-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L/pEJQPs8kaxwryTweejSEXclB8H656MGgMrFqYF8CmqVfpJ0rs51otcpGJN8BnV luYmc1zYFQjsZp3npFXm7A== 0000835541-98-000008.txt : 19981116 0000835541-98-000008.hdr.sgml : 19981116 ACCESSION NUMBER: 0000835541-98-000008 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980828 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOLECTRON CORP CENTRAL INDEX KEY: 0000835541 STANDARD INDUSTRIAL CLASSIFICATION: PRINTED CIRCUIT BOARDS [3672] IRS NUMBER: 942447045 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-11098 FILM NUMBER: 98747145 BUSINESS ADDRESS: STREET 1: 847 GIBRALTAR DR CITY: MILPITAS STATE: CA ZIP: 95035 BUSINESS PHONE: 4089578500 MAIL ADDRESS: STREET 1: 847 GIBRALTAR DR CITY: MILPITAS STATE: CA ZIP: 95035 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. ______________________ FORM 10-K ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ______________________________________________ Mark One [x] Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [Fee Required] For the Fiscal Year Ended August 28, 1998, or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 [No Fee Required] For the Transition Period From ____________ to ____________ Commission File Number 1-11098 SOLECTRON CORPORATION (Exact name of registrant as specified in its charter) Delaware 94-2447045 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 777 Gibraltar Drive, Milpitas, California 95035 (Address of principal executive offices and Zip Code) Registrant's telephone number, including area code: (408) 957-8500 Securities registered pursuant to Section 12(b) of the Act: Common Stock traded on New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Common Stock 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 report(s), and (2) has been subject to such filing requirements for the past 90 days. YES __X__ NO _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Registrant's Common Stock held by non- affiliates on October 31, 1998 (based upon the last reported price of the Common Stock on the New York Stock Exchange on such date) was approximately $4,220 million. As of October 31, 1998, there were approximately 118,587,395 shares of the Registrant's Common Stock outstanding. 1 DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 12, 1999, which the Company will file with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this report, is incorporated by reference in Part III of this Form 10-K to the extent stated herein. 2 SOLECTRON CORPORATION 1998 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS Page Part I Item 1. Business 4 Item 2. Properties 13 Item 3. Legal Proceedings 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 15 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 33 Item 8. Financial Statements and Supplementary Data 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 58 Part III Item 10. Directors and Executive Officers of the Registrant 59 Item 11. Executive Compensation 62 Item 12. Security Ownership of Certain Beneficial Owners and Management 62 Item 13. Certain Relationships and Related Transactions 62 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 63 Signatures 64 Solectron and the Solectron logo are registered trademarks of Solectron Corporation. All other names are trademarks and/or registered trademarks of their respective owners. 3 PART I ITEM 1: SOLECTRON BUSINESS Solectron Corporation (the Company or Solectron) is an independent provider of customized manufacturing services to electronics original equipment manufacturers (OEMs). Solectron provides a wide variety of pre-manufacturing, manufacturing and post-manufacturing services. Solectron's goal is to offer its customers the significant competitive advantages that can be obtained from manufacturing outsourcing such as access to advanced manufacturing technologies, shortened product time- to-market, reduced cost of production and more effective asset utilization. Solectron has manufacturing operations in locations throughout the world, including North America, Europe, the Asia/Pacific region and Brazil. Solectron believes that the geographically diverse locations of its facilities enable it to build closer regional relationships with its customers and to better meet its customers' cost and local market content requirements. Solectron Corporation was originally incorporated in California in August 1977 and reincorporated in Delaware in February 1997. Solectron's corporate headquarters are located at 777 Gibraltar Drive, Milpitas, California 95035. Its telephone number is (408) 957-8500 and its Internet address is www.Solectron.com. The information contained within this overview of the business is qualified in its entirety by, and is subject to, the detailed information, consolidated financial statements and notes thereto contained elsewhere within this document under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Financial Statements and Supplementary Data". Industry Overview Solectron is benefiting from increased worldwide market acceptance of, and reliance upon, the use of manufacturing specialists by many electronics OEMs. Solectron believes the trend towards outsourcing manufacturing will continue. OEMs utilize manufacturing specialists for many reasons including the following: Reduce Time to Market. Due to intense competitive pressures in the electronics industry, OEMs are faced with increasingly shorter product life-cycles and therefore have a growing need to reduce the time required to bring a product to market. OEMs can reduce their time to market by using a manufacturing specialist's manufacturing expertise and infrastructure. Reduce Investment. As electronic products have become more technologically advanced and are shipped in greater unit volumes, the necessary investment required for internal manufacturing has increased significantly for working capital, capital equipment, labor, systems and infrastructure. Use of manufacturing specialists enables OEMs to gain access to advanced manufacturing capabilities while substantially reducing overall resource requirements. Focus Resources. Because the electronics industry is experiencing greater levels of competition and more rapid technological change, many OEMs increasingly are seeking to focus their resources on activities and technologies in which they add the greatest value. By offering comprehensive electronics assembly and related manufacturing services, 4 manufacturing specialists allow OEMs to focus on their own core competencies such as product development and marketing. Access Leading Manufacturing Technology. Electronic products and electronics manufacturing technology have become increasingly sophisticated and complex, making it difficult for OEMs to maintain the necessary technological expertise to manufacture products internally. OEMs are motivated to work with a manufacturing specialist in order to gain access to the specialist's expertise in interconnect, test and process technologies. Improve Inventory Management and Purchasing Power. Electronics industry OEMs are faced with increasing difficulties in planning, procuring and managing their inventories efficiently due to frequent design changes, short product life-cycles, large investments in electronic components, component price fluctuations and the need to achieve economies of scale in materials procurement. OEMs can reduce production costs by using a manufacturing specialist's volume procurement capabilities. In addition, a manufacturing specialist's expertise in inventory management can provide better control over inventory levels and increase the OEM's return on assets. Access Worldwide Manufacturing Capabilities. OEMs are increasing their international activities in an effort to lower costs and access foreign markets. Manufacturing specialists with worldwide capabilities are able to offer such OEMs a variety of manufacturing location options to better address their objectives regarding cost, shipping location, frequency of interaction with manufacturing specialists and local content requirements of end-market countries. Strategy Solectron's goal is to offer its customers the significant competitive advantages of manufacturing outsourcing, such as access to advanced manufacturing technologies, shortened product time-to-market, lowest landed cost and more effective asset utilization. To achieve this goal Solectron's strategy emphasizes the following key elements: Quality. Solectron believes that product quality is a critical success factor in the electronics manufacturing market. Solectron strives for continuous improvement of its processes and has adopted a number of quality improvement and measurement techniques to monitor its performance. Solectron has received numerous superior service and quality awards, including the Malcolm Baldrige National Quality Award in 1991 and again in 1997, the Best Manufacturing Plant in North America Award from Industry Week in 1998, the North Carolina Quality Leadership Award in 1996, Malaysian Quality Management Excellence Award in 1996 as well as the Malaysian Prime Minister's Quality Award in 1997, the Texas Quality Award in 1996 and numerous awards from its customers. All of Solectron's manufacturing facilities, except for Fine Pitch Technology, Inc. and the recently-established facility in Romania, are certified under ISO-9000 standards, which are international quality standards for design, manufacturing and distribution management systems. Manufacturing Partnerships. An important element of Solectron's strategy is to establish partnerships with major and emerging OEM leaders in diverse segments across the electronics industry. Solectron's customer base consists of leaders in industry segments such as networking, telecommunications, workstations, personal computers, computer peripherals, instrumentation, semiconductor equipment and avionics. Due to the costs inherent in supporting customer 5 relationships, Solectron focuses its efforts on customers with which the opportunity exists to develop long-term business partnerships. Solectron's goal is to provide its customers with total manufacturing solutions for both new and more mature products, as well as across product generations. Solectron's manufacturing services range from providing design and New Product Introduction services, to just-in-time delivery on low to medium volume turnkey and consignment projects and projects that require more value-added services, to servicing OEMs that require price-sensitive, high-volume production. Turnkey Capabilities. Another element of Solectron's strategy is to provide a complete range of manufacturing management and value-added services, including materials management, board design, concurrent engineering, assembly of complex printed circuit boards and other electronic assemblies, test engineering, software manufacturing, accessory packaging and post-manufacturing services. Solectron believes that as manufacturing technologies become more complex and as product life-cycles shorten, OEMs will increasingly contract for manufacturing on a turnkey basis as they seek to reduce their time to market and capital asset and inventory costs. A substantial portion of Solectron's revenue is from its turnkey business. Solectron believes that the ability to manage and support large turnkey projects is a critical success factor and a significant barrier to entry for the market it serves. In addition, Solectron believes that due to the difficulty and long lead-time required to change manufacturers, turnkey projects generally increase an OEM's dependence on its manufacturing specialist, resulting in greater stability of Solectron's customer base and in closer working relationships. Solectron has been successful in establishing sole source positions with many of its customers for certain of their products. Advanced Manufacturing Process Technology. Solectron intends to continue to offer its customers the most advanced manufacturing process technologies, including surface mount technology (SMT) and ball-grid array (BGA) assembly and testing and emerging interconnect technologies. Solectron has developed substantial SMT expertise including advanced, vision-based component placement equipment. Solectron believes that the cost of SMT assembly facilities and the technical capability required to operate a high-yield SMT operation are significant competitive factors in the market for electronic assembly. Solectron also has the capability to manufacture using tape-automated-bonding, chip-on-substrate and other more advanced manufacturing processes. Diverse Geographic Operations. An important element of Solectron's strategy is to establish production facilities in areas of high customer density or where manufacturing efficiencies can be achieved. Solectron currently has operations throughout the United States and in Mexico, Brazil, Europe and Asia. Solectron believes that its facilities in these diverse geographic locations enable Solectron to better address its customers' objectives regarding cost, shipping location, frequency of interaction with manufacturing specialists and local content requirements of endmarket countries. In addition, Solectron has its Asia/Pacific headquarters office in Taipei, Taiwan, and program offices in Japan and Israel. Solectron intends to continue to expand its operations as necessary to continue to serve its existing customers and to develop new business. 6 International Manufacturing Capability Western United States. Solectron's headquarters and largest manufacturing operations are located in Silicon Valley, principally in Milpitas, California, in the midst of one of the largest concentrations of OEM electronics manufacturers. This facility offers a full range of services that span the product life cycle, including printed circuit board and systems design and prototyping; printed circuit board assembly; build-to-order, configure-to-order and complex systems assembly; end-of-life manufacturing; and depot repair. In addition, Solectron has a smaller site strategically located in Everett, Washington to help serve Solectron's customers in the Pacific Northwest and elsewhere. The Company's subsidiary, Force Computers, Inc. (Force), is a leading designer and supplier of open, scalable system- and board-level embedded computer platforms for the telecomunications, industrial and command and control markets. Unlike general purpose computers, embedded computers are incorporated into systems and equipment to perform a single or limited number of critical control functions and are generally integrated into larger automated systems. A processor independent company, Force delivers products based on SPARC, Pentium, PowerPC and 68K technologies and has expertise in system design, board design, system integration and manufacturing. Force also provides support services, such as system configurations, application consulting and training to its customers. Force further enhances the Company's array of services, particularly in pre-manufacturing areas. Force's corporate headquarters are located in San Jose, California. Its European headquarters are located in Munich, Germany. In addition to its headquarters locations, Force has sales support offices located throughout the United States and in various international locations. Another of the Company's subsidiaries, Fine Pitch Technology, Inc. (Fine Pitch), is also headquartered in San Jose, California. Fine Pitch provides extensive prototype services for electronics OEMs, further enhancing Solectron's ability to address the needs of design teams who require almost immediate availability of highly complex prototype assemblies. Southwestern United States. Solectron believes that its facility in Austin, Texas is situated in a geographic region with strong growth of electronics OEMs that will allow Solectron to better service its existing customers and to attract new ones. This facility, which has recently completed a major expansion, offers a full range of integrated solutions that span the product life cycle, from complex ASIC circuit design to printed circuit board and systems assembly and fulfillment to end-of-life services. Eastern United States. The Company's Eastern United States facility is located in Westborough, Massachusetts, near Boston, in the center of a geographic region with a large concentration of electronics OEMs. This facility offers circuit design services, printed circuit board and complex systems assembly and end-of-life manufacturing. The facility is located adjacent to a Fine Pitch site that specializes in quick-turn prototype services. The two groups work together to shorten customers' product development and manufacturing cycles, ultimately reducing their products' time-to-market. Southeastern United States. Solectron's Southeastern United States operations are located in Charlotte, North Carolina, Columbia, South Carolina and Duluth and Braselton, Georgia. The Company's operations in 7 Charlotte, North Carolina, which were recently augmented by the acquisition of International Business Machine Corporation's (IBM) Electronic Card Assembly and Test (ECAT) manufacturing assets, specializes in low- to medium-volume, highly complex printed circuit board assembly. This site also provides printed circuit boards to the Columbia, South Carolina site, which specializes in customized systems design services and complex computer systems assembly. The facility in Duluth, Georgia is Solectron's East Coast center for build-to-order and configure-to-order systems assembly. The facility in Braselton, Georgia was acquired from Mitsubishi Consumer Electronics America, Inc. (MCEA), a subsidiary of Mitsubishi Electric Corporation, in October 1998 and will provide a full range of manufacturing services to MCEA's Cellular Mobile Telephone division. The Company expects to merge the two Georgia locations into a new facility in Suwanee, Georgia during fiscal 1999. The locations in Columbia, South Carolina and Duluth, Georgia were recently acquired from NCR Corporation. Solectron believes that these facilities allow it to better pursue new business opportunities with new and existing customers having Southeastern United States operations, in particular because of Charlotte's status as a transportation hub and its relative proximity to major Southeastern United States electronics markets. Mexico. Solectron's site in Guadalajara, Mexico began providing a full range of printed circuit board assembly and systems build manufacturing services in the first quarter of fiscal 1998. This site was established to offer customers a low-cost, high volume manufacturing facility in North America. Brazil. Solectron's manufacturing operation in Sao Paulo, Brazil was acquired from Ericsson Telecom AB's Business Area Infocom Systems (Ericsson) in October 1997. This site provides full systems build capabilities, engineering, printed circuit board and flex assembly, custom packaging and distribution services, primarily to multinational customers seeking access to the Latin American market. Europe. Solectron has manufacturing operations in Bordeaux, France, Herrenberg, Germany, Dublin, Ireland, Timisoara, Romania and Dunfermline, Scotland. Each of these sites provides a full range of manufacturing capabilities to a multinational customer base. In addition, each site is developing an area of specific expertise to offer to all customers. The facility in France is the site of choice for depot repair in Europe, partly because of its centralized location, and also serves as a New Product Introduction Center. Germany offers design support, prototype services and low-volume, high-mix manufacturing services. In addition, Force's European headquarters are located in Munich, Germany. The Ireland facility provides systems design, build-to- order, configure-to-order and complex systems assembly. Romania provides a low-cost, high-volume manufacturing center for the European region. Scotland specializes in building printed circuit board assemblies, subassemblies and systems for multinational customers seeking entry into the European market. The Company also has a New Product Introduction Center in Sweden, which offers a full range of electronics product development services, including design and layout, concurrent engineering, test development and prototype engineering. Asia. Solectron's Southeast Asia manufacturing operations are located in Penang and Johor, Malaysia. The operations were established to better serve the needs of OEMs requiring price-sensitive, high-volume production capabilities and to provide more efficient manufacturing services to customers located in Southeast Asia. The facilities currently provide electronics assembly, materials management and other 8 services to customers located in Malaysia, Singapore, Japan, the United States and other locations. Solectron's facility in Suzhou, China began operations in fiscal 1997. This facility currently provides a full range of low-cost high volume manufacturing services. New Product Introduction Center. The Company's New Product Introduction (NPI) Center, is located in Sweden. The NPI Center offers a full range of electronics product development services, including design and layout, concurrent engineering, test development and prototype engineering. Alliance with Ingram Micro Inc. In October 1998, the Company announced that it had signed a definitive agreement with Ingram Micro Inc. under which the two companies will enter into a strategic alliance to provide global build-to-order and configure-to-order assembly services for personal computers, servers and related products in the United States, Canada, Europe, Asia and Latin America. The alliance will be managed by both companies under a joint management matrix that will include a sales and marketing staff, program management, information technology resources and test and process engineers and will, in most part, utilize existing facilities, systems and personnel. The companies expect that shipments to customers will begin in early calendar 1999. As Solectron manages the existing operations and expands geographically, it may experience certain inefficiencies from the management of geographically dispersed operations. In addition, Solectron's results of operations will be adversely affected if these new facilities do not achieve revenue growth sufficient to offset increased expenditures associated with geographic expansion. In fiscal 1998, approximately 33.8% of Solectron's sales were from operations outside of the United States. As a result of continuous customer demand overseas, Solectron expects foreign sales to increase. Solectron's foreign sales and operations are subject to risks of doing business abroad, including fluctuations in the value of currency, export duties, import controls and trade barriers (including quotas), restrictions on the transfer of funds, associate turnover, work stoppages, longer payment cycles, greater difficulty in accounts receivable collection, burdens of complying with a wide variety of foreign laws and, in certain parts of the world, political instability. While to date these factors have not had an adverse material impact on Solectron's results of operations, there can be no assurance that there will not be such an impact in the future. Manufacturing Solectron's Approach To achieve excellence in manufacturing, Solectron combines advanced manufacturing technology, such as computer-aided manufacturing and testing, with manufacturing techniques including just-in-time manufacturing, total quality management, statistical process control and continuous flow manufacturing. Just-in-time manufacturing is a production technique which minimizes work-in-process inventory and manufacturing cycle time while enabling Solectron to deliver products to customers in the quantities and time frame required. Total quality management is a management philosophy which seeks to impart high levels of quality in every operation of Solectron and is accomplished by the setting of quality objectives for every operation, tracking performance against those objectives, identifying work flow and policy changes required to achieve higher quality levels and a commitment by executive 9 management to support changes required to deliver higher quality. Statistical process control is a set of analytical and problem-solving techniques based on statistics and process capability measurements through which Solectron can track process inputs and resulting quality and determine whether a process is operating within specified limits. The goal is to reduce variability in the process, as well as eliminate aberrations that contribute to quality below the acceptable range of each process performance standard. In order to successfully implement these management techniques, Solectron has developed the ability to collect and utilize large amounts of data in a timely manner. Solectron believes this ability is critical to a successful assembly operation and represents a significant competitive factor, especially in large turnkey projects. To manage this data, Solectron uses sophisticated computer systems for material resource planning, shop floor control, work-in-process tracking, statistical process control and activity-based product costing. Electronics Assembly and Other Services Solectron's electronics assembly activities consist primarily of the placement and attachment of electronic and mechanical components on printed circuit boards and flexible cables. Solectron also assembles higher-level sub-systems and systems incorporating printed circuit boards and complex electromechanical components, in some cases manufacturing and packaging products for shipment directly to its customers' distributors. In addition, Solectron provides other manufacturing services including refurbishment and remanufacturing. Solectron manufactures on a turnkey basis, directly procuring some or all of the components necessary for production and on a consignment basis, where the OEM customer supplies all or some components for assembly. In conjunction with its assembly activities, Solectron also provides computer-aided testing of printed circuit boards, sub-systems and systems, which contributes significantly to Solectron's ability to deliver high quality products on a consistent basis. Solectron has developed specific strategies and routines to test board and system level assemblies. In-circuit tests verify that all components have been properly inserted and that the electrical circuits are complete. Functional tests determine if the board or system assembly is performing to customer specifications. Solectron either designs and procures test fixtures and develops its own test software or utilizes its customers' existing test fixtures and test software. In addition, Solectron provides environmental stress tests of the board or system assembly. Solectron provides turnkey manufacturing management to meet its customers' requirements, including procurement and materials management and consultation on board design and manufacturability. Individual customers may select various services from among Solectron's full range of turnkey capabilities. Procurement and materials management consists of the planning, purchasing, expediting, warehousing, preparing and financing of the components and materials required to assemble a printed circuit board or electronic system. OEMs have increasingly utilized electronic manufacturing specialists to purchase all or some components directly from component manufacturers or distributors and to finance and warehouse the components. 10 Solectron also assists its customers in evaluating board designs for manufacturability. Solectron evaluates the board design for ease and quality of manufacture and, when appropriate, recommends design changes to reduce manufacturing costs or lead times or to increase the quality of finished assemblies. Board design services consist of the engineering and design associated with the arrangement and interconnection of specified components on printed circuit boards to achieve an OEM's desired level of functionality. Solectron also offers ASIC design services and its subsidiary, Force Computers, offers product design services for the embedded computer market. Sales and Marketing Sales and marketing at Solectron is an integrated process involving direct salespersons and project managers, as well as Solectron's senior executives. Solectron's sales resources are directed at multiple management and staff levels within targeted accounts. Solectron also uses independent sales representatives in certain geographic areas. Solectron receives unsolicited inquiries resulting from advertising and public relations activities, as well as referrals from current customers. These opportunities are evaluated against Solectron's customer selection criteria and are assigned to direct salespersons or independent sales representatives, as appropriate. Historically, Solectron has had substantial recurring sales from existing customers. Over 92% of Solectron's net sales during fiscal 1998 were derived from customers which were also customers during fiscal 1997. Although Solectron seeks to diversify its customer base, a small number of customers currently are responsible for a significant portion of Solectron's net sales. During fiscal 1998, 1997 and 1996, Solectron's ten largest customers accounted for 68.7%, 65.5% and 64.0% of consolidated net sales, respectively. Several customers each accounted for more than 10% of net sales during these years. Hewlett-Packard Company represented 13.9%, 13.5% and 10.7% of net sales in fiscal 1998, 1997 and 1996, respectively. Cisco Systems, Inc. and Sun Microsystems, Inc. accounted for 10.7% and 10.5%, respectively, of consolidated net sales in fiscal 1998. Nortel Networks, Inc., formerly Bay Networks, Inc., accounted for 10.4% of net sales in fiscal 1997. No other individual customer accounted for more than 10% of Solectron's net sales in any of these years. Backlog Backlog consists of contracts or purchase orders with delivery dates scheduled within the next twelve months. At August 31, 1998, Solectron's backlog was approximately $1.3 billion. The backlog was approximately $875 million at August 31, 1997. Because customers may cancel or reschedule deliveries, backlog is not a meaningful indicator of future financial results. Competition The electronic manufacturing services industry is comprised of a large number of companies, several of which have achieved substantial market share. Solectron also faces competition from current and prospective customers that evaluate Solectron's capabilities against the merits of manufacturing products internally. Solectron competes with different companies depending on the type of service or geographic area. Certain of Solectron's competitors may have greater manufacturing, financial, research and development and marketing resources than Solectron. Solectron believes that the primary basis of competition in its targeted 11 markets is manufacturing technology, quality, responsiveness, the provision of value-added services and price. To remain competitive, Solectron must continue to provide technologically advanced manufacturing services, maintain quality levels, offer flexible delivery schedules, deliver finished products on a reliable basis and compete favorably on the basis of price. Solectron currently may be at a competitive disadvantage as to price when compared to manufacturers with lower cost structures, particularly with respect to manufacturers with established facilities where labor costs are lower. Associates As of August 31, 1998, Solectron employed 24,857 associates worldwide, including 4,857 temporary associates. Solectron's international operations employed 11,888 associates. Patents and Trademarks Solectron has obtained a limited number of U.S. patents related to the process and equipment used in its surface mount technology. The Company's subsidiary, Force Computers, holds a number of patents related to VME technology. In addition, as part of its recent acquisition of the IBM-ECAT manufacturing assets, the Company has access to a number of IBM patents. The Company also has registered trademarks in the United States and many countries throughout the world. These patents and trademarks are considered valuable to Solectron. Although Solectron does not believe that its trademarks, manufacturing process, Force's technology or the IBM patents to which it has access infringe on the intellectual property rights of third parties, there can be no assurance that third parties will not assert infringement claims against Solectron in the future. If such an assertion were to be made, it may become necessary or useful for Solectron to enter into licensing arrangements or to resolve such an issue through litigation. However, there can be no assurance that such license rights would be available to Solectron on commercially acceptable terms or that any such litigation could be resolved favorably. Additionally, such litigation could be lengthy and costly and could have an adverse material effect on Solectron's financial condition regardless of the outcome of such litigation. 12 ITEM 2: PROPERTIES The Company's manufacturing facilities are located throughout North America, Europe and Asia. The table below lists the locations and square feet owned or leased for the Company's major operations.
Square Feet Lease ---------------------- Termination Location Owned Leased Dates - -------------------- ---------- ---------- ----------- Americas: Milpitas, California (1) -- 1,385,000 1998 - 2005 San Jose, California -- 95,000 1999 - 2001 Duluth, Georgia -- 146,000 1999 Westborough, Massachusetts -- 100,000 2002 Charlotte, North Carolina 620,000 75,000 2001 Columbia, South Carolina -- 208,000 2000 Austin, Texas -- 783,000 2002 Everett, Washington -- 254,000 2003 Guadalajara, Mexico (2) 500,000 -- Sao Paulo, Brazil (3) -- 124,000 1999 Europe: Bordeaux, France 319,000 -- Herrenberg, Germany 181,000 -- Munich, Germany -- 210,000 1999 - 2001 Dublin, Ireland 41,000 71,000 1999 Timisoara, Romania (3) -- 18,000 1999 Dunfermline, Scotland 212,000 -- Norkopping, Sweden -- 32,000 2002 Asia: Suzhou, China 340,000 -- Johor, Malaysia -- 173,000 2001 Penang, Malaysia 190,000 179,000 2002
(1) Includes facilities located nearby in Fremont and Newark, California. (2) Includes approximately 37,000 square feet leased to a third party on a short-term lease. (3) Facilities owned by the Company are currently under construction at these locations. Around the world, the Company is subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during its manufacturing process. Any failure by the Company to comply with present and future regulations could subject it to future liabilities or the suspension of production. In addition, such regulations could restrict the Company's ability to expand its facilities or could require the Company to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. 13 ITEM 3: LEGAL PROCEEDINGS Not applicable. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. 14 PART II ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Common Stock Information The following table sets forth the quarterly high and low per share sales prices of Solectron's Common Stock for the two-year period ended August 31, 1998, as quoted on the New York Stock Exchange under the symbol SLR.
High Low -------- -------- Fiscal 1997 First Quarter 29 15/16 17 1/8 Second Quarter 30 11/16 25 3/4 Third Quarter 32 1/2 23 9/16 Fourth Quarter 45 9/16 29 9/16 Fiscal 1998 First Quarter 47 7/16 33 15/16 Second Quarter 49 5/8 28 7/8 Third Quarter 48 9/16 36 7/16 Fourth Quarter 53 1/8 35 7/16
Solectron has not paid any dividends since its inception and does not intend to pay any dividends in the foreseeable future. Additionally, the covenants to the Company's financing agreements prohibit the payment of cash dividends. As of August 31, 1998, there were approximately 1,011 stockholders of record based on data obtained from the Company's transfer agent. 15 ITEM 6: SELECTED FINANCIAL DATA The following selected historical financial information of Solectron has been derived from the historical consolidated financial statements and should be read in conjunction with the consolidated financial statements and the notes included therein. Five Year Selected Financial Highlights (in thousands, except per share data) Consolidated Statements of Income Data:
Years Ended August 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- --------- Net sales $5,288,294 $3,694,385 $2,817,191 $2,065,559 $1,456,779 Operating income 298,989 236,422 175,425 123,434 88,350 Income before income taxes 298,983 238,407 173,077 120,494 84,159 Net income 198,824 158,059 114,232 79,526 55,545 Basic net income per share (1) $1.72 $1.42 $1.12 $0.93 $0.68 Diluted net income per share (1) $1.65 $1.37 $1.08 $0.82 $0.59
Consolidated Balance Sheet Data:
As of August 31, ------------------------------------------------------ 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- Working capital $1,046,724 $ 931,690 $ 786,355 $ 355,603 $ 309,203 Total assets 2,410,568 1,876,419 1,452,198 940,855 766,395 Long-term debt 385,519 385,850 386,927 30,043 140,709 Stockholders' equity 1,181,326 919,069 700,569 538,141 330,789
(1) All net income per share amounts have been restated to conform to the requirements of Statement of Financial Accounting Standards No. 128, "Earnings per Share." 16 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements contained in the following Management's Discussion and Analysis of Financial Condition and Results of Operations, including, without limitation, statements containing the words "believes," "anticipates," "estimates," "expects," and words of similar import, constitute forward-looking statements which involve risks and uncertainties. Solectron's actual results could differ materially from those anticipated in these forward looking statements as a result of certain factors, including those factors set forth under "Trends and Uncertainties" below. General Solectron's net sales are derived from sales to electronics systems original equipment manufacturers (OEMs). The majority of Solectron's customers compete in the networking, data and voice communications, workstation, personal computer and computer peripheral segments of the electronics industry. The Company provides integrated solutions that span the entire product life cycle - from pre-production planning and design, to manufacturing, distribution and end-of-life product service and support. Solectron offers its customers competitive outsourcing advantages such as access to advanced manufacturing technologies, shortened time-to-market, reduced cost of production and more effective asset utilization. A discussion of some of the potential fluctuations in operating results is included under "Trends and Uncertainties". The Company has manufacturing operations in locations throughout the world, including North America, Europe, Asia/Pacific and Latin America. Solectron also has its Asia/Pacific headquarters office in Taipei, Taiwan and program offices located in Japan and Israel. The Company's subsidiaries, Force Computers and Fine Pitch Technologies, are both headquartered in San Jose, California. Force's European headquarters and a significant portion of its operations are located in Munich, Germany. In addition to its headquarters' locations, Force has sales support offices in various locations in the United States and internationally. During 1997, the Company established a strategic, global manufacturing partnership with Ericsson Telecom AB's Business Area Infocom Systems (Ericsson). The Company established a New Product Introduction center in Sweden, and production from certain Ericsson plants worldwide was transferred to Solectron manufacturing sites around the world. In October 1997, Solectron acquired certain assets, primarily equipment and inventory, of Ericsson's printed circuit board assembly operation located in Sao Paulo, Brazil. In addition, Solectron's subsidiary, Solectron Brasil Ltda., hired approximately 370 associates formerly employed by Ericsson Telecomunicacoes S.A. in Brazil. In April 1998, the Company acquired NCR Corporation's (NCR) manufacturing assets in three cities for a purchase price of approximately $79.5 million, subject to adjustment. The acquisition was accounted for as a purchase of assets and the purchase price was allocated to the assets acquired based on the relative fair values of the assets at the date of acquisition. Under the terms of the agreement, NCR will outsource the manufacturing of certain computer components to Solectron for at least five years and Solectron hired approximately 1,200 NCR manufacturing and related support associates. 17 In June 1998, the Company acquired International Business Machines Corporation's (IBM) Electronic Card Assembly and Test (ECAT) manufacturing assets in Charlotte, North Carolina and non-exclusive rights to certain IBM intellectual property for a purchase price of approximately $95.4 million, subject to adjustment. The acquisition was accounted for as a purchase of assets and the purchase price was allocated to the assets acquired, including the intellectual property rights, based on their relative fair values at the date of acquisition. Under the terms of the agreement, Solectron hired approximately 700 IBM manufacturing and related support associates and the Company will provide printed circuit board assembly services to IBM in North America for the next three years. In addition, IBM has made available to Solectron 115 patents and 51 disclosures (collectively the intellectual property rights) covering a wide spectrum of technologies and capabilities. IBM will also provide to Solectron failure analysis and characterization tools for process development and manufacturing, including fault detection and isolation. In October 1998, the Company acquired the wireless telephone manufacturing assets of Mitsubishi Consumer Electronics America, Inc.'s (MCEA) Cellular Mobile Telephone (CMT) division in Braselton, Georgia. MCEA is a subsidiary of Mitsubishi Electric Corporation (Mitsubishi). The acquisition is expected to be accounted for as a purchase of assets and the purchase price will be allocated to the assets acquired based on the relative fair values of the assets at the date of acquisition. Under the terms of the agreement, the Company will provide MCEA-CMT with a full range of manufacturing services for five years, including New Product Introduction management, printed circuit board assembly and full systems assembly for MCEA's branded and private-label cellular products sold within North America. In addition, Solectron has hired approximately 400 MCEA-CMT manufacturing and support associates. Also in October 1998, the Company announced that it had signed a definitive agreement with Ingram Micro Inc. under which the two companies will enter into a strategic alliance to provide global build- to-order and configure-to-order assembly services for personal computers, servers and related products in the United States, Canada, Europe, Asia and Latin America. The alliance will be managed by both companies under a joint management matrix that will include a sales and marketing staff, program management, information technology resources and test and process engineers and will, in most part, utilize existing facilities, systems and personnel. The companies expect that shipments to customers will begin in early calendar 1999. Results of Operations The electronics industry is subject to rapid technological change, product obsolescence and price competition. These and other factors affecting the electronics industry, or any of Solectron's major customers in particular, could have an adverse material effect on Solectron's results of operations. See "Trends and Uncertainties -- Potential Fluctuations in Operating Results" and "-- Competition" for further discussion of potential fluctuations in operating results. The following table sets forth, for the periods indicated, certain items in the Consolidated Statements of Income as a percentage of net sales. The financial information and the discussion below should be read in conjunction with the Consolidated Financial Statements and Notes thereto. 18
Years Ended August 31, ----------------------------- 1998 1997 1996 ----- ----- ----- Net sales 100.0% 100.0% 100.0% Cost of sales 89.8 88.4 90.0 ----- ----- ----- Gross profit 10.2 11.6 10.0 Operating expenses: Selling, general and administrative 4.1 4.7 3.6 Research and development 0.4 0.4 0.2 Acquisition costs -- 0.1 -- ----- ----- ----- Operating income 5.7 6.4 6.2 Net interest income (expense) 0.0 0.1 (0.1) ----- ----- ----- Income before income taxes 5.7 6.5 6.1 Income taxes 1.9 2.2 2.1 ----- ----- ----- Net income 3.8% 4.3% 4.0% ===== ===== =====
Net Sales The Company's net sales have increased significantly in each of the past several years, reflecting the growing trend toward outsourcing within the electronics industry. For the year ended August 31, 1998, net sales grew to $5.3 billion, an increase of 43.1% over fiscal 1997 net sales. Fiscal 1997 net sales of $3.7 billion were 31.1% greater than net sales in fiscal 1996. The sales growth in fiscal 1998 was attributable to significant increases in sales volume from both existing and new customers worldwide, including the completion of the transfer of production from certain Ericsson plants to various Solectron locations around the world. The new locations in Mexico, Brazil and Sweden and the ramp up of the Massachusetts location to full production also contributed to the increase in net sales. In addition, the acquisition of the three NCR sites and the IBM-ECAT manufacturing assets contributed four months and three months of sales, respectively, totaling $367 million to the 1998 period. The fiscal 1997 sales growth was due to significant increases in sales volume from both existing and new customers in North America, higher international sales, the acquisition of Force Computers in November 1996 and a full twelve months of sales from the Custom Manufacturing Services (CMS) business, located in Austin, Texas, which was acquired from Texas Instruments in March 1996. Within the Americas, the sites that benefited most from start-up and major new programs had substantial increases in net sales in fiscal 1998 over fiscal 1997. Sales growth at the Texas and Massachusetts sites was particularly strong as a result of these factors. In addition, the new sites in Mexico and Brazil, as well as the newly-acquired sites from NCR and IBM, contributed incremental net sales to fiscal 1998. The growth in fiscal 1997 sales over fiscal 1996 reflected increases in sales at all locations to existing and new customers. The overall increase in sales in fiscal 1997 over fiscal 1996 was partially offset by the effect of several ongoing programs reaching end of life and management actions to improve global load balancing and transitioning specific product programs. Sales in all of the Company's European and Asian manufacturing locations increased in fiscal 1998 over fiscal 1997 primarily as a result of core business growth and new accounts. Sales growth in the Company's location 19 in Scotland was particularly strong due to the ramp up of major customers' printed circuit board assembly activities in that location. Fiscal 1997 sales in most of the Company's European and Asian operations increased over fiscal 1996 sales as a result of the global load balancing efforts noted above, as well as higher sales to existing and new customers. These increases were partially offset by declines in sales during fiscal 1997 at the facility in France and some Asian locations related to older programs as these programs reached end of life. Although the Company does not currently anticipate any future decline in sales, to lessen the potential impact of any possible future declines to customers within any particular region or market segment, the Company is committed to seeking diversification of its customer base among many countries, market segments and product lines within market segments. Several major customers accounted for more than 10% of the Company's net sales in fiscal 1998, 1997 and 1996. The following table lists these customers and the percentage of net sales attributed to them.
Years Ended August 31, --------------------------------- 1998 1997 1996 -------- -------- -------- Hewlett-Packard Company (HP) 13.9% 13.5% 10.7% Cisco Systems, Inc. (Cisco) 10.7% * * Sun Microsystems, Inc. (Sun) 10.5% * * Nortel Networks, Inc. (formerly Bay Networks, Inc.) * 10.4% * - ------------- * Less than 10%
No other customers accounted for more than 10% of net sales during any of the years presented. Solectron's top ten customers accounted for 68.7%, 65.5% and 64.0% of consolidated net sales in fiscal 1998, 1997 and 1996, respectively. Solectron is still dependent upon continued revenues from HP, Cisco, Sun and its other top ten customers and there can be no guarantee that these or any other customers will not increase or decrease as a percentage of consolidated net sales either individually or as a group. Consequently, any material decrease in sales to these or other customers could have an adverse material effect on Solectron's results of operations. Net sales at Solectron's international sites, as a percentage of consolidated net sales, have varied over the last three fiscal years. International locations contributed 33.8% of consolidated net sales in fiscal 1998, compared to 26.8% and 30.9% in fiscal 1997 and 1996, respectively. In addition to the sales growth factors for Europe and Asia noted above, the Company's fiscal 1998 international sales also benefited from the addition in fiscal 1998 of new sites in Mexico and Brazil and the acquisition of the site in Ireland from NCR in April 1998. In fiscal 1997, international sales decreased as a percentage of consolidated sales due to strong growth in domestic sales, aided by the acquisition of the CMS business in Austin, Texas, which is substantially comprised of domestic sales, as well as the end-of-life issues described above. As a result of Solectron's international sales and facilities, Solectron's operations are subject to risks of doing business abroad. While to date these dynamics have not had an adverse material effect on 20 Solectron's results of operations, there can be no assurance that there will not be such an impact in the future. See "Trends and Uncertainties - -- International Operations," "-- Foreign Exchange Rate Sensitivity" and "-- Euro Conversion Issues" for further discussion of potential fluctuations in operating results associated with the risks of doing business abroad. Solectron's operations in Milpitas, California contributed a substantial portion of Solectron's net sales and operating income during fiscal 1998, 1997 and 1996. In recent quarters, management has undertaken deliberate actions to achieve improved global load balancing by transferring certain projects from the Milpitas site to other sites worldwide. However, the performance of the Milpitas operation is expected to continue to be a significant factor in the overall financial performance of Solectron. Any adverse material change to the customer base, product mix, efficiency or other attributes of this site could have an adverse material effect on Solectron's consolidated results of operations. Solectron believes that its ability to continue achieving growth will depend upon growth in sales to existing customers for their current and future product generations, successful marketing to new customers and future geographic expansion. Customer contracts can be canceled and volume levels can be changed or delayed. The timely replacement of delayed, canceled or reduced orders with new business cannot be assured. In addition, there can be no assurance that any of Solectron's current customers will continue to utilize Solectron's services. Because of these factors, there can be no assurance that Solectron's historical revenue growth rate will continue. See "Trends and Uncertainties" for a discussion of certain factors affecting the management of growth, geographic expansion and potential fluctuations in sales and results of operations. Gross Profit The gross margin percentage was 10.2%, 11.6% and 10.0% for fiscal 1998, 1997 and 1996, respectively. The decrease in fiscal 1998 from fiscal 1997 was due primarily to a shift toward higher volume projects and systems build projects that typically have lower margins, as well as start-up costs associated with the Company's operations in China and Mexico. In addition, gross margins of the newly acquired NCR operations are lower than the overall average margins of the rest of the Company primarily due to the fact that the majority of its net sales are derived from systems integration activities, which normally generate lower gross margins than printed circuit board assembly, as well as current underutilization of these facilities. The improvement in fiscal 1997 over fiscal 1996 was primarily due to the inclusion of Force since its acquisition in November 1996. Gross profit margins on Force's products are significantly higher than those of the rest of the Company. Without Force's contribution, gross margins for fiscal 1997 would have been 10.4%. In addition to the impact of Force, the improved gross margin percentage in fiscal 1997 reflects a shift in product mix toward the higher margin market segments, projects with a higher than normal consignment content and increased manufacturing efficiencies at the Dunfermline, Scotland and Austin, Texas sites. For the foreseeable future, Solectron's gross margin is expected to depend primarily on product mix, production efficiencies, utilization of manufacturing capacity, start-up and integration costs of new and acquired businesses, the percentage of sales derived from systems build projects, pricing within the electronics industry and the cost structure 21 at individual sites. Over time, gross margins at the individual sites and for the Company as a whole may continue to fluctuate. The Company anticipates that a larger percentage of its sales may be derived from systems build projects in future periods. Systems build projects typically have lower gross margin percentages than printed circuit board assembly projects. Increases in systems build business, additional costs associated with new projects and price erosion within the electronics industry could adversely affect the Company's gross margin. Additionally, changes in product mix could cause the Company's gross margin to fluctuate. Also, while the availability of raw materials appears adequate to meet the Company's current revenue projections for the foreseeable future, component availability is still subject to lead time and other constraints that could possibly limit the Company's revenue growth. Because of these factors and others discussed under "Trends and Uncertainties" below, there can be no assurance that the Company's gross margin will not fluctuate or decrease in future periods. Selling, General and Administrative Expenses In absolute dollars, selling, general and administrative (SG&A) expenses increased 26.3% in fiscal 1998 over fiscal 1997 and 72.4% in fiscal 1997 over fiscal 1996. The fiscal 1998 increase and a portion of the fiscal 1997 increase was due to investment in infrastructure such as personnel and related departmental expenses at all manufacturing locations as well as continuing investment in information systems to support the increased size and complexity of the Company's business. The inclusion of Force since its acquisition in November 1996 and the Austin, Texas site for the full year of fiscal 1997 accounted for approximately half of the fiscal 1997 increase. The addition in fiscal 1998 and 1997 of new sites in China, Massachusetts, Mexico, Brazil and Sweden and the NCR and IBM sites also contributed to the growth in SG&A expenses. As a percentage of net sales, SG&A expenses were 4.1%, 4.7% and 3.6% in fiscal 1998, 1997 and 1996, respectively. The Company anticipates SG&A expenses will continue to increase in terms of absolute dollars in the future, and may possibly increase as a percentage of net sales, as the Company continues to build the infrastructure necessary to support its current and prospective business. Research and Development Expenses With the exception of its Force Computers operation, the Company's research and development (R&D) activities have been focused primarily on the development of prototype and engineering design capabilities, fine pitch interconnecting technologies (which include ball-grid array, tape- automated bonding, multichip modules, chip-on-flex, chip-on-board and flip chip), high reliability environmental stress test technology and the implementation of environmentally friendly assembly processes, such as VOC-free and no-clean. Force's R&D efforts are concentrated on new product development and improvement of product designs through improvements in functionality and the use of microprocessors in embedded applications. Research and development expenses, in absolute dollars and as a percentage of net sales, respectively, were $20.9 million and 0.4% in fiscal 1998, $15.0 million and 0.4% in fiscal 1997 and $6.7 million and 0.2% in fiscal 1996. The increase in R&D expenses in fiscal 1998 compared to fiscal 1997 was due to increased R&D efforts at Force. The fiscal 1997 increase over fiscal 1996 was a result of the acquisition of Force in November 1996. The Company expects that R&D expenses will increase in absolute dollars in the future and may increase as a percentage of net sales as Force and the newly acquired NCR and IBM sites continue to invest in their R&D efforts. In addition, certain new R&D projects will be undertaken at some of the Company's 22 Asian sites, particularly at the Malaysia sites in connection with the tax holiday. (See "Income Taxes.") Acquisition Costs A one-time charge for acquisition costs of approximately $4.0 million was incurred in fiscal 1997 as a result of the acquisition of Force Computers in November 1996. Net Interest Income (Expense) Net interest income was zero in fiscal 1998 and $2.0 million in fiscal 1997 compared to net interest expense of $2.3 million in fiscal 1996. The Company issued convertible subordinated notes in February 1996 and senior notes in March 1996. Interest expense on the debt is approximately $24.9 million annually and in fiscal 1998 and 1997 was offset by interest earned on undeployed cash and investments. In fiscal 1998, the Company capitalized approximately $1.7 million of interest expense related to construction of its new facilities in China and Mexico. The Company used a portion of its cash and short-term investments to fund its acquisitions from NCR and IBM. Solectron expects to utilize more of the undeployed cash during future periods in order to fund anticipated future growth. See "Trends and Uncertainties -- Management of Growth" and "Potential Fluctuations in Operating Results." Income Taxes Income taxes increased to $100.2 million in 1998 from $80.3 million in fiscal 1997 and $58.8 million in fiscal 1996, primarily due to increased income before income taxes. Solectron's effective income tax rate decreased slightly to 33.5% in fiscal 1998 from 33.7% in fiscal 1997 and 34.0% in fiscal 1996. In general, the effective income tax rate is largely a function of the balance between income from domestic and international operations. Solectron's international operations, taken as a whole, have been taxed at a lower rate than in the United States, primarily due to the tax holiday granted to the Company's Malaysia sites. The Malaysian tax holiday is effective through January 31, 2002, subject to certain conditions, including certain levels of research and development expenditures. The Company has also been granted various tax holidays in China, which are effective for various terms and are subject to certain conditions. Liquidity and Capital Resources Working capital was $1.0 billion at August 31, 1998 compared to $932 million at the end of fiscal 1997. A major component of working capital at August 31, 1998 continued to be undeployed cash from the proceeds of the two debt offerings during fiscal 1996. In the third and fourth quarters of fiscal 1998, the Company used approximately $175 million of its cash and short-term investments to fund its acquisitions of the NCR and IBM-ECAT manufacturing assets. In the first quarter of fiscal 1999, the Company used additional funds for its acquisition of the wireless telephone manufacturing assets of MCEA's CMT division. As Solectron continues to grow, it is expected that the Company will require greater amounts of working capital to support its operations. The Company believes that its current level of working capital, together with cash generated from operations and the Company's available credit facilities, will provide adequate working capital for the foreseeable future. However, the Company may need to raise additional funds to finance more 23 rapid expansion, including establishing new locations or financing additional acquisitions. There can be no assurance that such funds, if needed, will be available on terms acceptable to the Company or at all. Inventory levels fluctuate directly with the volume of the Company's manufacturing. Changes or significant fluctuations in product market demands can cause fluctuations in inventory levels that may result in changes in levels of inventory turns and liquidity. Historically, the Company has been able to manage its inventory levels with regard to these fluctuations. However, should material fluctuations occur in product demand, the Company could experience slower turns and reduced liquidity. The increase in inventory levels at year end 1998 from year end 1997 is substantially a result of overall growth and the greater number of manufacturing locations at August 31, 1998 compared to August 31, 1997, as each location must maintain a level of inventory adequate to allow the location to respond to customer manufacturing requirements. Cash provided by operating activities was $150 million, $202 million and $102 million in fiscal 1998, 1997 and 1996, respectively. The decrease in fiscal 1998 from fiscal 1997 was primarily due to increased levels of accounts receivable and inventory partially offset by increases in net income, depreciation and amortization and current liabilities. The increase in fiscal 1997 from fiscal 1996 reflects increased net income, depreciation and amortization and current liabilities balances, partially offset by increases in accounts receivable and inventory balances. During fiscal 1998, the Company invested approximately $244 million in capital expenditures. A large portion of these expenditures related to the purchase of new equipment, primarily surface mount assembly and test equipment, to meet current and expected production levels, as well as to replace or upgrade older equipment that was retired or sold. Significant expenditures were also made for the acquisition of land and buildings for the Company's new manufacturing sites, principally in China, Mexico and Brazil. The Company expects capital expenditures in fiscal 1999 to be in the range of $225 million to $275 million. During fiscal 1998, the Company entered into an arrangement with a third-party leasing company under which certain of the Company's fixed assets have been sold to the leasing company and leased back. The Company is accounting for these transactions as operating leases. In addition to working capital as of August 31, 1998, which included cash and cash equivalents of $225 million and short-term investments of $84 million, the Company has available a $100 million unsecured multicurrency revolving credit facility that expires in April 2002 and a $120 million asset securitization arrangement that expires in August 1999. Both of these facilities are subject to financial covenants. The Company also has approximately $92 million in available foreign credit facilities. 24 "Year 2000" Issues The Company is aware of and is addressing the issues associated with the programming code in existing computer systems as the year 2000 approaches. The Year 2000 problem is pervasive and complex, as many computer systems, manufacturing equipment and industrial control systems will be affected in some way by the rollover of the two-digit year value to 00. Systems that do not properly recognize such dates could generate erroneous information or cause a system to fail. The Year 2000 issue creates risk for the Company from unforeseen problems in its own systems and from third parties with whom the Company deals on business transactions worldwide. Failures of the Company's and/or third parties' computer systems, manufacturing equipment and industrial control systems would have an adverse material impact on the Company's ability to conduct its business. The Company has formed a worldwide task force and has implemented a comprehensive program to analyze the Company's internal systems as well as all external systems (such as vendor, customer, banking systems, etc.) upon which the Company is dependent, to identify and evaluate any potential Year 2000 issues. This task force meets regularly and tracks progress against the program, modifying it as needed to help ensure timely completion. The Company is committed to achieving Year 2000 compliance; however, because a significant portion of the problem is external to the Company and therefore outside of its direct control, there can be no assurances that the Company will be fully or even significantly Year 2000 compliant at the critical juncture. In addition, as full testing of Year 2000 functionality must occur in a simulated environment, the Company will not be able to test full system Year 2000 interfaces and capabilities prior to the Year 2000. As of the end of fiscal 1998, the Company had completed an inventory of internal systems, hardware, software, manufacturing equipment and embedded chips in industrial control instruments. Each of these items was identified as mission critical, mission essential, mission impaired or mission non-critical. The Company is in the process of prioritizing and evaluating mission critical and mission essential items, identifying fixes and resources as appropriate, and performing and testing corrective measures. While the Company believes that its evaluation has been comprehensive, there can be no assurance that all systems critical to Year 2000 compliance have been identified, or that the corrective actions identified will be completed on time. As of the end of fiscal 1998, the Company had inventoried every key supplier of goods and services to the Company, and considered the potential impact on the Company and its customers of Year 2000 compliance by these suppliers. The Company also mailed surveys to many of these key suppliers, and is in the process of evaluating responses and sending follow-up letters. The Company plans to disqualify potentially non-compliant sources, look for alternative sources and re- qualify new suppliers to help mediate potential business disruptions. The Company is also involved with various geographic Year 2000 consortiums worldwide, with the intent to leverage contacts and information for commonly used suppliers and services such as utility companies. In addition, the Company is in the process of reviewing EDI linkages and data transmission for its customers and suppliers. While the Company believes that it will be able to qualify alternative suppliers as needed, until all supplier and customer survey responses have been received and evaluated, the Company can not fully evaluate the extent of potential problems and the costs associated with corrective actions. 25 The Company estimates the cost to complete its current compliance program to be in the range of $28 million to $42 million. Of this amount, approximately $7 million is associated with the replacement of capital equipment, of which approximately half is being purchased to replace non-compliant systems that would not otherwise have been replaced at this time. The variability in these estimates depends largely on the response from the Company's suppliers and the extent to which supplier re-qualification is needed. Cost estimates will also be re-evaluated as the status of the overall compliance program is updated. There can be no assurance that actual costs will not be materially higher than currently anticipated. A significant portion of these costs is not likely to be incremental costs to the Company, but rather will represent the redeployment of existing information technology resources. Certain other information technology projects have been delayed due to the focus on Year 2000 issues. The potential costs of the redeployment of personnel and delays in implementing other projects is not known but could be substantial. Although the Company has identified general contingency plans, such as the replacement and re-qualification of suppliers, the stockpiling of supplies and purchase of generators, a formal contingency plan will not be established until at least the third quarter of fiscal 1999 when the evaluation of suppliers is expected to be completed. The Company is unable to determine what effect the failure of systems because of Year 2000 issues by the Company or its suppliers or customers will have, but any significant failures could have an adverse material effect on the Company's results of operations and financial condition. Trends and Uncertainties Customer Concentration; Dependence on the Electronics Industry In fiscal 1998, 1997 and 1996, the Company's ten largest customers accounted for as much as 68.7% of consolidated net sales. The Company is dependent upon continued revenues from its top ten customers. Any material delay, cancellation or reduction of orders from these or other significant customers could have an adverse material effect on the Company's results of operations. During fiscal 1998, HP, Cisco and Sun accounted for 13.9%, 10.7% and 10.5%, respectively, of net sales, compared to 13.5% for HP and less than 10% for each of Cisco and Sun during fiscal 1997. There can be no assurance that the Company will continue to do business with HP, Cisco, Sun or any other customer. The percentage of the Company's sales to its major customers may fluctuate from period to period. Significant reductions in sales to any of these customers would have an adverse material effect on the Company's results of operations. The Company has long-term contracts (generally for terms of three to five years) with Ericsson, NCR, IBM and Mitsubishi under which these customers have committed to source production of certain products and components from the Company. However, these commitments to source production do not include firm volume purchase commitments. In addition, the Company has no firm long-term volume purchase commitments from its other customers, and over the past few years has experienced reduced lead times in customer orders. Also, customer contracts can be canceled and volume levels can be changed or delayed. The timely replacement of canceled, delayed or reduced contracts with new business cannot be assured. These risks are increased because a majority of the Company's sales are to customers in the electronics industry, which is subject to rapid technological change and product obsolescence. The factors affecting the electronics 26 industry in general, or any of the Company's major customers in particular, could have an adverse material effect on the Company's results of operations. There can be no assurance that sales to customers within any particular market segment will not experience decreases that could have an adverse effect on the Company's sales. Management of Growth; Geographic Expansion The Company has experienced substantial growth over the last five fiscal years, with net sales increasing from $1.5 billion in fiscal 1994 to $5.3 billion in fiscal year 1998. In recent years, the Company has acquired or established facilities in many locations. In the first quarter of fiscal 1998, the Company announced the opening of its Asia/Pacific headquarters office in Taipei, Taiwan, began operations in Guadalajara, Mexico, and as further discussed in "Partnership with Ericsson and Related Transactions," established a manufacturing facility near Sao Paulo, Brazil and opened a New Product Introduction center in Sweden. In April 1998, the Company announced plans to open a manufacturing facility in Timisoara, Romania, and in May 1998, announced the establishment of a program office in Israel. In addition, in April, June and October 1998, the Company completed its acquisitions of certain manufacturing facilities and associates from NCR, IBM and Mitsubishi, respectively. (See "Acquisition of NCR, IBM and Mitsubishi Assets.") In October 1998, the Company signed a definitive agreement with Ingram Micro, Inc. under which the two companies will enter into a strategic alliance. (See "Alliance with Ingram Micro.") During fiscal 1997, the Company announced the establishment of new manufacturing facilities in Suzhou, China; began operations at its manufacturing facility near Boston, Massachusetts; and in November 1996, acquired Force Computers Inc., which has operations in California and Germany. The Company continually evaluates growth and acquisition opportunities and may pursue additional opportunities over time. There can be no assurance that the Company's historical revenue growth will continue or that the Company will successfully manage the facilities in China, Mexico, Brazil and Romania, the partnership with and acquisitions from Ericsson, the acquisitions from NCR, IBM and Mitsubishi, the alliance with Ingram Micro or any other businesses or assets it may acquire in the future. As the Company manages its existing operations and expands geographically, it may experience certain inefficiencies as it integrates new operations and manages geographically dispersed operations. In addition, the Company's results of operations could be adversely affected if its new facilities do not achieve growth sufficient to offset increased expenditures associated with geographic expansion. The Company's expenses and working capital requirements will continue to increase as the new facilities become fully operational and the transaction with Mitsubishi is completed. Should the Company increase its expenditures in anticipation of a future level of sales that does not materialize, its profitability would be adversely affected. On occasion, customers may require rapid increases in production that can place an excessive burden on the Company's resources. Partnership with Ericsson and Related Transactions During 1997, the Company established a strategic, global manufacturing partnership with Ericsson Telecom AB's Business Area Infocom Systems. The Company established a New Product Introduction center in Sweden, and production from certain Ericsson plants worldwide was transferred to Solectron manufacturing sites around the world. In October 1997, 27 Solectron acquired certain assets, primarily equipment and inventory, of Ericsson's printed circuit board assembly operation located in Brazil. In addition, Solectron's subsidiary, Solectron Brasil Ltda., hired approximately 370 associates formerly employed by Ericsson Telecomunicacoes S.A. in Brazil. Under the terms of the agreement, Ericsson contracted for Solectron's services from Solectron Brasil Ltda. through September 1999. Thereafter, Solectron will bear the risk of filling the manufacturing capacity at the site with renewed business from Ericsson and new business from other customers. The transactions with Ericsson entail a number of risks, including successfully managing the integration of the operations, retention of key associates, integrating purchasing operations and information systems, managing an increasingly larger and more geographically disparate business and renewing the Ericsson business or replacing it with new business after expiration of the Ericsson commitment. In addition, the completion of the transactions with Ericsson has increased Solectron's expenses and working capital requirements and there is no assurance that Solectron will achieve sufficient revenue to offset the increased expenses. There can be no assurance that Solectron will successfully manage the risks of these transactions. Acquisitions of NCR, IBM and Mitsubishi Assets On April 27, 1998, the Company acquired NCR's manufacturing assets in three cities, two in the United States and one in Ireland, for a purchase price of approximately $79.5 million, subject to adjustment. As part of the transaction, Solectron hired approximately 1,200 NCR manufacturing and related support associates currently employed at these locations. Under the terms of the agreement, NCR will outsource the manufacturing of certain computer, computer peripheral and server components to Solectron for at least five years. Thereafter, Solectron will bear the risk of filling the manufacturing capacity at the sites with renewed business from NCR and new business from other customers. On June 1, 1998, the Company acquired IBM's ECAT manufacturing assets in Charlotte, North Carolina and non-exclusive rights to certain IBM intellectual property for a purchase price of approximately $95.4 million, subject to adjustment. Under the terms of the agreement, Solectron hired approximately 700 IBM manufacturing and related support associates and the Company will provide printed circuit board assembly services to IBM in North America for the next three years. In addition, IBM has made available to Solectron 115 patents and 51 disclosures (collectively the intellectual property rights) covering a wide spectrum of technologies and capabilities. IBM will also provide to Solectron failure analysis and characterization tools for process development and manufacturing, including fault detection and isolation. On October 1, 1998, the Company acquired the wireless telephone manufacturing assets of Mitsubishi Consumer Electronics America, Inc.'s (MCEA) Cellular Mobile Telephone (CMT) division in Braselton, Georgia. MCEA is a subsidiary of Mitsubishi Electric Corporation (Mitsubishi). Under the terms of the agreement, the Company will provide MCEA-CMT with a full range of manufacturing services for five years, including New Product Introduction management, printed circuit board assembly and full systems assembly for MCEA' s branded and private-label cellular products sold within North America. In addition, Solectron has hired approximately 400 MCEA-CMT manufacturing and support associates. The transactions with NCR, IBM and Mitsubishi entail a number of risks, including successfully managing the integration of the operations, 28 retention of key associates, integrating purchasing operations and information systems, managing an increasingly larger and more geographically disparate business, obtaining customers other than NCR, IBM and Mitsubishi for these facilities and renewing each of the NCR, IBM and Mitsubishi business or replacing it with new business after expiration of NCR's, IBM's and Mitsubishi's respective commitments. In addition, the transactions with NCR, IBM and Mitsubishi will increase Solectron's expenses and working capital requirements and there is no assurance that Solectron will achieve sufficient revenue to offset the increased expenses. There can be no assurance that Solectron will successfully manage the risks of these transactions. Alliance with Ingram Micro On October 1, 1998, the Company announced that it had signed a definitive agreement with Ingram Micro Inc. under which the two companies will enter into a strategic alliance to provide global build- to-order and configure-to-order assembly services for personal computers, servers and related products in the United States, Canada, Europe, Asia and Latin America. The alliance will be managed by both companies under a joint management matrix that will include a sales and marketing staff, program management, information technology resources and test and process engineers and will, in most part, utilize existing facilities, systems and personnel. The alliance with Ingram Micro entails a number of risks, including successfully establishing the joint management matrix for the alliance, retention of key associates, integrating purchasing operations and information systems and obtaining customers for the services to be provided by the alliance. In addition, the alliance with Ingram Micro will increase Solectron's expenses and working capital requirements and there is no assurance that Solectron will achieve sufficient revenue to offset the increased expenses. There can be no assurance that Solectron will successfully manage the risks of this alliance or that the terms of the alliance will be finalized. International Operations As a result of its international sales and facilities, the Company's operations are subject to risks of doing business abroad, including but not limited to, fluctuations in the value of currency, export duties, changes to import and export regulations (including quotas), possible restrictions on the transfer of funds, associate turnover, labor unrest, longer payment cycles, greater difficulty in collecting accounts receivable, the burdens and costs of compliance with a variety of foreign laws and in certain parts of the world, political instability. In addition, the Company has operations in several locations that are considered to have highly inflationary economies or volatile currencies, including Mexico, Brazil, China and Romania. While to date these factors have not had an adverse material impact on the Company's results of operations, there can be no assurance that there will not be such an impact in the future. Southeast Asia and Latin America are currently experiencing currency, economic and political instability. To date, the Company's operations have not experienced significant adverse effects from this instability. However, to the extent the Company's worldwide customers sell the products manufactured by Solectron into the Southeast Asia and Latin America markets, the customers' sales may be adversely affected, which could decrease demand for the Company's manufacturing services. The Company cannot predict whether such a decrease in demand will 29 materialize and if it does, whether it will have an adverse material effect on the Company's results of operations. The Malaysian government recently adopted currency exchange controls, including controls on ringgit held outside Malaysia, and established a fixed exchange rate for the ringgit against the U.S. dollar. The Company does not hold ringgit outside of Malaysia and therefore will not be affected by these controls. The fixed exchange rate, when applied to local expenses denominated in ringgit, will result in higher expenses when translated to U.S. dollars. However, such local expenses represent a small percentage of the Company's total costs and therefore the Company's results of operations will not be significantly affected in the near future. The long term impact of such controls is not predictable due to dynamic economic conditions that also affect or are affected by other regional or global economies. The Company has been granted a tax holiday for its Malaysia sites which is effective through January 31, 2002, subject to certain conditions. The Company has also been granted various tax holidays in China. These tax holidays are effective for various terms and are subject to certain conditions. There is no assurance that the current tax holidays will not be terminated or modified or that any future tax holidays that the Company may seek will be granted. If the current tax holidays are terminated or modified or if additional tax holidays are not granted in the future, the Company's effective income tax rate would likely increase. Foreign Exchange Rate Sensitivity The Company does not use derivative financial instruments for speculative purposes. The Company's policy is to hedge its foreign currency denominated transactions in a manner that substantially offsets the effects of changes in foreign currency exchange rates. The Company uses foreign currency borrowings and foreign currency forward contracts to hedge the currency risks of transactions denominated in foreign currencies. Gains and losses on these foreign currency hedges are generally offset by corresponding losses and gains on the underlying transaction. There were no material deferred gains or losses at August 31, 1998, and the Company does not hold or issue foreign exchange contracts for trading purposes. In addition, the Company's international operations in some instances act as a natural hedge because both operating expenses and a portion of sales are denominated in local currency. In these instances, although an unfavorable change in the exchange rate of a foreign currency against the U.S. dollar will result in lower sales when translated to U.S. dollars, operating expenses will also be lower in these circumstances. However, because less than 10% of net sales are denominated in currencies other than the U.S. dollar, the Company does not believe its total exposure to be significant. See Note 7 of Notes to Consolidated Financial Statements. Euro Conversion Issues On January 1, 1999, 11 of the 15 member countries of the European Union (the participating countries) are scheduled to establish fixed conversion rates between their existing sovereign currencies and the euro. 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 30 float freely against the U.S. dollar and other currencies of non- participating countries. The Company has established a task force that is evaluating the effects of the euro conversion on the Company and monitoring its readiness for the conversion. The Company does not believe that significant modifications of its information technology systems will be needed in order to handle euro transactions and reporting, and the Company is in the process of evaluating its tax positions and all outstanding contracts in currencies of the participating countries to determine the effects, if any, of the euro conversion. The Company does not expect the euro conversion to have a significant impact on its derivatives (see Note 7 of Notes to Consolidated Financial Statements) as the Company has already modified its hedging policies to take the euro conversion into account, and approximately 84% of its derivative instruments at August 31, 1998, mature in three months or less. While the Company believes that it will be ready for the euro conversion by the end of calendar 1998, and that the effects of the conversion will not have a significant adverse material effect on the Company's business and operations, there can be no assurances that such conversion will not have an adverse material effect on the Company's results of operations and financial position due to competitive and other factors that may be affected by the conversion that cannot be predicted by the Company. Availability of Components A substantial portion of the Company's net sales is derived from turnkey manufacturing in which the Company provides both materials procurement and assembly. In turnkey manufacturing, the Company potentially bears the risk of component price increases, which could adversely affect the Company's gross profit margins. At various times there have been shortages of components in the electronics industry. If significant shortages of components should occur, the Company may be forced to delay manufacturing and shipments, which could have an adverse material effect on the Company's results of operations. Potential Fluctuations in Operating Results The Company's operating results are affected by a number of factors, including the mix of turnkey and consignment projects, the mix of printed circuit board assembly and systems build projects, capacity utilization, price competition, the degree of automation that can be used in the assembly process, the efficiencies that can be achieved by the Company in managing inventories and fixed assets, the timing of orders from major customers, fluctuations in demand for customer products, the timing of expenditures in anticipation of increased sales, customer product delivery requirements, and increased costs and shortages of components or labor. Turnkey manufacturing currently represents a substantial portion of Solectron's sales. Turnkey projects, in which Solectron procures some or all of the components necessary for production, typically generate higher net sales and higher gross profits with lower gross margin percentages than consignment projects due to the inclusion in Solectron's operating results of sales and costs associated with the purchase and sale of components. Solectron assembles products with varying degrees of material content, which may cause Solectron's gross margin to fluctuate. In addition, the degree of start-up costs and inefficiencies associated with new sites and new customer projects may affect Solectron's gross margin. All of these factors can cause fluctuations in the Company's operating results. 31 Interest Rate Sensitivity The primary objective of the Company's investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, the Company maintains its portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations, certificates of deposit and money market funds. As of August 31, 1998, approximately 93% of the Company's total portfolio matures in one year or less, with the remainder maturing in less than two years. See Note 2 of Notes to Consolidated Financial Statements. The following table presents the amounts of the Company's cash equivalents and short-term investments that are subject to interest rate risk by year of expected maturity and average interest rates as of August 31, 1998:
1999 2000 Total Fair Value -------- -------- -------- ---------- (dollars in thousands) Cash equivalents and short- term investments $110,382 $21,275 $131,657 $131,657 Average interest rates 5.50% 5.78%
The Company's debt instruments are subject to fixed interest rates and, in the case of the convertible notes, to fixed conversion ratios into the Company's common stock. In addition, the amount of principal to be repaid at maturity is also fixed. Therefore, the Company is not subject to market risk from its debt instruments. See Note 6 of Notes to Consolidated Financial Statements. Competition The electronics manufacturing services industry is comprised of a large number of companies, several of which have achieved substantial market share. The Company also faces competition from current and prospective customers that evaluate Solectron's capabilities against the merits of manufacturing products internally. Solectron competes with different companies depending on the type of service or geographic area. Certain competitors may have greater manufacturing, financial, research and development and marketing resources than the Company. The Company believes that the primary bases of competition in its targeted markets are manufacturing technology, quality, responsiveness, the provision of value-added services and price. To be competitive, the Company must provide technologically advanced manufacturing services, high product quality levels, flexible delivery schedules and reliable delivery of finished products on a timely and price competitive basis. The Company currently may be at a competitive disadvantage as to price when compared to manufacturers with lower cost structures, particularly with respect to manufacturers with established facilities where labor costs are lower. Intellectual Property Protection The Company's ability to compete may be affected by its ability to protect its proprietary information. The Company holds a limited number of U.S. patents related to the process and equipment used in its surface mount technology. The Company's subsidiary, Force Computers, also holds a number of patents related to VME technology. The Company believes these patents are valuable. However, there can be no assurance that these patents will provide meaningful protection for the Company's manufacturing process and equipment innovations or Force's technology. 32 There can be no assurance that third parties will not assert infringement claims against the Company or its customers in the future, either against the patents the Company holds itself or against the IBM patents that the Company has access to. In the event a third party does assert an infringement claim, the Company may be required to expend significant resources to develop a non-infringing manufacturing process or technology or to obtain licenses to the manufacturing process or technology that is the subject of litigation. There can be no assurance that the Company would be successful in such development or that any such licenses would be available on commercially acceptable terms, if at all. In addition, such litigation could be lengthy and costly and could have an adverse material effect on the Company's financial condition regardless of the outcome of such litigation. Environmental Compliance The Company is subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during its manufacturing process. Any failure by the Company to comply with present and future regulations could subject it to future liabilities or the suspension of production. In addition, such regulations could restrict the Company's ability to expand its facilities or could require the Company to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. Dependence on Key Personnel and Skilled Associates The Company's continued success depends to a large extent upon the efforts and abilities of key managerial and technical associates. The loss of services of certain key personnel could have an adverse material effect on the Company. The Company's business also depends upon its ability to continue to attract and retain senior managers and skilled associates. Failure to do so could adversely affect the Company's operations. Possible Volatility of Market Price of Common Stock The trading price of the common stock is subject to significant fluctuations in response to variations in quarterly operating results, general conditions in the electronics industry and other factors. In addition, the stock market is subject to price and volume fluctuations that affect the market price for many high technology companies in particular, and that often are unrelated to operating performance. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See Management's Discussion and Analysis of Financial Condition and Results of Operations "Trend and Uncertainties -- Interest Rate Sensitivity" and "-- Foreign Exchange Rate Sensitivity." 33 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by item 8 of form 10-K is presented here in the following order: Page -------- Unaudited Quarterly Financial Information 34 Consolidated Balance Sheets 35 Consolidated Statements of Income 36 Consolidated Statements of Stockholders' Equity 37 Consolidated Statements of Cash Flows 38-39 Notes to Consolidated Financial Statements 40-56 Independent Auditors' Report 57 Unaudited Quarterly Financial Information For each fiscal quarter during the two fiscal years ended August 31, 1998 (in thousands, except percentages and per share data):
First Second Third Fourth 1998 Quarter Quarter Quarter Quarter - ---------------------- ---------- ---------- ---------- ---------- Net sales $1,136,820 $1,186,831 $1,278,167 $1,686,476 Gross profit $ 123,759 $ 126,162 $ 133,123 $ 155,262 Gross margin 10.9% 10.6% 10.4% 9.2% Operating income $ 67,438 $ 73,232 $ 72,371 $ 85,948 Operating margin 5.9% 6.2% 5.7% 5.1% Net income $ 44,888 $ 48,843 $ 49,178 $ 55,915 Basic net income per share $ 0.39 $ 0.42 $ 0.42 $ 0.48 Diluted net income per share $ 0.38 $ 0.41 $ 0.41 $ 0.46 First Second Third Fourth 1997 Quarter Quarter Quarter Quarter - ---------------------- ---------- ---------- ---------- ---------- Net sales $ 807,725 $ 858,698 $ 983,222 $1,044,740 Gross profit $ 86,148 $ 102,198 $ 115,877 $ 124,056 Gross margin 10.7% 11.9% 11.8% 11.9% Operating income $ 48,286 $ 55,563 $ 62,619 $ 69,954 Operating margin 6.0% 6.5% 6.4% 6.7% Net income $ 31,475 $ 37,565 $ 41,537 $ 47,482 Basic net income per share (1) $ 0.30 $ 0.33 $ 0.37 $ 0.42 Diluted net income per share (1) $ 0.29 $ 0.32 $ 0.36 $ 0.40
(1) All net income per share amounts have been restated to conform with the requirements of Statement of Financial Accounting Standards No. 128, "Earnings per Share." 34 SOLECTRON CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except per share data)
As of August 31, ------------------------ 1998 1997 ---------- ---------- ASSETS Current assets: Cash and cash equivalents $ 225,228 $ 225,073 Short-term investments 83,576 257,829 Accounts receivable, less allowances of $3,999 and $4,049, respectively 670,194 418,682 Inventories 788,519 494,622 Prepaid expenses and other current assets 120,041 103,426 ---------- ---------- Total current assets 1,887,558 1,499,632 Net property and equipment 448,039 326,361 Other assets 74,971 50,426 ---------- ---------- Total assets $2,410,568 $1,876,419 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 666,557 $ 415,896 Accrued employee compensation 72,053 56,218 Accrued expenses 34,906 48,787 Other current liabilities 67,318 47,041 ---------- ---------- Total current liabilities 840,834 567,942 Long-term debt 385,519 385,850 Other long-term liabilities 2,889 3,558 ---------- ---------- Total liabilities 1,229,242 957,350 ---------- ---------- Commitments Stockholders' equity: Preferred stock, $.001 par value; 1,200 shares authorized; no shares issued -- -- Common stock, $.001 par value; 200,000 shares authorized; 117,667 and 114,546 shares issued and outstanding, respectively 117 115 Additional paid-in capital 510,757 451,093 Retained earnings 677,436 478,612 Cumulative translation adjustment (6,984) (10,751) ---------- ---------- Total stockholders' equity 1,181,326 919,069 ---------- ---------- Total liabilities and stockholders' equity $2,410,568 $1,876,419 ========== ==========
See accompanying notes to consolidated financial statements. 35 SOLECTRON CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
Years Ended August 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Net sales $5,288,294 $3,694,385 $2,817,191 Cost of sales 4,749,988 3,266,106 2,534,813 ---------- ---------- ---------- Gross profit 538,306 428,279 282,378 Operating expenses: Selling, general and administrative 218,377 172,872 100,260 Research and development 20,940 14,985 6,693 Acquisition costs -- 4,000 -- ---------- ---------- ---------- Operating income 298,989 236,422 175,425 Interest income 24,753 28,536 13,302 Interest expense (24,759) (26,551) (15,650) ---------- ---------- ---------- Income before income taxes 298,983 238,407 173,077 Income taxes 100,159 80,348 58,845 ---------- ---------- ---------- Net income $ 198,824 $ 158,059 $ 114,232 ========== ========== ========== Net income per share: Basic $ 1.72 $ 1.42 $ 1.12 Diluted $ 1.65 $ 1.37 $ 1.08 Weighted average number of shares: Basic 115,833 111,502 101,676 Diluted 126,567 115,321 106,718
See accompanying notes to consolidated financial statements. 36 SOLECTRON CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
Common Stock Additional Cumulative Total ---------------- Paid-In Retained Translation Stockholders' Shares Amount Capital Earnings Adjustment Equity ------- ------- ---------- -------- ----------- ------------ Balances as of August 31, 1995 99,168 $ 99 $ 329,166 $206,321 $ 2,555 $ 538,141 Options exercised 1,238 1 10,163 -- -- 10,164 Stock issued under employee purchase plan 278 -- 4,339 -- -- 4,339 Conversion of long-term debt 3,946 4 30,398 -- -- 30,402 Stock issued in business combination 392 1 1,667 -- -- 1,668 Tax benefit associated with exercise of stock options -- -- 2,481 -- -- 2,481 Net income -- -- -- 114,232 -- 114,232 Translation adjustment -- -- -- -- (858) (858) ------- ------- ---------- -------- ----------- ------------ Balances as of August 31, 1996 105,022 105 378,214 320,553 1,697 700,569 Options exercised 3,008 3 31,316 -- -- 31,319 Stock issued under employee purchase plan 325 1 6,758 -- -- 6,759 Stock issued in business combination 6,191 6 24,012 -- -- 24,018 Tax benefit associated with exercise of stock options -- -- 10,793 -- -- 10,793 Net income -- -- -- 158,059 -- 158,059 Translation adjustment -- -- -- -- (12,448) (12,448) ------- ------- ---------- -------- ----------- ------------ Balances as of August 31, 1997 114,546 115 451,093 478,612 (10,751) 919,069 Options exercised 2,809 2 39,000 -- -- 39,002 Stock issued under employee purchase plan 312 -- 11,326 -- -- 11,326 Tax benefit associated with exercise of stock options -- -- 9,338 -- -- 9,338 Net income -- -- -- 198,824 -- 198,824 Translation adjustment -- -- -- -- 3,767 3,767 ------- ------- ---------- -------- ----------- ------------ Balances as of August 31, 1998 117,667 $ 117 $ 510,757 $677,436 $ (6,984) $ 1,181,326 ======= ======= ========== ======== =========== ============
See accompanying notes to consolidated financial statements. 37 SOLECTRON CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended August 31, --------------------------------- 1998 1997 1996 --------- --------- --------- Cash flows from operating activities: Net income $ 198,824 $ 158,059 $ 114,232 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 124,200 104,590 84,804 Interest accretion on zero- coupon subordinated notes -- -- 1,173 Interest accrual on long-term debt 27 19 12,507 Tax benefit associated with the exercise of stock options 9,338 10,793 2,481 Gain on disposal of fixed assets (2,277) -- -- Other (1,326) (7,135) (3,065) Changes in operating assets and liabilities: Accounts receivable (250,575) (66,293) (32,379) Inventories (164,058) (115,560) (27,053) Prepaid expenses and other current assets (40,424) (48,947) (234) Accounts payable 235,765 135,287 (56,784) Accrued expenses and other current liabilities 40,291 31,124 6,272 --------- --------- --------- Net cash provided by operating activities 149,785 201,937 101,954 --------- --------- --------- Cash flows from investing activities: Purchases of short-term investments (150,518) (274,160) (781,266) Sales and maturities of short-term investments 324,772 197,851 658,436 Acquisition of manufacturing locations (174,885) -- (131,893) Capital expenditures (244,375) (188,171) (115,446) Proceeds from leasing transactions 25,528 -- -- Proceeds from disposal of fixed assets 34,692 10,639 8,694 Other (14,394) 16,637 9,806 --------- --------- --------- Net cash used in investing activities (199,180) (237,204) (351,669) --------- --------- --------- Cash flows from financing activities: Proceeds from bank lines of credit -- -- 6,340 Proceeds from long-term debt -- -- 380,000 Debt acquisition costs -- -- (7,808) Repayments of long-term debt (1,205) (3,079) (4,796) Net proceeds from sale of common stock 50,328 38,078 14,503 Other (2,184) -- -- --------- --------- --------- Net cash provided by financing activities 46,939 34,999 388,239 --------- --------- ---------
(continued) 38 SOLECTRON CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (In thousands)
Years Ended August 31, --------------------------------- 1998 1997 1996 --------- --------- --------- Effect of exchange rate changes on cash and cash equivalents 2,611 (3,489) 347 --------- ---------- --------- Net increase (decrease) in cash and cash equivalents 155 (3,757) 138,871 Cash and cash equivalents at beginning of year 225,073 228,830 89,959 --------- --------- --------- Cash and cash equivalents at end of year $ 225,228 $ 225,073 $ 228,830 ========= ========= ========= Cash paid: Interest $ 24,999 $ 38,306 $ 517 Income taxes $ 75,817 $ 93,420 $ 54,937 Non-cash investing and financing activities: Issuance of common stock upon conversion of long-term debt $ -- $ -- $ 30,402 Issuance of common stock for business combination $ -- $ 24,018 $ 1,668
See accompanying notes to consolidated financial statements. 39 SOLECTRON CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS August 31, 1998 and 1997 Note 1: Summary of Significant Accounting Policies (a) Description of Operations and Principles of Consolidation: Solectron Corporation (the Company) is an independent provider of customized manufacturing services to original equipment manufacturers in the electronics industry and operates in this one industry segment. The Company's primary services include the manufacture and testing of printed circuit board assemblies as well as system level assembly and testing. The Company also provides materials procurement and materials management in support of its manufacturing, assembly and testing services. In addition, the Company provides consultation on board design and manufacturability and performs refurbishment, packaging and remanufacturing services. Manufacturing and assembly services include turnkey services, where the Company procures certain or all of the materials required for product assembly, and consignment services, where the customer supplies the materials necessary for product assembly. Turnkey services include material procurement and warehousing in addition to manufacturing and involve greater resource investment than consignment services. The Company has manufacturing operations located in North America, Europe, Asia and Latin America. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany accounts and transactions. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (b) Cash Equivalents and Short-Term Investments: Cash equivalents are highly liquid investments purchased with an original maturity of less than three months. Short-term investments are investment grade short- term debt instruments with original maturities greater than three months. Investments in debt securities are classified as "available-for-sale." Such investments are recorded at fair value, as determined from quoted market prices, and the cost of securities sold is determined based on the specific identification method. If material, unrealized gains and losses are reported as a component of stockholders' equity. (c) Inventories: Inventories are stated at the lower of weighted average cost or market. 40 (d) Property and Equipment: Property and equipment are recorded at cost. Depreciation and amortization are computed based on the shorter of the estimated useful lives or the related lease terms, using the straight-line method. Estimated useful lives are presented below. Machinery and equipment 2 - 5 years Furniture and fixtures 3 - 5 years Leasehold improvements Lease term Buildings 6 -50 years (e) Other Assets: Other assets consist of intangible assets, including intellectual property rights and goodwill, and debt issuance costs. Intangible assets are amortized using the straight-line method over the expected life of the asset -- ten years for intellectual property rights and ten years for goodwill. Debt issuance costs are amortized using the straight-line method, which does not differ materially from the interest method, over the debt term (ten years). (f) Impairment of Long-Lived Assets: The Company reviews property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property and equipment is measured by comparison of its carrying amount, including the unamortized portion of goodwill allocated to the property and equipment, to future net cash flows the property and equipment are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property and equipment, including the allocated goodwill, if any, exceeds its fair market value. The Company assesses the recoverability of enterprise level goodwill by determining whether the unamortized goodwill balance can be recovered through undiscounted future cash flows of the acquired operation. The amount of enterprise level goodwill impairment, if any, is measured based on projected discounted future cash flows using a discount rate reflecting the Company's average cost of funds. To date, no adjustments to the carrying value of the Company's long-lived assets have been required. (g) Income Taxes: The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. When necessary, a valuation allowance is recorded to reduce tax assets to an amount whose realization is more likely than not. The effect of changes in tax rates is recognized in the period in which the rate change occurs. (h) Net Income Per Share: Basic and diluted net income per share amounts for all periods presented have been calculated, and where necessary restated, to conform to the requirements of Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." Basic net income per share is calculated using the weighted average number of common shares outstanding during the period. Diluted net income per share is calculated using the weighted average number of common shares plus dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of stock options that are computed using the treasury stock method and shares issuable upon conversion of the Company's outstanding convertible notes computed using the as-if converted method. (i) Revenue Recognition: The Company recognizes revenue upon shipment of product to its customers. 41 (j) Employee Stock Plans: The Company accounts for its stock option plans and its Employee Stock Purchase Plan using the intrinsic value method. (k) Foreign Currency: Assets and liabilities of foreign subsidiaries where the local currency is the functional currency are translated at year-end exchange rates. The effects of these translation adjustments are reported as a separate component of stockholders' equity. Exchange gains and losses arising from transactions denominated in a currency other than the functional currency of the entity involved and remeasurement adjustments for foreign operations where the United States dollar is the functional currency are included in income. To date, the effect of such amounts on net income has not been material. (l) Derivatives: Gains and losses on foreign currency forward exchange contracts designated as hedges of assets and liabilities are included in income concurrently with the offsetting losses and gains on the related balance sheet item. Gains and losses on hedges of firm commitments and anticipated transactions are deferred and included in the basis of the transaction when it occurs. (m) Year-End: The Company's financial reporting year consists of either 52-week or 53-week periods ending on the last Friday in August. Fiscal years 1998 and 1997 each contained 52 weeks, and fiscal year 1996 contained 53 weeks. For purposes of presentation in the accompanying financial statements and notes thereto, the Company has indicated its accounting years as ending on August 31. The Company's subsidiaries, Solectron Texas, Inc. (Texas) and Solectron Brasil, Ltda. (Brazil) report their results one month in arrears. The Company's consolidated financial position as of August 31, 1998 includes the financial position of the Texas and Brazil operations as of July 31, 1998 and the Company's consolidated financial position as of August 31, 1997 includes the financial position of the Texas operation as of July 31, 1997. Similarly, the Company's consolidated results of operations and cash flows for the year ended August 31, 1998 include the results of operations and cash flows of the Texas and Brazil operations for the twelve months ended July 31, 1998. The Company's consolidated results of operations and cash flows for the years ended August 31, 1997 and 1996 include the results of operations and cash flows of the Texas operation for the twelve months ended July 31, 1997 and the four-month period since its acquisition ended July 31, 1996, respectively. (n) Recent Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. The Company expects that the adoption of SFAS No. 133 will have no material impact on its financial position, results of operations or cash flows. The Company will be required to implement SFAS No. 133 for its fiscal year ending August 31, 2000. 42 In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 requires that entities capitalize certain costs related to internal-use software once certain criteria have been met. The Company has not yet determined the impact of SOP 98-1 on its financial position, results of operations and cash flows. The Company will be required to implement SOP 98-1 for its fiscal year ending August 31, 2000. In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5 requires that all start-up costs related to new operations must be expensed as incurred. In addition, all start- up costs that were capitalized in the past must be written off when SOP 98-5 is adopted. The Company expects that the adoption of SOP 98-5 will have no material impact on its financial position, results of operations or cash flows. The Company will be required to implement SOP 98-5 for its fiscal year ending August 31, 2000. (o) Reclassifications: Certain prior year amounts have been reclassified to conform to the 1998 presentation. Note 2: Cash, Cash Equivalents and Short-Term Investments Cash, cash equivalents and short-term investments consisted of the following at August 31:
Cash and Cash Short-Term Equivalents Investments ------------- ----------- (in thousands) 1998 - ------- Cash $ 91,527 $ -- Money market funds 74,225 -- Certificates of deposit 42 11,353 Municipal market auction securities 800 -- U.S. government securities 27,778 47,118 Corporate obligations 6,026 17,509 Municipal obligations 5,424 -- Other 19,406 7,596 -------- -------- $225,228 $ 83,576 ======== ======== 1997 - ------- Cash $ 39,725 $ -- Money market funds 81,350 -- Certificates of deposit 9,822 23,249 Municipal market auction securities 7,723 -- Corporate market auction securities 14,206 -- U.S. government securities 6,685 173,304 Corporate obligations 58,422 51,542 Municipal obligations 7,140 -- Other -- 9,734 -------- -------- $225,073 $257,829 ======== ========
43 Short-term investments are carried at fair market value, which approximates cost. As of August 31, 1998 and 1997, unrealized gains and losses were not material. Realized gains and losses for the years ended August 31, 1998, 1997 and 1996 were not material. As of August 31, 1998, all of the Company's short-term investments mature within two years. Note 3: Inventories Inventories as of August 31, 1998 and 1997 consisted of:
1998 1997 -------- -------- (in thousands) Raw materials $577,764 $365,630 Work-in-process 210,755 128,992 -------- -------- $788,519 $494,622 ======== ========
Note 4: Property and Equipment Property and equipment as of August 31, 1998 and 1997 consisted of:
1998 1997 -------- -------- (in thousands) Land $ 23,074 $ 18,070 Buildings and improvements 94,012 46,441 Machinery and equipment 531,310 432,963 Furniture and fixtures 106,353 76,485 Leasehold improvements 46,653 41,647 Construction-in-progress 58,429 33,171 -------- -------- 859,831 648,777 Less accumulated depreciation and amortization 411,792 322,416 -------- -------- Net property and equipment $448,039 $326,361 ======== ========
Note 5: Lines of Credit The Company has available a $100 million unsecured multicurrency revolving line of credit that expires April 30, 2002. Borrowings under the credit facility bear interest, at the Company's option, at either the bank's prime rate, the London interbank offering rate (LIBOR) plus a margin, or the bank's certificate of deposit (CD) rate plus a margin. The margin under the LIBOR or CD rate options will vary depending on the Company's Standard & Poor's Corporation and/or Moody's Investor Services, Inc. rating for its long-term senior unsecured debt and was 0.4% at August 31, 1998. Under the agreement, the Company must meet certain financial covenants. As of August 31, 1998 and 1997, there were no borrowings outstanding under this line of credit. The Company also has $114.9 million in foreign lines of credit and other bank facilities. Borrowings are payable on demand. The interest rates range from the bank's prime lending rate to the bank's prime rate plus 2.0%. As of August 31, 1998, borrowings and guaranteed amounts under these lines of credit were $22.7 million, which had a weighted-average interest rate of 4.9% per annum. 44 The Company has entered into an asset securitization arrangement with a bank under which it may sell up to $120 million of eligible accounts receivable. The arrangement is subject to certain financial covenants and management representations. The arrangement expires in August 1999. No transaction has occurred under this arrangement. Note 6: Long-Term Debt Long-term debt at August 31, 1998 and 1997 consisted of:
1998 1997 -------- -------- (in thousands) 6% subordinated notes due 2006, face value $230,000, fair value of $333,500 in 1998 and $318,274 in 1997. Convertible into 6,804 shares of common stock $230,000 $230,000 7 3/8% senior notes due 2006, face value $150,000, fair value of $157,680 in 1998 and $149,300 in 1997 149,771 149,745 Other, fair value of $5,748 in 1998 and $6,105 in 1997 5,748 6,105 -------- -------- Total long-term debt $385,519 $385,850 ======== ========
In February 1996, the Company issued convertible, subordinated notes for an aggregate principal amount of $230 million. These notes are in denominations of and have a maturity value of $1,000 each, payable on March 1, 2006. Interest is payable semi-annually at a rate of 6% per annum. The notes are subordinated to all existing and future senior indebtedness of the Company. Each note is convertible at any time by the holder into shares of common stock at a conversion price of $33.81 per share. Beginning on March 3, 1999, the notes are redeemable for cash at the option of the Company, in whole or in part, at redemption prices ranging from 104.2% of the principal amount in 1999 to 100% of the principal amount in 2006. Upon a change in control of the Company, each holder of the notes has the right to require the Company to repurchase the notes for 100% of the principal amount. In March 1996, the Company issued $150 million aggregate principal amount of senior notes. The notes are in denominations of and have a maturity value of $1,000 each and are due on March 1, 2006. Interest is payable semi-annually at a rate of 7 3/8% per annum. The notes may not be redeemed prior to maturity. Note 7: Financial Instruments Fair Value of Financial Instruments The fair value of the Company's cash, cash equivalents, accounts receivable and accounts payable approximates the carrying amount due to the relatively short maturity of these items. The fair value of the Company's short-term investments (see Note 2) is determined based on quoted market prices. The fair value of the Company's long-term debt (see Note 6) is determined based on broker trading prices. 45 Derivatives The Company enters into forward exchange contracts to hedge foreign currency exposures on a continuing basis for periods consistent with its committed exposures. These transactions generally do not subject the Company to risk of accounting loss because gains and losses on these contracts offset losses and gains on the assets, liabilities and transactions being hedged. The Company is exposed to credit-related losses in the event of non-performance by the parties in these contracts. The counterparties to these contracts are substantial and credit-worthy multinational commercial banks. The risk of counterparty non-performance associated with these contracts is remote. Because these contracts have maturities of less than six months, the amounts of unrealized gains and losses are immaterial. The Company had $31.3 million and $75.6 million of aggregate foreign currency forward exchange contracts outstanding at the end of fiscal years 1998 and 1997, respectively, primarily for the purchase and sale of European currencies, the Japanese yen, the Malaysian ringgit and the U.S. dollar by the Company's international subsidiaries. Business and Credit Concentrations Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, short- term investments and trade accounts receivable. The Company's cash, cash equivalents and short-term investments are managed by recognized financial institutions that follow the Company's investment policy. The Company's investments are comprised of investment grade short-term debt instruments, and the Company's investment policy limits the amount of credit exposure in any one issue. Concentrations of credit risk in accounts receivable resulting from sales to major customers are discussed in Note 13. The Company generally does not require collateral for sales on credit. The Company closely monitors extensions of credit and has not experienced significant credit losses in the past. Note 8: Commitments The Company leases various facilities under operating lease agreements. The facility leases expire at various dates through 2006. Substantially all leases require the Company to pay property taxes, insurance and normal maintenance costs. Payments under certain leases are periodically adjusted based on LIBOR rates. The leases for certain of the Company's facilities in Milpitas and San Jose, California, and Everett, Washington, provide the Company with the option at the end of each of the leases of either acquiring the property at its original cost or arranging for the property to be acquired. The Company is contingently liable under a first loss clause for a decline in market value of these leased facilities totaling up to $93.1 million in the event the Company does not purchase the properties at the ends of the lease terms. The Company must also maintain compliance with financial covenants similar to its credit facilities. During fiscal 1998, the Company entered into an arrangement with a third-party leasing company under which certain of the Company's fixed assets with a carrying value of approximately $31.3 million were sold to the leasing company and leased back. The Company is accounting for these transactions as operating leases. 46 Future minimum payments related to lease obligations, including the $93.1 million contingent liability discussed above, are $39.5 million, $29.8 million, $20.9 million, $65.1 million and $44.9 million in each of the years in the five-year period ending August 31, 2003 and an aggregate $2.6 million for periods after that date. Rent expense was $33.3 million, $22.9 million and $17.0 million for the years ended August 31, 1998, 1997 and 1996, respectively. Note 9: Retirement Plans The Company has various retirement plans that cover a significant number of its associates. The major pension plans are defined contribution plans, which provide pension benefits in return for services rendered, provide an individual account for each participant, and have terms that specify how contributions to the participant's account are to be determined rather than the amount of pension benefits the participant is to receive. Contributions to these plans are based on varying percentages of each participant's base salary. The Company's expense for the defined contribution plans totaled $4.5 million, $3.0 million and $2.3 million, in 1998, 1997 and 1996, respectively. Note 10: Income Taxes The components of income taxes for the years ended August 31, 1998, 1997 and 1996 were as follows (in thousands):
1998 1997 1996 -------- -------- -------- Current: Federal $ 74,123 $ 62,618 $ 48,817 State 15,319 10,923 7,151 Foreign 14,611 5,944 4,204 -------- -------- -------- 104,053 79,485 60,172 -------- -------- -------- Deferred: Federal (7,819) (8,808) (2,579) State (1,586) (1,067) (233) Foreign (3,827) (55) (996) -------- -------- -------- (13,232) (9,330) (3,808) -------- -------- -------- Charge in lieu of taxes attributable to employee stock plans 9,338 10,793 2,481 -------- -------- -------- Total $100,159 $ 80,348 $ 58,845 ======== ======== ========
47 The overall effective income tax rate (expressed as a percentage of financial statement income before income taxes) differed from the expected U.S. income tax rate for the years ended August 31, 1998, 1997 and 1996 as follows:
1998 1997 1996 ------- ------- ------- Federal tax rate 35.0% 35.0% 35.0% State income tax, net of federal tax benefit 3.2 3.1 2.8 Tax exempt interest -- -- (0.1) Income of international subsidiaries taxed at different rates (0.9) 0.2 0.5 Tax holiday (7.1) (3.8) (5.0) Other 3.3 (0.8) 0.8 ---- ---- ---- Effective income tax rate 33.5% 33.7% 34.0% ==== ==== ====
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of August 31, 1998 and 1997 were as follows (in thousands):
1998 1997 -------- -------- Deferred tax assets: Accruals, allowances and reserves $ 18,696 $ 14,240 State income tax 6,137 3,054 Pre-operating costs 14 15 Acquired intangible assets 1,926 2,039 Net undistributed profits of subsidiaries 2,220 1,635 Plant and equipment 5,839 1,778 Other 3,413 2,976 -------- -------- Total deferred tax assets 38,245 25,737 -------- -------- Deferred tax liabilities: Other (359) (1,083) -------- -------- Total deferred tax liabilities (359) (1,083) -------- -------- Net deferred tax assets $ 37,886 $ 24,654 ======== ========
Based on the Company's historical operating income, management believes it is more likely than not that the Company will realize the benefit of the deferred tax assets recorded and, accordingly, has established no valuation allowance. Worldwide income before income taxes for the years ended August 31, 1998, 1997 and 1996 consisted of the following (in thousands):
1998 1997 1996 -------- -------- -------- U.S. $216,979 $198,029 $140,900 Non-U.S. 82,004 40,378 32,177 -------- -------- -------- Total $298,983 $238,407 $173,077 ======== ======== ======== 48 During the fiscal year ended August 31, 1997, the Company adopted a change regarding undistributed earnings of its German subsidiaries, which previously were deemed to be permanently reinvested. The effect of this change was the recognition of net deferred tax assets for foreign tax credit utilization of approximately $0.6 million and $1.6 million for the years ended August 31, 1998 and 1997, respectively. Cumulative undistributed earnings of the international subsidiaries amounted to $210.6 million as of August 31, 1998, of which approximately $195.6 million is intended to be permanently reinvested. The amount of income tax liability that would result had such earnings been repatriated is estimated to be approximately $46.3 million. The Company has been granted a tax holiday for its Malaysia sites which is effective through January 31, 2002, subject to certain conditions. The Company has also been granted various tax holidays in China, which are effective for various terms and are subject to certain conditions. Note 11: Stockholders' Equity Pro Forma Fair Value Disclosures The Company accounts for its employee stock plans, consisting of fixed stock option plans and an employee stock purchase plan, using the intrinsic value method. Accordingly, no compensation expense related to these plans has been recognized in the Company's financial statements. The table below sets out the pro forma amounts of net income and net income per share that would have resulted for the years ended August 31, 1998, 1997 and 1996 if the Company accounted for its employee stock plans under the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation."
1998 1997 1996 -------- -------- -------- (in thousands, except per share data) Net income As reported $198,824 $158,059 $114,232 Pro forma $173,559 $144,786 $108,905 Net income per share: Basic As reported $ 1.72 $ 1.42 $ 1.12 Pro forma $ 1.50 $ 1.30 $ 1.07 Diluted As reported $ 1.65 $ 1.37 $ 1.08 Pro forma $ 1.46 $ 1.27 $ 1.03 49 For purposes of computing pro forma net income, the fair value of each option grant and Employee Stock Purchase Plan purchase right is estimated on the date of grant using the Black-Scholes option pricing model. The assumptions used to value the option grants and purchase rights are stated below.
1998 1997 1996 ---------------- ---------------- ---------------- Expected life of options 4 years 4.3 years 4.3 to 4.7 years Expected life of purchase rights 3 months 3 months 3 months Volatility 44% 40% 40% Risk-free interest rate 5.1% to 5.9% 5.2% to 6.5% 5.1% to 6.7% Dividend yield zero zero zero
Options vest over several years and new option grants are generally made each year. Because of this and because the provisions of SFAS No. 123 are effective only for fiscal years 1998, 1997 and 1996, the pro forma amounts shown above may not be representative of the pro forma effect on reported net income in future years. Stock Option Plans The Company's stock option plans provide for grants of options to associates to purchase common stock at the fair market value of such shares on the grant date. The options vest over a four-year period beginning generally on the grant date. The term of the options is five years for options granted prior to November 17, 1993 and seven years for options granted thereafter. In connection with the acquisition of Force Computers, Inc. (see Note 15), the Company assumed all options outstanding under the Force option plan, after the application of the exchange ratio. Options under the Force plan generally vest over a four-year period beginning on the grant date and have a ten-year term. No further options may be granted under the Force plan. 50 A summary of stock option activity under the plans for the years ended August 31, 1998, 1997 and 1996 follows:
1998 1997 1996 ------------------ ------------------ ------------------ Weighted Weighted Weighted Number Average Number Average Number Average of Exercise of Exercise of Exercise Shares Price Shares Price Shares Price --------- -------- --------- -------- --------- -------- Outstanding, beg. of year 10,229,510 $18.99 9,431,576 $14.82 7,983,680 $11.69 Granted 2,676,682 $44.86 3,403,074 $26.82 3,173,878 $20.10 Assumed from Force plan -- -- 839,264 $ 2.20 -- -- Exercised (2,809,115) $14.82 (3,007,754) $ 9.76 (1,237,774) $ 8.22 Canceled (630,743) $28.16 (436,650) $21.03 (488,208) $15.07 ---------- ---------- ---------- Outstanding, end of year 9,466,334 $26.93 10,229,510 $18.99 9,431,576 $14.82 ========== ========== ========== Exercisable at year-end 4,735,145 $20.72 5,181,725 $15.85 5,023,686 $12.48 ========== ========== ========== Weighted-average fair value of options granted during the year $18.61 $11.23 $ 8.47
Information regarding the stock options outstanding at August 31, 1998 is summarized in the table below.
Outstanding Exercisable ---------------------------------- --------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number of Contractual Exercise Number of Exercise Prices Shares Life Price Shares Price - ------------- ----------- ----------- -------- ----------- -------- $ 1.32-$ 5.14* 163,929 7.23 years $ 3.73 48,089 $ 3.20 $13.31-$19.00 3,292,447 2.94 years $16.08 2,786,199 $15.71 $20.38-$23.94 2,180,878 4.37 years $23.04 1,087,925 $22.91 $24.50-$29.63 1,140,920 5.30 years $27.85 383,793 $28.40 $37.16-$39.94 478,119 6.04 years $38.38 103,604 $38.04 $41.38-$50.75 2,210,041 6.38 years $45.70 325,535 $44.25 ---------- --------- $ 1.32-$50.75 9,466,334 4.59 years $26.93 4,735,145 $20.72 ========== =========
*Options in this range of exercise prices represent the options assumed in connection with the acquisition of Force. A total of 12,576,596 shares of common stock remain reserved for issuance under the plans as of August 31, 1998. On December 1 of each year, each independent member of the Company's Board of Directors is granted an option to purchase 6,000 shares of common stock at the then current fair market value. Such options vest over one year. 51 Employee Stock Purchase Plan Under the Company's Employee Stock Purchase Plan (the Purchase Plan), associates meeting specific employment qualifications are eligible to participate and can purchase shares quarterly through payroll deductions at the lower of 85% of the fair market value of the stock at the commencement or end of the offering period. The Purchase Plan permits eligible associates to purchase common stock through payroll deductions for up to 10% of qualified compensation. As of August 31, 1998, 2,155,194 shares remain available for issuance under the Purchase Plan. The weighted-average fair value of the purchase rights granted in fiscal 1998, 1997 and 1996 was $9.98, $5.92 and $4.72, respectively. Note 12: Geographic Information Information about the Company's operations in different geographic regions is presented in the table below:
Operating Identifiable Net Sales Income Assets ---------- --------- ------------ (in thousands) Fiscal 1998: North America $3,857,545 $247,791 $1,562,667 Europe 1,067,231 37,142 461,639 Asia and other 363,518 14,056 386,262 ---------- -------- ---------- $5,288,294 $298,989 $2,410,568 ========== ======== ========== Fiscal 1997: North America $2,862,941 $200,664 $1,357,189 Europe 580,486 22,157 312,552 Asia and other 250,958 13,601 206,678 ---------- -------- ---------- $3,694,385 $236,422 $1,876,419 ========== ======== ========== Fiscal 1996: North America $1,981,788 $142,470 $1,117,875 Europe 490,606 7,775 224,172 Asia and other 344,797 25,180 110,151 ---------- -------- ---------- $2,817,191 $175,425 $1,452,198 ========== ======== ==========
Net sales and operating income reflect the destination of the product shipped. 52 Note 13: Major Customers Net sales to major customers as a percentage of consolidated net sales for the years ended August 31, 1998, 1997 and 1996 were as follows:
1998 1997 1996 ------ ------ ------ Hewlett-Packard Corporation 14% 14% 11% Cisco Systems, Inc. 11% * * Sun Microsystems, Inc. 11% * * Nortel Networks, Inc. (formerly Bay Networks, Inc.) * 10% * --------------------------- * net sales less than 10%
The Company has concentrations of credit risk as a result of sales to these and other of the Company's significant customers. In particular, Hewlett-Packard Corporation accounts for approximately 13% of total accounts receivable at August 31, 1998. The concentration of credit risk is intensified due to the fact that the majority of the Company's customers are in the same industry. The Company has considered its concentrations of credit risk in establishing its reserves for bad debt and considers such reserves to be adequate. Note 14: Purchase of Assets In October 1997, the Company acquired certain assets, primarily equipment and inventory, of Ericsson Telecom AB's Business Area Infocom Systems' (Ericsson) printed circuit board assembly operation located in Sao Paulo, Brazil. The acquisition was accounted for as a purchase of assets and the purchase price was allocated to the assets acquired based on the relative fair values of the assets at the date of acquisition. Under the terms of the agreement, Ericsson will contract for the Company's services through its subsidiary, Solectron Brasil Ltda. through September 1999. In addition Solectron Brasil Ltda. hired approximately 370 associates formerly employed by Ericsson. In April 1998, the Company acquired NCR Corporation's (NCR) manufacturing assets in three cities for a purchase price of approximately $79.5 million, subject to adjustment. The acquisition was accounted for as a purchase of assets and the purchase price was allocated to the assets acquired based on the relative fair values of the assets at the date of acquisition. Under the terms of the agreement, NCR will outsource the manufacturing of certain of its computer, computer peripheral and server components to Solectron for at least five years and Solectron hired approximately 1,200 NCR manufacturing and related support associates. In June 1998, the Company acquired International Business Machines Corporation's (IBM) Electronic Card Assembly and Test (ECAT) manufacturing assets in Charlotte, North Carolina. In addition, the Company acquired non-exclusive rights to certain IBM intellectual property. The total purchase price for the manufacturing assets and the intellectual property rights was approximately $95.4 million, subject to adjustment. The transaction was accounted for as a purchase of assets, and the purchase price was allocated to the assets acquired based on the relative fair values of the assets at the date of acquisition. Approximately $17.0 million of the purchase price was allocated to the intellectual property rights, which will be amortized on a straight-line basis over ten years. 53 Under the terms of the agreement, Solectron hired approximately 700 IBM manufacturing and related support associates and the Company will provide printed circuit board assembly services to IBM in North America for the next three years. In addition, IBM has made available to Solectron 115 patents and 51 disclosures (collectively the intellectual property rights) covering a wide spectrum of technologies and capabilities. IBM will also provide to Solectron failure analysis and characterization tools for process development and manufacturing, including fault detection and isolation. Note 15: Business Combinations Poolings of Interests In November 1996, the Company exchanged approximately 6.2 million shares of common stock for all of the outstanding stock of Force Computers, Inc. (Force) and assumed all of the outstanding options of Force after giving effect to the exchange ratio. Force is a designer and provider of computer platforms for the embedded market. This transaction was accounted for under the pooling of interests method. The results of operations of Force prior to its acquisition were not material to the Company's consolidated results of operations. Accordingly, the Company's historical financial statements have not been restated to reflect the financial position and results of operations of Force, and pro forma financial information has not been disclosed. The Company incurred transaction expenses of $4.0 million directly related to the acquisition of Force. In March 1996, the Company exchanged common stock and common stock options for all of the outstanding stock and options of Fine Pitch Technology, Inc. (Fine Pitch), a provider of prototype services. This transaction was accounted for under the pooling of interests method. The results of operations of Fine Pitch prior to its acquisition were not material to the Company's consolidated results of operations. Accordingly, the Company's historical financial statements have not been restated to reflect the financial position and results of operations of Fine Pitch, and pro forma financial information has not been disclosed. Purchases In March 1996, the Company completed its purchase of Texas Instruments Incorporated's Custom Manufacturing Services (CMS) business. This business, principally located in Austin, Texas, was acquired for approximately $132 million. Under the terms of the agreement, Solectron purchased the CMS business in Austin, Texas and certain assets of the CMS business in Kuala Lumpur, Malaysia (collectively the CMS operations). The Company subsequently has moved the CMS business in Kuala Lumpur to Solectron's Penang, Malaysia operations. This transaction was accounted for under the purchase method of accounting. The acquisition resulted in goodwill of approximately $38 million, which is being amortized on a straight-line basis over 10 years. 54 The following pro forma financial information gives effect to the acquisition of the CMS operations on a purchase accounting basis for the year ended August 31, 1996, as if the CMS operations had been acquired at the beginning of that period. The preparation of this financial information requires the use of management's estimates. This pro forma financial information includes certain adjustments for goodwill amortization, increased depreciation expense, a decrease in interest income (related to the assumed liquidation of certain current investments for the purchase of the CMS operations) and the related income tax effects. This pro forma combined information is not purported to be indicative of the results that would have actually been obtained if the combination had been in effect during the periods indicated, or that may be obtained in the future. In addition, it does not reflect the effects of any synergy that might be achieved from the newly combined operations. Pro forma financial information: Year Ended August 31, 1996 ---------- (in thousands, except per share data) Net sales $3,152,962 Net income $ 115,085 Net income per share: Basic $ 1.13 Diluted $ 1.09 55 16. Net Income per Share The following table sets forth the computation of basic and diluted net income per share for the years ended August 31, 1998, 1997 and 1996.
1998 1997 1996 -------- -------- -------- (in thousands, except per share data) Net income - basic $198,824 $158,059 $114,232 Interest expense from convertible subordinated notes, net of taxes 9,593 -- 739 -------- -------- -------- Net income - diluted $208,417 $158,059 $114,971 ======== ======== ======== Weighted average shares - basic 115,833 111,502 101,676 Common stock equivalents-stock options 3,930 3,819 2,578 Common shares issuable upon assumed conversion of convertible subordinated notes 6,804 -- 2,464 -------- -------- -------- Weighted average shares - diluted 126,567 115,321 106,718 ======== ======== ======== Net income per share - basic $ 1.72 $ 1.42 $ 1.12 ======== ======== ======== Net income per share - diluted $ 1.65 $ 1.37 $ 1.08 ======== ======== ========
For the years ended August 31, 1998, 1997 and 1996 options to purchase 2.1 million, 0.5 million and 1.3 million shares, respectively, of common stock with exercise prices greater than the average fair market value of the Company's stock for the period of $42.52, $29.59 and $20.22, respectively, were not included in the calculation because the effect would have been antidilutive. In addition, the calculations for the years ended August 31, 1997 and 1996 did not include the 6.8 million common shares issuable upon conversion of the convertible subordinated notes as they would also have been antidilutive. 56 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Solectron Corporation: We have audited the accompanying consolidated balance sheets of Solectron Corporation and subsidiaries as of August 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended August 31, 1998. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the Index at Item 14(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Solectron Corporation and subsidiaries as of August 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended August 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Mountain View, California September 14, 1998 57 ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable 58 PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT Solectron's executive officers and directors and their ages as of August 31, 1998 are as follows: Name Age Position - ---------------------------- ------ ------------------------------- Koichi Nishimura, Ph.D. 60 President, Chief Executive Officer and Chairman of the Board David Kynaston 57 Vice President and President Solectron Europe Stephen T. Ng 43 Senior Vice President and Chief Materials Officer Leslie T. Nishimura * 54 Senior Vice President and President Solectron Washington, Inc. Ken Tsai 55 Senior Vice President and President Solectron Asia Susan S. Wang 47 Senior Vice President, Chief Financial Officer and Secretary Walter W. Wilson 54 Senior Vice President and President Solectron Americas Saeed Zohouri, Ph.D. 47 Senior Vice President, Chief Technology Officer and President Solectron North America Winston H. Chen, Ph.D. (4) 57 Director Richard A. D'Amore (4) 45 Director Charles A. Dickinson (3)(4)(5) 74 Director Heinz Fridrich (1)(2)(5) 65 Director Philip V. Gerdine, Ph.D. (2) 59 Director William A. Hasler (3)(5) 56 Director Kenneth E. Haughton, Ph.D. (3) 70 Director Paul R. Low, Ph.D. (1)(2) 65 Director Osamu Yamada (4) 69 Director - --------------- * Resigned from the Company in September 1998. (1) Member of the Audit Committee, which was replaced by the Audit and Finance Committee effective September 1, 1998. (2) Member of the Audit and Finance Committee. (3) Member of the Compensation Committee (4) Member of the Nominating Committee (5) Member of Information Technology Committee 59 Dr. Koichi Nishimura has served as a director since 1991, Chairman of the Board since September 1996, Chief Executive Officer since 1992 and President since 1990. He was Co-Chief Executive Officer from 1991 to 1992 and Chief Operating Officer from 1988 to 1991. From 1964 to 1988, Dr. Nishimura was employed by International Business Machines Corporation (IBM) in various technology and management positions. He also serves as a director of Merix Corporation. Mr. David Kynaston joined Solectron in February 1996 as Vice President and President of Solectron Europe. Mr. Kynaston worked for Philips Electronics for the previous 15 years in various capacities, including Managing Director of Philips Mullard Ltd. subsidiary, Managing Director of the Business Communications Systems Division and most recently, Managing Director of the Private Mobile Radio Division. Mr. Kynaston has also held senior technical management positions at EMI Medical Ltd. and Cambridge Scientific Instruments Ltd. Mr. Stephen T. Ng joined Solectron in September 1989 as Vice President, Worldwide Material Purchasing and is currently Senior Vice President and Chief Materials Officer of Solectron. Prior to joining Solectron, Mr. Ng had 11 years experience in materials management in various capacities with Xerox Corporation. His last position prior to joining Solectron was Manager, Material Operations at Xerox Corporation. Mr. Leslie T. Nishimura, a founder of the Company, resigned from the Company in September 1998. He had served as Senior Vice President of Solectron since 1989, President of Solectron Asia from 1991 to 1993, Secretary of Solectron from 1989 to 1992 and Vice President, Manufacturing Technology of Solectron from 1978 to 1989. Mr. Nishimura's prior experience includes various materials, production control and inventory control supervisory positions at Ritter Co., Burndy Corporation and the Norden Division of United Technologies, Inc. Mr. Ken Tsai is President of Solectron Asia and has served as Senior Vice President of Solectron since May 1995. Mr. Tsai was Vice President of Solectron from 1990 to 1995. He served as Director of Manufacturing for Solectron from 1989 to 1990 and in various manufacturing and other positions from 1984 to 1989. Prior to joining Solectron, Mr. Tsai served in various management and business planning positions at American Cyanamid Company from 1968 to 1984. Ms. Susan S. Wang has served as Senior Vice President and Chief Financial Officer of Solectron since 1990 and as Secretary since 1992. She was Vice President, Finance and Chief Financial Officer of Solectron from 1986 to 1990 and Director of Finance of Solectron from 1984 to 1986. Prior to joining Solectron, Ms. Wang held various accounting and finance positions with Xerox Corporation. Ms. Wang also held accounting and auditing positions with Westvaco Corp. and Price Waterhouse & Co. She is a Certified Public Accountant. Mr. Walter W. Wilson has served as President, Solectron Americas since April 1997, President, Solectron North America from September 1995 to March 1997, President Solectron California Corporation from March 1992 to February 1996 and Senior Vice President of Solectron since 1990. From 1989 to 1990 he served as an operational Vice President of Solectron. From 1965 to 1989 Mr. Wilson was employed by IBM in manufacturing and product development. During his IBM tenure, he held management positions in the United States, West Germany and Japan. 60 Dr. Saeed Zohouri has served as Senior Vice President and Chief Technology Officer since 1994, President Solectron California Corporation from March 1996 to August 1998 and President, Solectron North America since August 1998. Dr. Zohouri joined Solectron in 1980; he has held various management positions and has also served as Director of Technology. His prior experience includes teaching chemistry at a major international university. Dr. Winston H. Chen is a founder of the Company and has served as a director of Solectron since 1978, Chairman of the Board from 1990 to 1994, President from 1979 to 1990, Chief Executive Officer from 1984 to 1991 and as Co-Chief Executive Officer from 1991 through 1992. Dr. Chen is currently Chairman of the Paramitas Foundation. From 1970 to 1978, Dr. Chen served as Process Technology and Development Manager of IBM. He also serves as a director of Intel Corporation and Edison International. Mr. Richard A. D'Amore has served as a director of Solectron since 1985. Mr. D'Amore has been a general partner of North Bridge Venture Partners since 1992. He also serves as a director of Math Soft, Inc., VEECO Instruments, Inc. and Xionics Document Technologies, Inc. Mr. Charles A. Dickinson has served as a director of Solectron since 1984, and as Chairman of the Board of Directors from 1986 to 1990 and from 1994 to September 1996. He served as an independent consultant to Solectron from 1991 to 1993. He served as President, Solectron Europe from September 1993 to February 1996. From 1986 to 1990, he was Chairman of the Board of Directors, President and Chief Executive Officer of Vermont Micro Systems, Inc. He also serves as a director of Trident Microsystems, Inc., Aavid Thermal Technologies, Inc., Lecroy Corporation and Dense Pac Microsystems, Inc. Mr. Heinz Fridrich has served as a director of the Company since April 1996. Mr. Fridrich is currently a member of the faculty of the University of Florida. From 1950 to 1993, Mr. Fridrich held a number of manufacturing and operations management positions in Europe and the United States with IBM. He currently serves as a director of Central Hudson Gas & Electric Company and VEECO Instruments, Inc. Dr. Philip V. Gerdine has served as a director of the Company since May 1998. Dr. Gerdine served as Executive Director, Siemens AG and as managing director of The Plessey Company from September 1989 to September 1998 and previously was Vice President-Corporate Development of Siemens Corporation. Prior to joining Siemens in July 1988, Dr. Gerdine held senior management positions with General Electric Co., Price Waterhouse, and The Boston Consulting Group. He currently serves as a director of Applied Materials, Inc. Mr. William A. Hasler has served as a director of the Company since May 1998. Mr. Hasler is currently co-chief executive officer of Aphton Corporation, an international biotechnology firm. Prior to joining Aphton, he was Dean and Department Chair of the Haas School of Business at the University of California, Berkeley. He currently serves as a director of Quickturn Design Systems Inc., Walker Interactive Systems Inc., TCSI Corporation and Tenera, Inc. Dr. Kenneth E. Haughton has served as a director of Solectron since 1985. Dr. Haughton is currently an independent consultant. From 1990 to 1991, he was Vice President of Engineering at Da Vinci Graphics, a computer graphics firm. From 1989 to 1990, Dr. Haughton was an independent consultant and from 1982 to 1989, he served as Dean of Engineering at Santa Clara University. He also serves as a director of Seagate Technology. 61 Dr. Paul R. Low has served as a director of Solectron since 1993 and is currently the President of PRL Associates. Prior to founding PRL Associates, Dr. Low worked for IBM from 1957 to 1992. Dr. Low held senior management and executive positions with successively increasing responsibility, including President, General Technology Division and IBM Corporate Vice President; President of General Products Division; and General Manager, Technology Products business line, also serving on IBM's corporate management board. He also serves as a director of Applied Materials, Inc., VEECO, NCD and XION. Mr. Osamu Yamada has served as a director of Solectron since 1994. From 1990 to 1991, he was Chairman and Chief Executive Officer of BankCal Tri-State Corporation, a wholly owned subsidiary of The Mitsubishi Bank, Limited. From 1987 to 1990, he was Senior Managing Director of The Mitsubishi Bank, Limited, and in an overlapping period from 1985 to 1990, he was also Chairman, President and Chief Executive Officer of Bank of California. Prior to that, he held a number of key management positions with The Mitsubishi Bank, Limited organization. Mr. Yamada currently serves on a number of boards of major universities and cultural centers. There is no family relationship among any of the foregoing individuals. ITEM 11: EXECUTIVE COMPENSATION The information required by item 11 of Form 10-K is incorporated by reference to the information contained in the section captioned "Executive Officer Compensation" of the Registrant's definitive Proxy Statement (Notice of Annual Meeting of Stockholders) for the fiscal year ended August 31, 1998 to be held on January 12, 1999 which the Company will file with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this report. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding this item is incorporated herein by reference from the section entitled "Security Ownership of Certain Beneficial Owners and Management" of the Registrant's definitive Proxy Statement (Annual Meeting of Stockholders) for the fiscal year ended August 31, 1998. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information with respect to this item is incorporated herein by reference from the section entitled "Certain Transactions" of the Registrant's definitive Proxy Statement (Annual Meeting of Stockholders) for the fiscal year ended August 31, 1998. 62 PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K (a) 1. Financial Statements. The financial statements listed in Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, above are filed as part of this Annual Report on Form 10-K, beginning on page 34. 2. Financial Statement Schedule. The financial statement Schedule II - VALUATION AND QUALIFYING ACCOUNTS is filed as part of this annual report on Form 10-K, at page 65. 3. Exhibits. The exhibits listed in the accompanying Index to Exhibits are filed as part of this Annual Report on Form 10-K. (b) Reports on Form 8-K. During the fiscal quarter ended August 31, 1998 no current reports on Form 8-K were filed. 63 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOLECTRON CORPORATION (Registrant) Date: November 12, 1998 By /s/ Koichi Nishimura (Koichi Nishimura, President, Chief Executive Officer and Chairman of the Board) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Name Title Date - -------------------------- --------------------- ----------------- /s/ Koichi Nishimura President, Chief Koichi Nishimura, Ph.D. Executive Officer, and Chairman of the Board November 12, 1998 /s/ Susan Wang Chief Financial Susan S. Wang Officer (Principal Financial and Accounting Officer), Senior Vice President and Secretary November 12, 1998 /s/ Winston H. Chen Director November 12, 1998 Winston H. Chen, Ph.D. /s/ Richard A. D'Amore Director November 12, 1998 Richard A. D'Amore /s/ Charles A. Dickinson Director November 12, 1998 Charles A. Dickinson /s/ Heinz Fridrich Director November 12, 1998 Heinz Fridrich /s/ Philip V. Gerdine Director November 12, 1998 Philip V. Gerdine, Ph.D. /s/ William A. Hasler Director November 12, 1998 William A. Hasler /s/ Kenneth E. Haughton Director November 12, 1998 Kenneth E. Haughton, Ph.D. /s/ Paul R. Low Director November 12, 1998 Paul R. Low, Ph.D. /s/ Osamu Yamada Director November 12, 1998 Osamu Yamada 64 SOLECTRON CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (in thousands)
Amounts Balance at Charged Balance at Beginning To End Description of Period Operations (Deductions) Of Period - ---------------------- --------- ---------- ------------ ---------- Year ended August 31, 1996: Allowance for doubtful accounts receivable $3,501 $1,651 $(2,160) $2,992 Year ended August 31, 1997: Allowance for doubtful accounts receivable $2,992 $2,319 $(1,262) $4,049 Year ended August 31, 1998: Allowance for doubtful accounts receivable $4,049 $2,254 $(2,304) $3,999
65 INDEX TO EXHIBITS Exhibit Number Description - ----------- ---------------------------------------------------------- 2.1 [B] Agreement and Plan of Reorganization, by and among the Company, Force Acq. Corp. and Force Computers, Inc. as amended. 3.1 [I] Certificate of Incorporation of the Company. 3.2 [I] Bylaws of the Company. 10.1 [A] Preferred Stock Purchase Agreement dated September 29, 1983, together with amendments thereto dated February 28, 1984 and June 23, 1988. 10.2 [I] Form of Indemnification Agreement between the Company and its officers, directors and certain other key employees. 10.3 [D] 1983 Incentive Stock Option Plan, as amended August 13, 1991. 10.4 [E] 1988 Employee Stock Purchase Plan, as amended October 1992. 10.5 [H] Amended and Restated 1992 Stock Option Plan. 10.6 [C]+ Asset Purchase Agreement dated as of January 29, 1996, as amended and restated as of March 29, 1996 by and among Solectron Texas, L.P., the Company and Texas Instruments, Incorporated. 10.7 [F] Stock Acquisition Agreement dated August 28, 1993, between the Company and Solectron California Corporation. 10.8 [G] Lease Agreement between BNP Leasing Corporation, as Landlord, and the Company, as Tenant, Effective September 6, 1994. 10.9 [G] Purchase Agreement, by and between the Company and BNP Leasing Corporation, dated September 6, 1994. 10.10 [G] Pledge and Security Agreement, by and between the Company, as Debtor, and BNP Leasing Corporation, as Secured Party, dated September 6, 1994. 10.11 [G] Assignment and Assumption Agreement between the Company and Solectron California Corporation, dated November 9, 1994. 10.12 [G] Custodial Agreement by and between the Company, Banque Nationale De Paris and BNP Leasing Corporation, dated September 6, 1994. 10.13 [I] Modification Agreement (First Amendment to Purchase Agreement and Second Amendment to Lease Agreement) by and between the Company and BNP Leasing Corporation, dated May 1, 1997. 10.14 [I] Credit Agreement between the Company and Bank of America National Trust and Savings Association, as Agent and Issuing Bank, dated April 30, 1997. 10.15a [I] Purchase and Sale Agreement among Solectron Corporation, as Originator, Servicer and Guarantor, Solectron California Corporation, as Originator, and Solectron Funding Corporation, as the Initial Purchaser, dated September 17, 1997 10.15b [I] Receivables Purchase Agreement, among Solectron Funding Corporation, as Seller, Solectron Corporation, individually and as Servicer, Receivables Capital Corporation, as Issuer and Bank of America National Trust and Savings Association, as Administrator, dated September 17, 1997. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Independent Auditors. 27.1 Financial Data Schedule. 66 INDEX TO EXHIBITS (Continued) Footnotes Description [A] Incorporated by reference to the Exhibits to the Company's Registration Statement on Form S-1 (File No. 33-22840). [B] Incorporated by reference to the Exhibits to the Company's Registration Statement on Form S-4 as amended, filed November 20, 1996. (File No. 333-15983). [C] Incorporated by reference to the Exhibits of the Company's Form 10-Q for the quarter ended February 29, 1996. [D] Incorporated by reference to the Exhibits to Company's Registration Statement on Form S-8 (File No. 33-46686). [E] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1992. [F] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1993. [G] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1994. [H] Incorporated by reference to the Exhibits to Company's Registration Statement on Form S-8 filed March 31, 1997 (File No. 333-24293). [I] Incorporated by reference to the Exhibits to Company's Form 10-K for the year ended August 31, 1997. + Confidential treatment has been granted for certain portions of these documents. 67 EX-21 2 Exhibit 21.1 SOLECTRON CORPORATION SUBSIDIARIES State or Other Jurisdiction of Subsidiary Incorporation or Organization - ------------ ------------------------------ The Americas - ------------ Solectron California Corporation California Solectron Georgia Corporation Georgia Solectron Massachusetts Corporation California Solectron South Carolina Corporation South Carolina Solectron Technology, Inc. California Solectron Texas, Inc. Delaware Solectron Washington, Inc. California Fine Pitch Technology, Inc. California Force Computers, Inc. Delaware Solectron Brasil, Ltda. Brazil Solectron de Mexico, S.A. de C.V. Mexico Europe - ------------ Solectron France, S.A. France Solectron GmbH Germany Solectron Ireland Cayman Islands Solectron Israel Ltd. Israel Solectron Romania Srl Romania Solectron Scotland Ltd Scotland Solectron Sweden AB Sweden Asia - ------------ Solectron Japan, Inc. Japan Solectron Technology (Suzhou) Co., Ltd Suzhou, Peoples Republic of China Solectron Technology SDN. BHD. Malaysia EX-23 3 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS SOLECTRON CORPORATION: We consent to the incorporation by reference in the registration statements (Nos. 333-24293, 333-02523, 333-17643, 33-58580, 33-46686, 33-57575, 33-75270 and 33-33461) on Forms S-3 and S-8 of Solectron Corporation of our report dated September 14, 1998, relating to the consolidated balance sheets of Solectron Corporation and subsidiaries as of August 31, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended August 31, 1998, and the related schedule, which report appears in the August 31, 1998, annual report on Form 10-K of Solectron Corporation. KPMG Peat Marwick LLP Mountain View, California November 11, 1998 EX-27 4
5 0000835541 SOLECTRON CORPORATION 1000 YEAR AUG-28-1998 AUG-28-1998 225,228 83,576 674,193 (3,999) 788,519 1,887,558 859,831 (411,792) 2,410,568 840,834 385,519 0 0 117 1,181,209 2,410,568 5,288,294 5,288,294 4,749,988 4,749,988 237,063 2,254 24,759 298,983 100,159 198,159 0 0 0 198,159 1.72 1.65
EX-27 5
5 Restated to conform to requirements of SFAS No. 128. 0000835541 SOLECTRON CORPORATION 1000 YEAR YEAR AUG-29-1997 AUG-30-1996 AUG-29-1997 AUG-30-1996 225,073 228,830 257,829 181,520 422,731 344,192 (4,049) (2,992) 494,622 368,862 1,499,632 1,144,724 648,777 466,797 (322,416) (217,227) 1,876,419 1,452,198 567,942 358,369 385,850 386,927 0 0 0 0 115 105 918,954 700,464 1,876,419 1,452,198 3,694,385 2,817,191 3,694,385 2,817,191 3,266,106 2,534,813 3,266,106 2,534,813 189,538 105,302 2,319 1,651 26,551 15,650 238,407 173,077 80,348 58,845 158,059 114,232 0 0 0 0 0 0 158,059 114,232 1.42 1.12 1.37 1.08
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