,855 11,331
-------- --------- --------- ---------
Income from operations 542 1,471 731 12,134
Other expense:
Interest expense,net 5,023 4,418 14,669 4,088
Transaction expenses - 142 45 8,455
-------- --------- --------- ---------
Loss before taxes and
extraordinary item (4,481) (3,089) (13,983) (409)
Income tax provision (benefit) - (1,052) (3,497) 1,015
-------- --------- --------- ---------
Loss before extraordinary item (4,481) (2,037) (10,486) (1,424)
Extraordinary item-loss on early
extinguishment of debt, net of
tax benefit of $403 - - (617) -
-------- --------- --------- ---------
Net loss (4,481) (2,037) (11,103) (1,424)
Redeemable preferred stock
dividends and accretion of
preferred stock discount (945) (825) (2,678) (825)
-------- --------- --------- ---------
Net loss to common stockholders $ (5,426) $ (2,862) $ (13,781) $ (2,249)
======== ========= ========= =========
Net loss per common share -
basic and diluted:
Loss before extraordinary item$ (1.08) $ (0.57) $ (2.63) $ (1.35)
Extraordinary item - - (0.12) -
-------- --------- --------- ---------
Net loss per share $ (1.08) $ (0.57) $ (2.75) $ (1.35)
======== ========= ========= =========
The accompanying notes are an integral part of the financial statements.
4
MCMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Nine months ended
June 3, May 28,
1999 1998
--------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (11,103) $ (1,424)
Adjustments to reconcile net loss to net cash
provided by (used for) operating activities:
Loss on extinguishment of debt 617 -
Depreciation and amortization 11,609 9,026
Loss (gain) on sale of property, plant and equipment 15 (57)
Write-off of deferred loan costs - 206
Changes in operating assets and liabilities:
Receivables (8,195) (323)
Inventories (15,265) (17,831)
Other assets (1,077) (564)
Accounts payable and accrued expenses 10,477 17,460
Interest payable 4,487 4,211
Deferred income taxes (315) (662)
Other liabilities 22 248
--------- ---------
Net cash provided by (used for) operating activities (8,728) 10,290
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for property, plant and equipment (13,913) (17,548)
Proceeds from sales of property, plant and equipment 11 376
--------- ---------
Net cash used for investing activities (13,902) (17,172)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contributions 48 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 27,897 175,000
Repayments of debt (10,009) (1,513)
Payment of deferred debt issuance costs (1,274) (7,809)
Purchase of treasury stock (50) -
--------- ---------
Net cash provided by financing activities 16,612 3,517
--------- ---------
Effect of exchange rate changes on cash and
cash equivalents 6 (221)
--------- ---------
Net decrease in cash and cash equivalents (6,012) (3,586)
Cash and cash equivalents at beginning of period 7,542 13,636
--------- ---------
Cash and cash equivalents at end of period $ 1,530 $ 10,050
========= =========
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. Other 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
total comprehensive loss, which includes net loss plus other
comprehensive loss, for the third quarter and first nine
months of fiscal 1999 was $4,406,000 and $10,976,000,
respectively. The Company's comprehensive loss was
$1,907,000 and $3,177,000 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
June 3, September 3,
1999 1998
----------- -----------
Raw materials and supplies $ 27,594 $ 18,126
Work in process 16,577 11,020
Finished goods 901 670
----------- -----------
$ 45,072 $ 29,816
=========== ===========
4. Accounts payable and accrued expenses
June 3, September 3,
1999 1998
----------- -----------
Trade accounts payable $ 48,879 $ 39,152
Short-term equipment contracts 868 543
Salaries, wages, and benefits 4,240 3,619
Other 1,038 1,119
----------- -----------
$ 55,025 $ 44,433
=========== ===========
6
5. Long-term Debt
June 3, September 3,
1999 1998
----------- ------------
<s)
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% at September 3, 1998) $ - $ 9,500
Senior credit facility, principal
payments at the Company's option to
February 26, 2004, interest due monthly,
interest rates ranging from 7.19% to
7.75% (7.32% weighted average as of
June 3, 1999) 26,057 -
Senior equipment loan facility, principal
payments at the Company's option to
February 26, 2004, interest due monthly,
8.00% weighted average interest at
June 3, 1999 1,828 -
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 June 3, 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% 283 445
Note payable, monthly installments
through December 26, 1999, interest rate
of 5.95% 253 -
---------- -----------
Total debt 203,421 185,157
Less current portion (448) (420)
---------- -----------
Long-term debt, net of current portion $ 202,973 $ 184,737
========== ===========
On February 26, 1999, the Company entered into a $60 million Senior
Credit Facility which matures on February 26, 2004. The Senior 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 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 Senior Credit Facility includes a quarterly commitment fee of
0.375% per annum based upon the average unused portion and contains customary
covenants such as restrictions on capital expenditures, additional indebtedness
and the payment of dividends. In particular, the Senior 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 undrawn availability of more than $10
million. In addition, if at any time undrawn availability is less than $10
million, the fixed charge ratio will be applied to the immediately preceding
month with respect to the twelve months then ended. The Senior Credit Facility
7
also contains customary events of default. Any default under the Senior Credit
Facility could result in default of the Notes and Redeemable Preferred
Stock, as defined below. As of June 3, 1999, the Company had a $26.1 million
outstanding balance under the revolving credit facility and a $1.8 million
outstanding balance on the equipment loan facility.
On July 13, 1999, the Company amended the Senior Credit Facility (as
amended, the "Credit Facility"). The amendment adds existing equipment to the
borrowing base, modifies the advance rates and raises the maximum amount
available to borrow based on inventory collateral, and allows the full amount
of the credit facility to be drawn without triggering financial covenants if
adequate collateral is available. As of July 13, 1999, the Company had a
$20.2 million outstanding balance under the revolving credit facility and a
$2.1 million outstanding balance on the equipment loan facility. As of
July 13, 1999, the Company had approximately $21 million available to borrow
under the Credit Facility without triggering the fixed charge ratio covenant,
and $7.9 million available to borrow under the equipment loan facility,
respectively. As of July 13, 1999, had the Company consumed its adjusted
availability and been required to test the fixed charge ratio covenant, the
tested would not have been satisfied.
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 begin-
ning 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 Loss Per Share
Basic earnings per share is computed using net loss 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 stock 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 nine months ended
June 3, 1999 and May 28, 1998 is computed based on the weighted average number
of common shares outstanding during each period of 5,014,711, 5,004,903,
5,000,000 and 1,667,333, respectively. The Company's basic earnings per share
and its fully diluted earnings per share were the same for the three and nine
month periods ended June 3, 1999 and May 28, 1998 because of the antidilutive
effect of outstanding convertible securities and stock options.
7. Income Taxes
The effective rate of the tax benefit for the three and nine months
ended June 3, 1999 was none and 26.0%, respectively. The effective tax rate
for fiscal 1999 primarily reflects the statutory corporate income tax rate,
the net effect of state taxation, the effect of a tax holiday granted to the
Company's Malaysian operation and a reduction in the benefit from income taxes
due to the increase in the valuation allowance discussed below. The effective
rate for the corresponding three month period of fiscal 1998 was 34.1%. The
decrease in the effective rate of the tax benefit for the three month period
ended June 3, 1999 relative to the corresponding period of fiscal 1998 was
primarily due to the increase in the valuation allowance discussed below. For
the corresponding nine month period of fiscal 1998 the Company had an income tax
provision of $1.0 million and a pre tax loss of $0.4 million. The difference
between the income tax benefit for the nine months ended June 3, 1999 and the
income tax expense for the corresponding period of 1998 relates to
nondeductible transaction costs related to the Recapitalization, in fiscal
1998, offset in part by an increase in the valuation allowance established
during fiscal 1999. The Company does not provide for U.S. tax on the
earnings of some of its foreign subsidiaries and, therefore, the effective
rate may vary significantly from period to period.
During the three months ended June 3, 1999, the Company increased its
valuation allowance by $2.2 million to a balance of $2.7 million for the
amount of the deferred tax asset which may not be realizable 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
the notes and redeemable preferred stock to redeem a portion of MEIC's
outstanding equity interest for approximately $249.2 million. MEIC continues
to hold 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 June 3, 1999, September 3, 1998 or
May 28, 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 8.0% and 6.2%
of the Company's net sales for the three and nine months ended June 3, 1999,
respectively.
Results of Operations
Three months ended Nine months ended
------------------ ------------------
June 3, May 28, June 3, May 28,
1999 1998 1999 1998
------- -------- --------- -------
Net sales 100.0% 100.0% 100.0% 100.0%
Costs of sales 94.2 93.4 94.5 90.0
------- ------- ------- -------
Gross margin 5.8 6.6 5.5 10.0
Selling, general and
administrative expenses 5.3 4.9 5.3 4.8
------- ------- ------- -------
Income from operations 0.5 1.7 0.2 5.2
Interest expense, net 4.6 5.0 4.6 1.8
Transaction expenses - 0.2 - 3.6
------- ------- ------- -------
Loss before taxes (4.1) (3.5) (4.4) (0.2)
Income tax provision (benefit) - (1.2) (1.1) 0.4
Extraordinary loss - - (0.2) -
------- ------- ------- -------
Net loss (4.1)% (2.3)% (3.5)% (0.6)%
======= ======= ======= =======
Depreciation and
amortization (1) 3.6% 4.0% 3.4% 3.9%
======= ======= ======= =======
(1) For the three and nine months ended June 3, 1999, the depreciation
and amortization amount excludes $234,000 and $700,000, respectively,
of deferred loan amortization that was expensed as interest.
9
Three Months Ended June 3, 1999 Compared to Three Months Ended May 28, 1998
Net Sales. Net sales for the three months ended June 3, 1999 increased
by $21.7 million, or 24.5%, to $110.3 million from $88.6 million for the
three months ended May 28, 1998. The increase in net sales is primarily the
result of higher volumes of PCBA and system level shipments to customers in
the networking and telecommunications industries. These increases were
partially offset by lower PCBA and system level prices, lower volumes and
prices on custom turnkey memory modules and lower prices on consigned memory
modules.
Net sales attributable to foreign subsidiaries totaled $8.4 million for
the three months ended June 3, 1999, compared to $6.0 million for the
corresponding period of fiscal 1998. The growth in foreign subsidiary net
sales is primarily the result of higher volumes of PCBA shipments in
both Malaysia and Belgium. This increase was negatively impacted by a shift
from a turnkey to consignment model with the Company's largest customer at the
Belgian facility early in the second quarter of fiscal 1999.
Gross Profit. Gross profit for the three months ended June 3, 1999
increased by $0.5 million, or 8.7%, to $6.4 million from $5.9 million for the
three months ended May 28, 1998. Gross margin for the three months ended
June 3, 1999 decreased to 5.8% of net sales from 6.6% for the comparable
period ended May 28, 1998. The increase in gross profit resulted primarily
from increased sales at the Nampa, Malaysian and Belgian facilities partially
offset by lower sales and increased demand volatility at the Durham facility.
The Company's gross margin declined due to an increase in volume of PCBA
sales accompanied by lower prices, lower prices on consigned memory modules and
increased system level shipments, which typically have lower margins.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") for the three months ended June 3, 1999
increased by $1.4 million, or 32.7%, to $5.8 million from $4.4 million for the
three months ended May 28, 1998. This increase for the three months ended
June 3, 1999 was primarily the result of expenses associated with additional
senior management to support future growth, additional program management
personnel and additional expenses and headcount associated with the Company
operating as a stand alone entity following the Recapitalization. SG&A
expenses included a non-cash foreign currency expense of $0.4 million for the
three months ended June 3, 1999 primarily related to an intercompany loan
between the Company and its Belgian subsidiary.
Interest Expense. Interest expense for the three months ended
June 3, 1999 increased by $0.6 million, or 13.7%, to $5.0 million from
$4.4 million for the three months ended May 28, 1998 due principally to
additional borrowings on the Company's Credit Facility.
Provision for Income Taxes. There was no income tax expense or benefit
for the three months ended June 3, 1999 compared to a benefit of $1.1 million
for the three months ended May 28, 1998. There was no effective rate for the
three months ended June 3, 1999, as compared to 34.1% for the corresponding
period of fiscal 1998. The decrease in the effective rate of the tax benefit
during the three months ended June 3, 1999 relative to the corresponding
period of fiscal 1998 was primarily due to an increase in the valuation
allowance eliminating any income tax benefit for the three months ended
June 3, 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.
Net Loss. For the reasons stated above, the net loss for the three
months ended June 3, 1999 increased by $2.4 million to $4.5 million from
$2.0 million for the three months ended May 28, 1998. As a percentage of
net sales, net loss for the three months ended June 3, 1999 was 4.1%
compared to 2.3% for the three months ended May 28, 1998.
Nine Months Ended June 3, 1999 Compared to Nine Months Ended May 28, 1998
Net Sales. Net sales for the nine months ended June 3, 1999 increased
by $83.7 million, or 35.7%, to $317.9 million from $234.2 million for the
nine months ended May 28, 1998. The increase in net sales is primarily the
result of higher volumes of PCBA and system level shipments to customers in
the networking and telecommunications industries. These increases were
partially offset by lower PCBA prices, lower volumes and prices of custom
turnkey memory modules, and lower prices on consigned memory modules.
Net sales attributable to foreign subsidiaries totaled $22.6 million for
the nine months ended June 3, 1999, compared to $15.1 million for the
corresponding period of fiscal 1998. The growth in foreign subsidiary net sales
is primarily the result of additional sales of PCBA shipments at the
Company's Malaysian operation. This increase was partially offset by lower
volumes of custom turnkey memory modules at the Malaysian facility and by a
shift from a turnkey to consignment model at the Belgian facility early in
the second quarter of fiscal 1999.
10
Gross Profit. Gross profit for the nine months ended June 3, 1999
decreased by $5.9 million, or 25.1%, to $17.6 million from $23.5 million for
the nine months ended May 28, 1998. Gross margin for the nine months ended
June 3, 1999 decreased to 5.5% of net sales from 10.0% for the comparable
period ended May 28, 1998. The decrease in gross profit and margin resulted
primarily from increased demand volatility at the Durham facility and higher
volumes of PCBA sales with lower average selling prices, lower prices on
consigned memory modules, a decline in custom turnkey memory module sales
at the Nampa and Malaysian facilities and increased system level shipments,
which typically have lower margins.
Selling, General and Administrative Expenses. SG&A expenses for the
nine months ended June 3, 1999 increased by $5.5 million, or 48.8%, to
$16.9 million from $11.3 million for the nine months ended May 28, 1998.
This increase for the nine months ended June 3, 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 stand alone
entity following the Recapitalization. SG&A expenses included a non-cash
foreign currency expense of $0.7 million related to an intercompany loan
between the Company and its Belgian subsidiary
Interest Expense. Interest expense for the nine months ended
June 3, 1999 increased to $14.7 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 nine months ended
June 3, 1999 decreased by $4.9 million to a benefit of $3.9 million from an
expense of $1.0 million for the nine months ended May 28, 1998. The Company's
effective income tax rate for its benefit for the first nine months of
fiscal 1999 was 26.0%. For the corresponding nine month period of fiscal 1998
the Company had an income tax provision of $1.0 million and a pre tax loss of
$.4 million. The difference between the income tax benefit for the nine months
ended June 3, 1999 and the income tax expense for the corresponding period of
1998 relates to nondeductible transaction costs related to the Recapitalization,
in fiscal 1998, offset in part by an increase in the valuation allowance
established during fiscal 1999.
During the nine months ended June 3, 1999, the Company set up a valuation
allowance of $2.7 million for the amount of the deferred tax asset which may
not be realizable 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 nine months ended June 3, 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, net loss for the nine months
ended June 3, 1999 increased by $9.7 million to a loss of $11.1 million from a
loss of $1.4 million for the nine months ended May 28, 1998. As a percentage
of net sales, net loss for the nine months ended June 3, 1999 was 3.5%
compared to 0.6% for the nine months ended May 28, 1998.
Liquidity and Capital Resources
During the first nine months of fiscal 1999, the Company's cash and cash
equivalents decreased by $6.0 million. Net cash consumed by operating
activities was $8.7 million. Net cash used by investing activities was $13.9
million and net cash provided by financing activities was $16.6 million. Net
cash used by investing activities during the first nine 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 Credit
Facility.
The $8.7 million of cash consumed by operations was primarily due to an
increase in accounts receivable of $8.2 million and an increase in inventory of
$15.3 million during the nine months ended June 3, 1999. The growth in accounts
receivables related primarily to increased sales. The inventory increase
related to increased sales and, to a lessor extent, an end of quarter delay
related to supplier delivery of key components and the transition from legacy
material software to the new ERP software. The average collection period for
accounts receivable and the average inventory turns were 36.9 days and 9.9
turns, respectively, for the nine months ended June 3, 1999 compared to 43.6
days and 11.5 turns, respectively, for the corresponding period in fiscal
1998. The average collection period for accounts receivable and the average
inventory turns were 39.0 days and 10.0 turns, respectively, for the three
months ended June 3, 1999 compared to 35.6 days and 10.0 turns, respectively,
for the three months ended March 4, 1998. The average collection period and
average inventory turn levels vary, among other things, as a function of sales
11
volume, sales volatility, product mix, payment terms with customers and
suppliers and the mix of consigned and turnkey business.
Capital expenditures during the first nine months of fiscal 1999 were
$13.9 million, including $9.8 million for additional manufacturing capacity
primarily in the U.S. and $4.1 million toward the implementation of the ERP
system. The Company anticipates additional capital expenditures of $0.9
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 which matures on February 26, 2004. The Senior 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 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 Senior Credit Facility includes a quarterly commitment fee of 0.375% per
annum based upon the average unused portion and contains customary covenants
such as restrictions on capital expenditures, additional indebtedness and the
payment of dividends. In particular, the Senior 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 undrawn availability of more than $10 million.
In addition, if at any time undrawn availability is less than $10 million, the
fixed charge ratio will be applied to the immediately preceding month with
respect to the twelve months then ended. The Senior Credit Facility also
contains customary events of default. Any default under the Senior Credit
Facility could result in default of the Notes and Redeemable Preferred
Stock, as defined below. As of June 3, 1999, the Company had a $26.1 million
outstanding balance under the revolving credit facility and a $1.8 million
outstanding balance on the equipment loan facility.
On July 13, 1999, the Company amended the Senior Credit Facility
(as amended, the "Credit Facility"). The amendment adds existing equipment
to the borrowing base, modifies the advance rates and raises the maximum
amount available to borrow based on inventory collateral, and allows the full
amount of the credit facility to be drawn without triggering financial
covenants if adequate collateral is available. As of July 13, 1999, the
Company had a $20.2 million outstanding balance under the revolving credit
facility and a $2.1 million outstanding balance on the equipment loan facility.
As of July 13, 1999, the Company had approximately $21 million available to
borrow under the Credit Facility without triggering the fixed charge ratio
covenant, and $7.9 million available to borrow under the equipment loan
facility, respectively. As of July 13, 1999, had the Company consumed its
adjusted availability and been required to test the fixed charge ratio
covenant, the tested would not have been satisfied. 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
12
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
issue which includes, among other things, implementing a new ERP system. The
Company substantially completed implementation of this software in its US
facilities late in the third quarter of fiscal 1999 with completion scheduled
for the Company's Malaysian facility early in the fourth quarter of fiscal
1999 and the Belgian facility in late 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 and operational
systems Year 2000 compliant.
As part of the Company's Year 2000 compliance evaluation, the Company
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
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 $11.4 million, excluding internal programming
time on existing systems. The total amount spent during the first nine months of
fiscal 1999 and since inception on this implementation was $4.4 million and
$10.2 million, respectively, with anticipated expenditures of approximately
$1.2 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 other areas of the Company affected by the Year 2000 problem, including
problems which might arise from the failure of the Company's key suppliers and
customers to timely and adequately address Year 2000 issues. Contingency plans
with respect to supplier Year 2000 problems may include, among other things,
dual 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.
While the Company believes the ERP implementation has been successful the
Company has encountered, and expects to continue to encounter, certain
operational issues, which it expects to resolve shortly. 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
13
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.
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 June 3, 1999, the Company had
approximately $203.4 million of total indebtedness outstanding, and Series B
12-1/2% Senior Preferred Stock (the "Redeemable Preferred Stock") outstanding
with an aggregate liquidation preference of $29.2 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 Senior 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
14
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
nine 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 undrawn availability of more
than $10 million. As of July 13, 1999, had the Company consumed its adjusted
availability and been required to test the fixed charge ratio covenant, the
tested would not have been satisfied.
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 nine months of fiscal 1999 approximately 83.7% of net
sales were derived from networking and telecommunications customers. In
addition, for the third quarter and first nine months of fiscal 1999, the
Company's ten largest customers accounted for approximately 88.0% and 87.3%,
respectively, of net sales. The Company's top two customers accounted for
approximately 44.5% and 20.5%, respectively, of net sales in the first nine
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 opera-
tions. 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 con-
dition 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 technologi-
cal change, product obsolescence and price competition. Many of the
Company's customers in these industries are affected by general economic
conditions. Currency devaluations and economic slowdowns in various Asian
and European economies may have an adverse effect on the results of operations
15
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."
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 and plant 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."
16
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 substantially
completed implementation of this software in its US facilities late in the
third quarter of fiscal 1999 with completion scheduled for the Company's
Malaysian facility early in the fourth quarter of fiscal 1999 and the Belgian
facility in late 1999. While the Company believes the ERP implementation has
been successful the Company has encountered, and expects to continue to encoun-
ter, certain operational issues, which it expects to resolve shortly. There
can be no assurance that the Company will be successful and timely in its
implementation efforts and any delay of, or problems associated with, such
implementation could have a material adverse affect on the Company's business,
financial condition and results of operations.
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 target-
ed 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 manage-
ment 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. In June 1999, the Company announced that
it would move its Penang, Malaysia facility from the original 18,000 square foot
facility into an 118,000 square foot facility by September of 1999. 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
17
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 third quarter of fiscal 1999, net sales attributable to foreign
operations totaled $8.4 million or 7.6% of total net sales. 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.
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 June 3, 1999 were $5.8 million
(8.7% of total fixed assets) and $4.6 million (7.0% of total fixed assets) in
Belgium and Malaysia, respectively. As of June 3, 1999, the Company's $2.1
million net cumulative translation loss was comprised of a $2.2 million
cumulative translation loss for the Malaysian operation offset by a $0.1
million cumulative translation gain for the Belgian operation. The Company's
equity investments in Belgium and Malaysia are long-term in nature and, there-
fore, the translation 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 1.0% and 6.0% of consolidated
sales for the quarter ended June 3, 1999 for Belgium and Malaysia, respective-
ly. 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 Belgian 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
Belgian operation from the Belgian Franc to the Euro and is required to
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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.
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 poten-
tial 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 sub-
stantial 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 third quar-
ter and first nine months of fiscal 1999 were $0.4 million and $0.7 million, re-
spectively, for the Belgian operation. There were no transaction losses for the
Malaysian operation in either period.
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PART II OTHER INFORMATION
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ITEM 6. EXHIBITS
(a) The following are filed as part of this report:
Exhibit Description
10.17(a) Lease, dated as of June 18, 1999, by and between MCMS, Sdn.
Bhd. and Klih Project Management, Sdn. Bhd.
10.4 (c) First Amendment, dated as of July 13, 1999,
to Credit Agreement, dated as of February 26, 1999,
among MCMS, Inc., PNC Bank, as agent, and various
lending institutions.
27 Financial Data Schedules.
(b) Reports on Form 8-K:
During the third 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: July 16, 1999 /s/ Chris J. Anton
Vice President, Finance and Chief
Financial Officer (Principal Financial
Officer and Accounting Officer)
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