-----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, IFkKkmmVxY5L94phak8pZxjlr37Mk9gI97OGhsPqEd/y5xI52mFY6BpW9IMxGkCd /N4A8d05+E8I0du9tUf3gQ== 0000950144-98-011788.txt : 19981030 0000950144-98-011788.hdr.sgml : 19981030 ACCESSION NUMBER: 0000950144-98-011788 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980731 FILED AS OF DATE: 19981029 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CMC INDUSTRIES INC CENTRAL INDEX KEY: 0000913270 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 621434910 STATE OF INCORPORATION: DE FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22974 FILM NUMBER: 98733324 BUSINESS ADDRESS: STREET 1: 4950 PATRICK HENRY DRIVE CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 601-287-3771 MAIL ADDRESS: STREET 1: 1801 FULTON DRIVE CITY: CORINTH STATE: MS ZIP: 38834 10-K 1 CMC INDUSTRIES, INC. 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ x ] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended July 31, 1998 [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____ to ___ Commission file number: 0-22974 CMC INDUSTRIES, INC. (Exact name of registrant as specified in its charter) DELAWARE 62-1434910 (State of incorporation) (IRS Employer Identification No.) 4950 PATRICK HENRY DRIVE, SANTA CLARA, CA 95054 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (408) 982-9999 Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] 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 [ ] State the aggregate market value of the voting stock held by non-affiliates of the registrant: $18,629,507 at October 9, 1998. Shares of Common Stock, $.01 par value per shares outstanding at September 30, 1998: 7,593,556 DOCUMENTS INCORPORATED BY REFERENCE Documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated: Portions of the Proxy Statement relating to the 1998 Annual Meeting of Shareholders: Part III Portions of the 1998 Annual Report to Shareholders: Part II, Part IV (2) 2 PART I ITEM 1. BUSINESS CMC, Industries, Inc. ("CMC" or the "Company") together with its predecessor business, has been a manufacturer of telecommunications systems and equipment for over 30 years. The Company was incorporated in 1990 to acquire from Alcatel Network Systems, Inc. ("Alcatel"), certain businesses operated from 1960 to 1987 by ITT and from 1987 to 1990 by Alcatel, n.v., a joint venture between ITT and Compagnie Generale d'Electricite. In August 1993, the Company transferred certain assets and related liabilities associated with its telecommunications business to Cortelco Systems Holding Corp. ("Cortelco") in exchange for 1,000,000 shares of Preferred Stock of Cortelco. These transactions effectively transferred to Cortelco all of the Company's assets and liabilities not related to its electronic manufacturing business. The Company has provided independent electronic manufacturing services to a diverse base of customers in both the telecommunications and computer electronics industries. The Company manufactures a wide range of products for its customers including sophisticated telecommunications equipment, personal computers, computer peripherals and subassemblies and printed circuit board ("PCB") assemblies. CMC provides a broad spectrum of manufacturing services primarily based on the manufacture of PCB assemblies utilizing automated pin-through-hole technology ("PTH"), surface mount technology ("SMT") and ball grid array ("BGA") placement techniques. PTH technology involves the attachment of electronic components to a PCB by inserting the leads of the components through holes in the board and soldering the leads on the underside of the board. SMT and BGA technologies involve the attachment of electronic components directly to the surface of the board, and accordingly permits components to be mounted on each side of the board. In addition, the Company provides full systems integration assembly and test, materials procurement, distribution, product design and engineering support services. The Company has manufacturing facilities in Corinth, Mississippi, Santa Clara, California (Silicon Valley) and Hermosillo, Mexico. The Company believes that these locations enable it to meet the cost and geographic distribution requirements of its customers. The Company's major customers currently include RELTEC Corporation ("RELTEC"), Diamond Multimedia Systems, Inc. ("Diamond"), Next Level Communications ("Next Level"), Logitech, Inc., Harris Corporation, Premisys Communications, Inc. ("Premisys"), Midway Games, Inc. ("Midway"), IBM Corporation and Cortelco. CUSTOMERS AND MARKETING Telecommunications products have been manufactured at CMC's facility in Corinth, Mississippi for over 30 years. From 1960 to 1987, the operations at Corinth were owned and operated by ITT, which established a reputation for quality manufacturing of telecommunications products and services to its customers. The Company believes the telecommunications manufacturing expertise that it has acquired over three decades is a competitive strength, allowing it to meet customer requirements for strict quality control, prompt turnaround and flexible response to design changes. Capitalizing on this expertise, the Company has expanded into the manufacture of computer equipment and related peripherals and data networking equipment. The Company is seeking to leverage its capacity and manufacturing expertise by expanding sales to new customers with products that are similar to its current customer base in the telecommunications, data communications, computer-related products and value-added electronics industries. In addition, the Company seeks to position its manufacturing operations at strategic sites throughout the United States and worldwide. Corinth, Mississippi is located in close proximity to major North American freight hub locations, allowing for inexpensive ground transport and overnight air delivery throughout the country. The Company's California facility is located in Santa Clara, in the heart of Silicon Valley, the site of many of the Company's current and potential customers. During 1998, the Company added a manufacturing operation in Hermosillo, Mexico, an international procurement office in Taipei, Taiwan and a sales and procurement office in Huntsville, Alabama. Hermosillo offers an attractive cost structure and solid logistics for current and prospective customers and the location between two leading technical universities within the city provides access to a pool of qualified engineers and technicians. The Asian Procurement office in Taiwan and corporate procurement office in Huntsville, Alabama were established to increase access to low cost materials throughout a product's life cycle. CMC provides electronic manufacturing services to major telecommunications OEMs as well as suppliers of computer monitors, computer peripherals, data networking equipment and other electronic components. In turn, CMC's customers sell these manufactured products into domestic and worldwide markets. Products manufactured by the Company include telephones, ISDN equipment, key and PBX/ACD systems, various data communications products and telecommunications switching equipment and printed circuit board assemblies for computer and communications 2 3 equipment. Services provided include design for manufacturability and test, materials procurement, prototyping, plastic injection molding, printed circuit board assembly, full board-level test, system integration and configuration, full system test, packaging, distribution and field return and repair support. Generally, relationships between the Company and its customers for the manufacture of product and related services are defined by a succession of purchase orders placed by the customer and performed upon by CMC. The Company offers electronic manufacturing services to its customers on both a turnkey and consignment basis, with over 90% of the Company's net sales derived from turnkey projects. In turnkey relationships, the Company both procures components and other supplies and provides full manufacturing services. In consignment relationships, the customer purchases and then provides components and other supplies to the Company, and the Company charges for only labor and overhead. The establishment of a turnkey relationship requires significant investment of resources by both an OEM customer and a contract manufacturer. An OEM customer must incur expense to qualify a contract manufacturer by certifying the quality of the manufacturer's processes and services and, in some cases, must also qualify a contract manufacturer's sources of component supply. The OEM customer also works with a contract manufacturer to refine product design and manufacturing processes in order to optimize manufacturability. The Company believes that OEM customers seek to establish relationships with turnkey manufacturing partners they perceive will be able to meet their production requirements over a long period of time and for successive product generations. The Company believes that these relationships, once established, tend to be sustaining in nature due to the significant investment of time and resources by both the Company and the OEM customer. Accordingly, the Company believes that its emphasis on turnkey manufacturing results in greater stability of its customer base. However, the Company's results of operations have been in the past and may be in the future materially adversely affected in the event customers for whom the Company manufactures products should cancel or reschedule their existing and forecast orders. Such cancellations or rescheduling could result in inefficient utilization of equipment and personnel dedicated to the manufacture of the specific products. Moreover, because of such stability, the Company may be unable to secure turnkey manufacturing projects from new OEM customers working with competitors of the Company. The failure of the Company to develop relationships with new OEM customers also may materially and adversely affect the Company's results of operations. CMC develops and maintains customer relationships through the efforts of the Company's management team, direct sales force, program managers and project engineers. Project engineers and program managers receive extensive training in the Company's manufacturing and service capabilities in order to respond to the specific needs of customers. CMC's project engineers work with the customers' engineers and technical personnel to ensure a close working relationship and understanding of the specific needs of each customer. The Company's four largest customers in fiscal 1998 and their respective percentages of CMC's net sales for 1998 and 1997, respectively, were as follows: Micron Electronics ("Micron"), 24% and 21%; RELTEC, 12% and 11%; Global Village Communications ("Global Village"), 11% and 14% and Diamond, 9% and 2%. The Company is currently recognizing revenues from Diamond at an annualized rate of approximately $50 million, which is less than originally expected. During the past 18 months, the Company initiated business with a number of new customers, including Premisys, Midway and Next Level. As previously disclosed, the Company's manufacturing relationship with Micron was discontinued at the end of the second quarter of fiscal 1998. Following Global Village's sale of its modem business to Boca Research, Inc. ("Boca") in June 1998, manufacturing of products for Boca has declined to minimal levels The Company derives revenues primarily from OEM arrangements which prohibit the selling of the products manufactured to anyone other than the OEM customer. As a result, the Company does not typically allow its customers to return products, other than for repairs of defective materials. In such cases, the Company charges the customer for the repair unless the defect resulted from faulty manufacturing and occurred within an applicable warranty period. This policy applies to both affiliated and non-affiliated customers. It has been the Company's experience that orders for production of a given product or product line typically decline over time as the customer's product or product line matures. Generally, the Company has customers with products at various stages in the product life cycles including development, volume production and end-of-life production. In the event that the Company is unable to compensate for any material reduction in sales of a given product over time through production of replacement or new products for the customer or through new business with alternative customers, the Company's revenues and operating results could be materially adversely affected. 3 4 MANUFACTURING Manufacturing Services The Company's vertically-integrated turnkey manufacturing services include component procurement and testing, PCB assembly using SMT, PTH and BGA techniques, post-assembly PCB testing, in-circuit test development, full system integration and test, and product design and engineering support services. The Company provides a complete, vertically-integrated manufacturing solution with manufacturing capabilities as diverse as plastic injection molding, final unit assembly and testing. The Company delivers finished products to the OEM or, if requested, delivers products directly to the OEMs' customers. The Company offers comprehensive and advanced manufacturing solutions to its customers. The Company's broad range of manufacturing capabilities includes both automated PTH and more advanced SMT processes, including BGA assemblies. The Company offers vertical services such as component procurement, test, product design, and other engineering services. Accordingly, the Company's production processes can accommodate the manufacture of a broad range of communications and electronics components and products. While the Company continually seeks to improve the flexibility of its production systems, the commencement of production of new products typically involves startup costs, lower yields and other inefficiencies. Achievement of volume production for a new product typically requires a period as short as several days for products substantially similar to those previously manufactured by the Company, to as many as several months for completely new products. Since turnkey manufacturing may be a substitute for all or a portion of a customer's in-house manufacturing capability, continuous technical and administrative communication between the Company and its customer is required. CMC establishes a close relationship with each OEM customer in the early stages of product development to assist the customer in the evaluation of board designs and thereby improve manufacturability and testability. Building on this knowledge, CMC's technical staff monitors manufacturing process yields and may propose engineering changes for product improvement and cost reductions. Certain of the products manufactured by CMC are in the early stages of their life cycles and may therefore have ongoing design or engineering changes. The Company believes a critical element of turnkey manufacturing services is the ability to respond rapidly to engineering design changes. The Company believes that its history in design and manufacturing, particularly in the telecommunications industry, and its close working knowledge of its customers' products enables the Company to meet its customers' needs effectively. A key element in turnkey manufacturing services is the procurement of materials, which consists of the planning, purchasing, expediting, warehousing and financing of the components and other materials required to assemble a PCB or system-level assembly. OEMs increasingly have required contract manufacturers to purchase all or some components directly from component manufacturers or distributors and to warehouse and finance the components and materials. The Company orders materials and components based on purchase orders received and accepted and seeks to minimize its inventory of materials or components that are not identified for use in filling specific orders. Electronic components are purchased directly by the Company and, in certain circumstances, the Company bears the risk of component price fluctuations. The electronics industry has been characterized by shortages from time to time of microprocessors and other semiconductor components, which shortages have led to allocations by third-party suppliers. These delays to date have not had a material adverse effect on the Company's results of operations. If component shortages occur, the Company may not be able to secure quantities required to fulfill orders, which could result in delays in shipments, cancellation or delays in orders, or losses resulting from price increases by suppliers of parts or components, all of which could have a material adverse effect on the Company's results of operations. CMC provides complete turnkey manufacturing solutions for its customers from its vertically-integrated 350,000 square foot facility in Corinth, Mississippi and its 75,000 square foot facility in Santa Clara, California and from a new 110,000 square foot facility in Hermosillo, Mexico. The Company provides full SMT assembly as well as complete system integration, test and box-build capabilities at each location. Manufacturing Processes CMC manufactures for its customers a wide variety of complex and technologically advanced products that require a coordinated manufacturing process. The process requires the application of advanced manufacturing technologies 4 5 and computerized in-circuit, functional and system testing techniques. Current processes at CMC include fine-pitch SMT, PTH, BGA and system box-build assemblies. CMC seeks to add product lines that require advanced technological processes, in order to further develop its manufacturing expertise. Company employees regularly attend training seminars on the latest developments in manufacturing technologies. In PTH production, components are attached by pins (also called "leads") inserted through and soldered to plated holes in the PCB. In SMT production, the leads on integrated circuits and other electronic components are soldered to the surface of the PCB rather than inserted into holes. SMT can accommodate a substantially higher number of leads in a given area than PTH, thereby permitting the PCB to interconnect a greater density of integrated circuits, which permits tighter component spacing and a reduction in the PCB dimensions. Additionally, SMT allows components to be placed on both sides of the PCB, thereby permitting even greater density. The substantially finer lead-to-lead spacing or "pitch" in SMT requires a manufacturing process far more exacting than the PTH interconnect products. Because of their high number of leads, most very large scale integrated circuits are configured for SMT production. SMT components are constantly changing, with BGA becoming the package selection of many component manufacturers. The BGA assembly process uses small balls of solder (instead of leads that could bend and break), located directly underneath the part, to interconnect the component and circuit board. X-ray equipment is instrumental in the development of BGA process parameters, since the balls are located underneath the component and are not visible through standard inspection techniques. The Company utilizes a computerized material requirements planning system to direct the flow of materials through the manufacturing cycle. Printed circuit board assemblies with PTH components are assembled using automatic insertion machines for all eligible components, including axial, dual inline package, radial and square-wire pins, which for most products allows over 90% of the total PTH components to be automatically inserted. Manually assembled components are either purchased or prepared in-house to allow for "drop-in" assembly on a moving assembly conveyor that feeds the PCB assemblies directly into an automated soldering system that solders the pins to the PCB. For SMT printed circuit assemblies, CMC has full capability to run either "top-side," "bottom-side" or "mixed-technology" PCB assemblies. Equipment capabilities include screen-printing with vision and computer-controlled alignment; high-speed, in-line epoxy dispensing; surface-mount component placement with speeds up to 44,500 components per hour per machine; assembly of fine-pitch components and computer-controlled infrared reflow soldering. The Company subjects assembled and soldered boards to board-level in-circuit and functional testing. As part of the final unit assembly process, the Company also functionally tests all products to verify conformance to customer specifications. If desired, product testing can include burn-in at elevated temperatures utilizing the Company's in-house burn-in chambers. Printed circuit boards utilized for telecommunication systems receive final system tests to verify the functional integrity of each system. Quality The Company believes that the quality of its manufacturing and customer services is critical to customer satisfaction and long-term success. CMC has emphasized the pursuit of high quality for many years. From 1960 to 1987, CMC's Corinth facility was part of ITT, which pioneered many quality improvement processes. Many of CMC's manufacturing and customer support personnel were trained in quality principles and practices as employees of ITT. CMC's quality assurance engineers have for many years received training through in-house programs and by attending seminars, including enrollment in The ITT Quality College. The Company has achieved ISO 9001 certification at its Mississippi facility and ISO 9002 certification at its California facility. The Company believes that the process of attaining ISO certification serves as an excellent tool for quality improvement, enabling the Company to provide consistency and excellence in its products and services. Also, since certain potential customers prefer or require manufacturers to have achieved ISO certification, such certification may offer certain competitive advantages. The Company believes that compliance with ISO will allow it to expand its bid opportunities, especially with customers who participate in world-wide markets. In addition to ISO certification, the Mississippi facility has achieved certification to British Approval Board for Telecommunications (BABT). Achieving BABT certification broadens CMC's opportunities with telecommunication customers by providing manufacturing solutions that meet the United Kingdom national requirements or Common Technical Regulations under Directive 91/263/EEC. 5 6 ENVIRONMENTAL CONTROLS The Company is subject to a variety of regulations concerning environmental laws related to the use, storage, discharge and disposal of hazardous chemicals utilized during the manufacturing process and constantly monitors its operations to avoid violations. Although the Company believes that its facilities are currently in compliance with applicable environmental laws, there can be no assurance that violations have not occurred and will not occur. In the event of any violations of environmental laws, the Company could be held liable for damages and for the costs of remedial actions and could also be subject to revocation of its effluent discharge permits. Any such revocation could require the Company to cease or limit production, thereby having a material adverse impact on the Company's business and results of operations. To date, environmental regulations have not restricted the Company's ability to operate or expand its manufacturing operations or caused the Company to incur significant expense. Environmental laws, however, could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with a violation. See "Legal Proceedings." COMPETITION The electronics manufacturing services industry is highly competitive. Competitive manufacturing services are available from many independent sources as well as in-house manufacturing operations of current and potential customers. In addition, certain large electronics manufacturers are transforming existing manufacturing facilities into contract manufacturing operations. The Company also competes with foreign contract manufacturers which, due to lower cost of labor, have become significant competitors with respect to high volume products or those with a high labor content. The Company believes that its primary competitors are Solectron Corporation, Avex, Inc., Flextronics International Ltd., Jabil Circuit, Inc., and SCI Systems, Inc. CMC believes that the primary competitive issues in the markets in which it focuses are quality of manufacturing processes, surface mount capacity and total production capacity, responsiveness to customer needs, price, quality, reliable delivery and financial resources. CMC believes that it competes favorably with respect to most of these factors. However, certain of the Company's competitors have greater SMT and total production capacity and greater financial resources than the Company. In addition, certain overseas competitors are able to offer low-cost production for certain types of products, particularly those which require a higher labor content. To remain competitive, the Company must continue to expand its advanced manufacturing technologies, provide superior quality and service, and be price competitive. In addition, the Company's new manufacturing facility in Hermosillo, Mexico is an effort to expand manufacturing capacity while reducing costs. If the Company were to become unable to compete effectively in terms of quality, delivery, advanced manufacturing, service or price, the Company's business, financial condition and results of operations could be materially adversely affected. BACKLOG The Company's backlog was approximately $42.1 million at July 31, 1998 and $56.9 million at July 31, 1997. Backlog consists of purchase orders received by the Company primarily for shipment within 180 days. Cancellation and postponement of purchase orders occasionally occur, and the Company negotiates charges to such customers that vary depending on the timing and circumstances of the cancellation or postponement. Because of possible rescheduling and cancellation, backlog does not necessarily reflect future sales levels. PATENTS AND TRADEMARKS The Company owns four patents related to telephone equipment, but does not believe that patent or trademark protection is an important competitive factor in its market. EMPLOYEES At July 31, 1998, the Company had 1,205 full time employees and 197 temporary employees. At such date, the Company had 1,086 hourly employees and 316 salaried employees, including 863 in manufacturing, 299 in manufacturing support, 128 in engineering and quality, 38 in sales and marketing, and 74 in general and administrative. The only 6 7 employees of the Company represented by a labor union are those employees in its Mexico operation, and the Company has never experienced a work stoppage or strike. The Company believes its relationships with its employees are good. FACTORS THAT MAY AFFECT THE COMPANY The foregoing discussion of the Company's business, operations and competitive position contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those projected in the forward-looking statements as a result of certain of the risk factors set forth below and elsewhere in this document. In addition to the other information contained and incorporated by reference in this document, the following factors should be considered carefully in evaluating the Company and its business. Potential Fluctuations in Operating Results. The Company's operating results are affected by a number of factors, including the timing and mix of manufacturing 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 customers, fluctuations in demand for customer products, the timing of expenditures in anticipation of increased sales, customer product delivery requirements, increased costs and shortages of components or labor and economic conditions generally. All of these factors can cause substantial fluctuations in the Company's operating results. The Company's expenditures (including, but not limited to, equipment, inventory and labor) are based, in part, on its expectations as to future revenues and, to a large extent, are fixed in the short term. Accordingly, the Company has in the past and may in the future be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenues, and any significant shortfall of demand in relation to the Company's expectations or any material delay or cancellation of customer orders could have an almost immediate material adverse effect on the Company's operating results. As a result, it is possible that in some future period, the Company's operating results could fail to meet the expectations of public market analysts or investors. In such events, or in the event that adverse conditions prevail or are perceived to prevail generally or with respect to the Company's business, the trading price of Company's Common Stock could drop significantly. The Company's gross profit as a percentage of sales in future periods may be materially adversely affected by various factors associated with the Company's production of new product lines, acquisition of new manufacturing equipment and continued dependence on turnkey contracts (and the inventory risks inherent therein). Expansion of capacity will result in a higher fixed cost structure which will require increased revenue and/or significant improvements in operating efficiencies in order to maintain historical gross margins. Additionally, the commencement of production of new products typically involves significant startup costs, lower yields and other inefficiencies. New products do not generate gross margins as high as products which have been in volume production for several months. The Company also expects that competition may continue to intensify, which could also result in lower gross margins. Customer Concentration; Dependence on Industry Trends. A small number of customers are currently responsible for a significant portion of the Company's net sales. In the fiscal years ended July 31, 1998, 1997 and 1996, the Company's four largest customers in such periods accounted for approximately 56%, 61%, and 63%, respectively, of consolidated net sales. Sales to Micron Electronics, Inc. accounted for approximately 24% and 21% of the Company's revenues for the fiscal years ended July 31, 1998 and July 31, 1997, respectively. As previously disclosed, the relationship with Micron has been discontinued and the Company's business and results of operations may be materially adversely affected by such discontinuation in future quarters. Any material delay, cancellation or reduction of orders from these or other customers could have a material adverse effect on the Company's results of operations. 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 could have a material adverse effect on the Company's results of operations. In addition, customer contracts can be canceled and volume levels can be materially changed or delayed. The timely replacement of canceled, delayed or reduced contracts with new business cannot be assured. These risks are exacerbated because the Company's sales are to customers in segments of the electronics industry subject to rapid technological change and product obsolescence. The factors affecting these industries in general, or any of the Company's major customers in particular, could have a material adverse effect on the Company's results of operations. Relationship with Cortelco. The Company has had numerous transactions with its former affiliate and customer, Cortelco Systems Holding Corp. ("Cortelco"). Mr. Lee, a director of the Company, is also a director of Cortelco, and is the 7 8 largest stockholder of each of the Company and Cortelco. Transactions between the Company and Cortelco include the transfer of certain assets and related liabilities associated with the telephone business to Cortelco in exchange for 1,000,000 shares of Preferred Stock of Cortelco in August 1993 and the execution of an agreement to provide certain products and related support services to customers of Cortelco. The Company has the right to require that the Preferred Stock be redeemed by Cortelco beginning on August 1, 1999 in five annual installments of $2.5 million each. There can be no assurances that such payments will be made by Cortelco on a timely basis, if at all. Historically, Cortelco has not been as current as other customers in making payments on its trade accounts with the Company. In July 1998, the Company converted certain older accounts receivable from Cortelco totaling $2.0 million into a note receivable. Under the terms of the note, Cortelco has agreed to pay the balance over a three-year term with monthly payments of $50,000, plus interest and a final installment of $200,000 due at the end of the three-year period. Interest accrues on the note at a rate of 9.0% per annum. The Company continues to provide credit for manufacturing services sold to Cortelco in the form of trade receivables, and as of September 30, 1998, had approximately $4,430,000 in trade receivables from Cortelco. Cortelco's payments on its trade accounts with the Company have in the past been late, and there can be no assurances that such payments or payments on the note will in the future be made on a timely basis, if at all. 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, which evaluate the Company's capabilities against the merits of manufacturing products internally. The Company competes with different companies depending on the type of service or geographic area. Certain of the Company's competitors have broader geographic breadth. They also may have greater manufacturing, financial, research and development and marketing resources than the Company. The Company believes that the primary basis of competition in its targeted markets is manufacturing technology, quality, responsiveness, and 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. Shortages of Electronics Components. Most of the Company's net sales are derived from turnkey manufacturing services in which the Company procures components from third-party suppliers and bears the risk of component shortages. The electronics industry has been characterized by shortages from time to time in semiconductor and other components, which shortages have led to allocations by third-party suppliers. The Company's inability to procure desired supplies of certain components has in the past led, and may in the future lead, to some delays in shipments by the Company to its customers. These delays to date have not had a material adverse effect on the Company's results of operations. If these component shortages persist or intensify, however, the Company may not be able to secure quantities required to fulfill customer orders, which could result in delays in shipments, or cancellation or delays in customer orders, each of which could have a material adverse effect on the Company's results of operations. Management of Growth. There can be no assurance that the Company will successfully manage the integration of new business and the growth, if any, of the Company's operations. In addition, the Company may experience certain inefficiencies as it manages geographically dispersed operations. Should the Company increase its expenditures in anticipation of a future level of sales which does not materialize, its results of operations could be materially adversely affected. On occasion, customers may require rapid increases in production which can place an excessive burden on the Company's resources. There can be no assurance that the Company will be capable of meeting the demands placed upon the Company's resources by these or any other customers. 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. In this regard, see "Legal Proceedings." Risk of Defects. The electronics products manufactured for customers by the Company are highly complex and may at times contain undetected design and/or manufacturing errors or failures. Such defects have been discovered in the past, and there can be no assurance that, despite the Company's quality control and quality assurance efforts, such defects 8 9 will not occur in the future. If such defects occur in quantities or too frequently, the Company's business and operating results may be materially and adversely affected. Dependence on Key Personnel and Skilled Employees. The Company's continued success depends to a large extent upon the efforts and abilities of key managerial and technical employees. The loss of services of certain key personnel could have a material adverse effect on the Company. The Company's business also depends upon its ability to continue to attract and retain senior managers and sales representatives and other skilled employees. Failure to do so could have a material adverse effect on the Company's operations. Possible Volatility of Market Price of Common Stock. The trading price of the Company's Common Stock is subject to significant fluctuations in response to variations in quarterly operating results, general conditions in the electronics manufacturing services industry as well as the industries of the Company's customers, and other factors. In addition, the stock market is subject to price and volume fluctuations which affect the market price for many high technology companies in particular, and which may or may not be unrelated to operating performance. There can be no assurance as to the trading price of the Company's Common Stock at any time in the future. 9 10 ITEM 2. PROPERTIES. The Company's principal facility is a 350,000 square foot manufacturing plant located on sixty-four acres in Corinth, Mississippi. The plant and land are leased at the rate of approximately seven thousand dollars annually, pursuant to a lease with the Industrial Development Board of Alcorn County, Mississippi, with options to renew the lease until 2060. The Company also leases a 75,000 square foot facility in Santa Clara, California, 20,000 square feet of warehouse space in Corinth, Mississippi, an international purchasing office in Taiwan and a sales and procurement office in Huntsville, Alabama. The Company owns a 4.4-acre track of land in Hermosillo, Mexico and an 110,000 square foot manufacturing facility located thereon. Although there are currently no specific plans for further expansion, the Company continually evaluates customer needs and market opportunities to expand its facilities geographically. ITEM 3. LEGAL PROCEEDINGS. The Company is involved from time to time in litigation incidental to its business. Management believes that the outcome of current litigation will not have a material adverse effect upon the results of operations or financial condition of the Company and will not disrupt the normal operations of the Company. In December 1993, the Company retained the services of an industrial safety consultant to assist in quantifying the potential exposure to the Company in connection with clean-up and related costs of a former manufacturing site, commonly known as the ITT Telecommunications site in Milan, Tennessee and more particularly described as a 50.1 acre tract surveyed by Construction Layout Service of Milan, Tennessee. The consultant initially estimated that the cost to remove the contaminated soil and deliver it to an appropriate hazardous waste site would be approximately $200,000. Based upon this advice, the Company subsequently entered into a voluntary agreement to investigate the site with the Tennessee Department of Environment and Conservation. In addition, the Company agreed to reimburse a tenant of the site $115,000 for expenditures previously incurred to investigate environmental conditions at the site. The Company recorded a total provision of $320,000 based on these estimates. In fiscal 1995, an environmental expert concluded that the cost of a full study combined with short and long-term remediation of the site may cost between $3 and $4 million. During fiscal 1996, the State of Tennessee's Department of Environment and Conservation named certain potentially responsible parties ("PRPs") in relation to the former facility. The Company was not named as a PRP. However, Alcatel, Inc., a PRP named by the State of Tennessee's Department of Environment and Conservation and a former owner of the Company, is seeking indemnification from the Company. To date, Alcatel has not filed any legal proceedings to enforce its indemnification claim. However, there can be no assurance that Alcatel will not initiate such proceedings or that any other third parties will not assert claims against the Company relating to remediation of the site. In the event any such proceedings are initiated or any such claim is made, the Company believes it has numerous defenses which it will vigorously assert. There can be no assurance that if any proceedings are initiated or any such claim is asserted, defense or resolution of such matter will not have a material adverse effect on the Company's financial position or results of operations. In connection with a fiscal 1996 staff reduction, certain terminated employees subsequently claimed that the Company had engaged in age discrimination in their dismissal and sought damages of varying amounts. The Company defended the actual and threatened claims vigorously during fiscal 1998 incurring approximately $275,000 in legal costs over the course of the year. On August 6, 1998, a judgment was rendered in the favor of one plaintiff in the amount of $127,000 which the Company is reviewing for possible appeal. A second plaintiff's claim for $53,000 has also been filed. The EEOC has negotiated with the Company to reach a monetary settlement for other potential claimants. Without admitting any liability, the Company has agreed to enter into a Conciliation Agreement with the EEOC and pay approximately $500,000 to settle all such claims and limit future litigation costs. As a result of these events and the significant ongoing costs to defend these claims, in October 1998, the Company concluded that its interest would be best served to settle all such matters. The Company has reserved $975,000 to resolve all such claims, which represents its best estimate of funds to ultimately be paid to such claimants. This charge has been recorded as of July 31, 1998. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS None. 10 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. On December 9, 1993, the Securities and Exchange Commission declared effective the Company's Registration Statement with respect to an initial public offering of 1,750,000 shares of Common Stock. The Common Stock is listed on the Nasdaq National Market under the symbol "CMCI." The following table sets forth, for the periods indicated, the high and low sale prices for the Company's Common Stock as reported on the Nasdaq National Market. Such prices represent prices between dealers and do not include retail mark-ups, mark-downs or commissions and may not represent actual transactions.
High Low ---- --- Fiscal Year 1998: - ----------------- First quarter $ 11.13 $ 6.38 Second quarter 14.18 5.75 Third quarter 11.75 8.38 Fourth quarter 10.00 6.63 Fiscal Year 1997: - ----------------- First quarter 8.88 5.63 Second quarter 12.63 7.88 Third quarter 13.50 5.50 Fourth quarter 9.13 6.25
There were approximately 220 holders of record of the Common Stock as of September 30, 1998. The Company believes it had in excess of 1,000 beneficial shareholders as of September 30, 1998. The Company had 7,593,556 shares outstanding as of September 30, 1998. The Company has not paid any cash dividends and does not anticipate paying any cash dividends in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA. The Company's Selected Financial Data is hereby incorporated by reference to page 8 of its 1998 Annual Report to Shareholders. Excerpts of such Annual Report are filed as Exhibit 13.1 hereto. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. The Company's Management's Discussion and Analysis of Financial Condition and Results of Operation is hereby incorporated by reference to pages 9 through 17 of its 1998 Annual Report to Shareholders. Excerpts of such Annual Report are filed as Exhibit 13.1 hereto. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information set forth in the Consolidated Financial Statements contained in excerpts of the 1998 Annual Report to Shareholders is incorporated herein by reference. An index to the Company's Consolidated Financial Statements is set forth at Part IV, Item 14(2) at page 13. The selected quarterly financial data set forth under the caption "Quarterly Results" at page 11 of excerpts of the 1998 Annual Report to Shareholders is incorporated herein by this reference. 11 12 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to the directors and executive officers of the Company is incorporated by reference from the Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders. Such Proxy Statement has been filed previously with the Securities and Exchange Commission. ITEM 11. EXECUTIVE COMPENSATION. Certain information relating to executive compensation included in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders is incorporated herein by reference. Such Proxy Statement has been filed previously with the Securities and Exchange Commission. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Certain information relating to stock ownership included in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders is incorporated herein by reference. Such Proxy Statement has been filed previously with the Securities and Exchange Commission. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Certain information relating to transactions with management included in the Proxy Statement relating to the 1998 Annual Meeting of Shareholders is incorporated herein by reference. Such Proxy Statement has been filed previously with the Securities and Exchange Commission. 12 13 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (1) EXHIBITS Exhibit Description Number ----------- [S] [C] 3.1* Restated Certificate of Incorporation. 3.2* Amended and Restated Bylaws. 4.1* Form of Common Stock Certificate. 4.2*** Securities Purchase Agreement, dated as of May 15, 1996, by and between the Company and each of the investors listed therein. 10.1* Agreement and Plan of Reorganization between CMC Industries, Inc. and International Telecommunication Asia PTE, Ltd. dated as of October 2, 1993. 10.2* Lease Agreement between The Board of Supervisors of Alcorn County, Mississippi and International Telephone and Telegraph Corp. dated August 1, 1961, as amended and supplemented and related documents. 10.3* Lease Agreement between Corinth Telecommunications Corp. (now known as CMC Manufacturing, Inc.) and Douglas Jumper and Truitt Stockton d/b/a Jumper-Stockton Warehouses for the Pinecrest Road warehouse dated October 20, 1992. 10.4* Lease Agreement between Corinth Telecommunications Corp. (now known as CMC Manufacturing, Inc.) and Douglas Jumper and Truitt Stockton d/b/a/ Jumper-Stockton Warehouses for the Sawyers Road warehouse dated October 20, 1992. 10.5(1) Loan and Security Agreement dated September 26, 1996 (and Amendments) among CMC Industries, Inc., CMC California, Inc., and CMC Mississippi, Inc. and Bank of America Illinois and related documents. 10.6* License Agreement between ITT Corporation and ITT Telecom Products Corporation (now known as CMC Manufacturing, Inc.) dated December 30, 1986. 10.7* Agreement between Cortelco International, Inc. and CMC Manufacturing, Inc. dated as of September 1, 1993. 10.8* Cortelco USA, Inc. (now known as CMC Manufacturing, Inc.) Profit Sharing Savings Plan and Trust for Salaried Employees. 10.9* Hourly Pension Plan for Employees of ITT Telecom Products Corporation (now known as CMC Manufacturing, Inc.) at Corinth. 10.10**** CMC Industries, Inc. 1990 Equity Incentive Plan, amended and restated as of November 15, 1996. 10.11* Form of Indemnification Agreement between CMC Industries, Inc. and certain officers and directors. 10.12** Lease Agreement between Guzik Investments, L.P. and CMC Industries dated June 14, 1995. 10.13**** CMC Industries, Inc. 1996 Employee Stock Purchase Plan. 10.14***** Executive Employment Agreement between CMC Industries, Inc. and Jack O'Rear dated August 1, 1997. 13.1 Excerpts from the 1998 Annual Report to Shareholders. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Independent Accountants. 27.1 Financial Data Schedule (For SEC electronic filing purposes only) * Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1, Registration No. 33-70126. ** Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended July 31, 1995. *** Incorporated by reference to exhibits filed with the Registrant's Current Report on Form 8-K filed the Securities and Exchange Commission on May 24, 1996. **** Incorporated by reference to exhibits filed with the Registrant's Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on October 22, 1996. ***** Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended July 31, 1997. (1) FILED BY AMENDMENT 13 14 (2) FINANCIAL STATEMENTS AND SCHEDULES Consolidated Financial Statements of CMC Industries, Inc. and subsidiaries Consolidated Balance Sheets as of July 31, 1998 and 1997 Consolidated Statements of Income for the Years Ended July 31, 1998, 1997 and 1996 Consolidated Statements of Changes In Stockholders' Equity for the Years Ended July 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the Years Ended July 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Report of Independent Accountants The Financial Statements are hereby incorporated by reference to pages 18 to 35 of the Company's 1998 Annual Report to Shareholders. Excerpts of such Annual Report are filed as Exhibit 13.1 hereto. All schedules specified by the Securities and Exchange Commission are inapplicable or omitted pursuant to Regulation S-X since the information is included in the Consolidated Financial Statements or related notes. (3) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended July 31, 1998. 14 15 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. CMC INDUSTRIES, INC. /s/ Matthew G. Landa ------------------------------ Date: October 28, 1998 Matthew G. Landa, President, Chief Executive Officer and Director 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.
Signature Title Date --------- ----- ---- /s/ David S. Lee Chairman of the Board October 28, 1998 - ----------------------------- David S. Lee /s/ Matthew G. Landa President, Chief Executive October 28, 1998 - ------------------------------ Officer and Director Matthew G. Landa /s/ Andrew J. Moley Executive Vice President, October 28, 1998 - ------------------------------ Chief Financial Officer and Andrew J. Moley Director /s/ Ira Coron Director October 28, 1998 - ------------------------------ Ira Coron /s/ Frederick W. Gibbs Director October 28, 1998 - ------------------------------ Frederick W. Gibbs Director - ------------------------------ Charles Holloway /s/ Richard M. Moley Director October 28, 1998 - ------------------------------ Richard M. Moley /s/ M. Kenneth Oshman Director October 28, 1998 - ------------------------------ M. Kenneth Oshman
15 EX-13.1 2 EXCERPTS FROM THE 1998 ANNUAL REPORT 1 EXHIBIT 13.1 8 CMC Industries, Inc. and Subsidiaries SELECTED CONSOLIDATED FINANCIAL DATA The following table summarizes certain selected consolidated financial data which should be read in conjunction with the Company's consolidated financial statements and related notes and with Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. The selected consolidated financial data as of July 31, 1998 and 1997, and for each of the years in the three-year period ended July 31, 1998, have been derived from, and are qualified by reference to, audited financial statements included elsewhere herein.
Years Ended July 31, ------------------------------------------------------------------ 1998 1997 1996 1995 1994 -------- -------- -------- --------- -------- Historical Income Statement Data: Net sales ............................ $301,955 $214,485 $164,711 $ 144,303 $163,779 Cost of sales ........................ 283,828 201,081 153,956 136,691 150,793 -------- -------- -------- --------- -------- Gross profit ......................... 18,127 13,404 10,755 7,612 12,986 Selling, general and administrative expenses ..... 12,697 9,454 8,251 7,062 6,168 Restructuring charge ................. -- -- 792 -- -- Research and development expenses .... -- -- -- -- -- -------- -------- -------- --------- -------- Operating income ..................... 5,430 3,950 1,712 550 6,818 Interest expense, net ................ 1,384 1,350 1,512 1,561 1,386 Interest income from sales-type leases -- -- -- -- -- -------- -------- -------- --------- -------- Income (loss) before income taxes .... 4,046 2,600 200 (1,011) 5,432 Income tax provision (benefit) ....... 1,515 994 95 (1,051) 2,056 -------- -------- -------- --------- -------- Net income ........................... $ 2,531 $ 1,606 $ 105 $ 40 $ 3,376 ======== ======== ======== ========= ======== Net income per share (1) Basic ........................... $ 0.35 $ 0.24 $ 0.02 $ 0.01 $ 0.63 ======== ======== ======== ========= ======== Diluted ......................... $ 0.34 $ 0.22 $ 0.02 $ 0.01 $ 0.60 ======== ======== ======== ========= ======== Weighted average shares (1) Basic ........................... 7,205 6,757 6,235 6,087 5,348 Diluted ......................... 7,553 7,167 6,449 6,253 5,664 Historical Balance Sheet Data: Working capital ...................... $ 15,591 $ 20,635 $ 20,914 $ 21,739 $ 19,862 Total assets ......................... 94,605 96,543 67,434 65,963 66,426 Long-term debt and capital lease obligations ..... 2,268 4,390 6,261 6,341 5,545
- ------------------- (1) Net income per share is calculated as described in Note 2 of Notes to Consolidated Financial Statements. The Company has never paid or declared any cash dividends. 2 CMC Industries, Inc. and Subsidiaries 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL CMC Industries, Inc. ("CMC" or the "Company") was incorporated in 1990 to acquire certain businesses operated from the Company's Corinth, Mississippi manufacturing facility since 1960. In August 1993, the Company transferred certain assets and related liabilities associated with its telephone business to Cortelco Systems Holding Corp. ("Cortelco"), an affiliate through common ownership, in exchange for 1,000,000 shares of redeemable preferred stock of Cortelco. This restructuring allowed CMC to focus on contract manufacturing services while Cortelco pursued the development and distribution of telephones and telecommunications products. The Company offers contract manufacturing services to its customers on both a turnkey and consignment basis, with over 90% of the Company's net sales in fiscal 1998 derived from turnkey projects. On turnkey contracts, the Company both procures the components and other supplies and provides full manufacturing services. On consignment contracts, the customer provides the components and other supplies to the Company, and the Company charges only for labor and overhead; thus, sales volumes per assembly are generally lower and the gross margins are generally higher on consignment contracts since the Company does not procure materials for the assembly. Set forth below are analyses of the Company's results of operations for the fiscal years ended July 31, 1998, 1997 and 1996. Results of operations for the years ended July 31, 1998 and 1997 are discussed together in the section immediately below, followed by a discussion of results for the years ended July 31, 1997 and 1996. RESULTS OF OPERATIONS FOR THE YEAR ENDED JULY 31, 1998 VERSUS 1997 Total net sales for fiscal 1998 were $302.0 million, up 41% from $214.5 million for fiscal 1997. Approximately $174.0 million, or 58% of the Company's sales in fiscal 1998 were to customers from the communications (telecommunications and data networking) industry as compared to $143.1 million, or 67%, in fiscal 1997. As previously announced, the Company's manufacturing relationship with Micron Electronics, Inc. ("Micron"), the Company's largest customer from the computer industry in both fiscal 1998 and fiscal 1997, was discontinued at the end of the second quarter of fiscal 1998. Sales to Micron were $71.4 million and $45.4 million in fiscal 1998 and 1997, respectively. When compared to the prior fiscal year, sales to customers other than Micron increased by 36% (to $230.6 million from $169.1 million). This increase was accomplished with sales to new customers and increased sales to certain existing customers. The Company initiated business in fiscal 1998 with Midway Games, Inc. (formerly known as Williams Electronics) and Premisys Communications, Inc. and began shipments late in the third quarter of fiscal 1998 under a new turnkey contract with Diamond Multimedia Systems, Inc. ("Diamond"), an existing customer previously served only on a consignment basis. The Company is currently recognizing revenues from Diamond at an annualized rate of approximately $50 million, which is less than originally expected. The Company also began shipments in the first quarter of fiscal 1999 under a recently awarded full turnkey contract with Next Level Communications. This paragraph contains forward-looking statements and readers are urged to consider the "Factors that May Affect the Company" in this regard. 3 10 CMC Industries, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Gross profit for fiscal 1998 was $18.1 million or 6.0% of net sales, as compared to $13.4 million or 6.2% of net sales for fiscal 1997. The decrease in gross profit as a percentage of sales in fiscal 1998 when compared to the prior fiscal year was principally due to a change in product mix, with the costs of materials as a percentage of total costs of goods sold increasing in the current fiscal year when compared to the prior fiscal year. Since the markup on the costs of materials is typically less than the markup on the costs of conversion (including labor and overhead), gross profit as a percentage of sales usually declines as the materials portion of total costs increases. Gross profit was also adversely affected in fiscal 1997 by the effect of a $989,000 write-off of certain inventory balances. Selling, general and administrative expenses were $12.7 million or 4.2% of net sales in fiscal 1998, as compared to $9.5 million or 4.4% of net sales for fiscal 1997. Included in the fiscal 1998 expenses were $1.3 million of costs for defense and settlement of certain claims of age discrimination resulting from a September 1995 reduction in force. Without admitting any liability, the Company has agreed to enter into a Conciliation Agreement with the EEOC to settle claims related to this matter and limit future litigation costs. Although other selling, general and administrative expenses decreased as a percentage of net sales, such expenses increased in absolute dollars in fiscal 1998 primarily due to additions to the Company's sales force and management team, expenses incurred to expand and upgrade information systems and an increase in selling expenses directly associated with the higher sales levels. Net interest expense for both fiscal 1997 and fiscal 1998 was approximately $1.4 million. Most of the Company's debt bears interest at variable rates which were lower, on average, in fiscal 1998 than in fiscal 1997; however, the impact of the reduced rates was substantially offset by higher average debt balances in fiscal 1998 compared to fiscal 1997. See "Liquidity and Capital Resources." The Company's effective tax rate was approximately 37.4% for fiscal year 1998 and 38.2% for fiscal year 1997. The effective income tax rates approximate the blended U.S. and state statutory rates. RESULTS OF OPERATIONS FOR THE YEAR ENDED JULY 31, 1997 VERSUS 1996 Total net sales for fiscal 1997 were $214.5 million, up 30% from $164.7 million for fiscal 1996. Sales to Micron, a new box build customer serving the computer market, accounted for $45.4 million, or 21% of the Company's revenues in fiscal 1997. The Company initiated business with Micron in the second quarter of fiscal 1997. Approximately $143.1 million, or 67% of the Company's sales in fiscal 1997 were to customers from the communications (telecommunications and data networking) industry as compared to $107.8 million, or 66%, in fiscal 1996. Revenue growth in the communications segment was accomplished in fiscal 1997 with sales to new customers and increased sales to certain existing customers. Gross profit for fiscal 1997 was $13.4 million or 6.2% of net sales, as compared to $10.8 million or 6.5% of net sales for fiscal 1996. The decrease in gross profit as a percentage of sales on a year-to-year basis was partially due to a pre-tax charge of $989,000 taken by the Company in the fourth quarter of fiscal 1997 to write off remaining inventory balances relating to certain customers. The Company's gross margins were also adversely impacted throughout the second half of fiscal 1997 by the decline of certain high margin consignment business and costs associated with the commencement of new turnkey business. 4 CMC Industries, Inc. and Subsidiaries 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Selling, general and administrative expenses were $9.5 million or 4.4% of net sales in fiscal 1997, as compared to $9.0 million (including $792,000 in non-recurring restructuring charges) or 5.5% of net sales for fiscal 1996. Although selling, general and administrative expenses decreased as a percentage of net sales, such expenses increased in absolute dollars in fiscal 1997 primarily due to additions to the Company's sales force, increases in expenses incurred to expand and upgrade information systems and an increase in selling expenses directly associated with the higher sales levels. Net interest expense for fiscal 1997 was $1.4 million as compared to $1.5 million for fiscal 1996. The decrease in fiscal 1997 compared to fiscal 1996 was primarily due to lower average debt balances. The Company's effective tax rate for fiscal 1997 was approximately 38.2% as compared to 47.5% for fiscal 1996. The fluctuation from year to year resulted from the relationship between the amortization of goodwill and pre-tax income. Goodwill amortization is treated as an expense for financial purposes but is not deductible for tax purposes. QUARTERLY RESULTS The following table contains selected unaudited consolidated financial results for each of the four fiscal quarters for fiscal 1997 and 1998.
Year Ended July 31, 1997 Year Ended July 31, 1998 --------------------------------------------- ------------------------------------------ (In Thousands) Quarter Ended Quarter Ended --------------------------------------------- ------------------------------------------ October 31 January 31 April 30 July 31 October 31 January 31 April 30 July 31 Net sales $41,941 $56,332 $54,369 $ 61,843 $90,626 $88,431 $58,565 $ 64,333 Gross profit 3,500 3,936 3,679 2,289 5,558 5,505 3,969 3,095 Selling, general and administrative expenses 1,995 2,200 2,410 2,849 3,099 3,182 2,731 3,685 Operating income (loss) 1,505 1,736 1,269 (560) 2,459 2,323 1,238 (590) Interest expense, net 319 288 384 359 395 357 311 321 Net income (loss) 736 900 550 (580) 1,290 1,229 580 (568)
AS A PERCENTAGE OF SALES - --------------------------------------------------------------------------------------------------------------- Net sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Gross profit 8.3 7.0 6.8 3.7 6.1 6.2 6.8 4.8 Selling, general and administrative expenses 4.8 3.9 4.4 4.6 3.4 3.6 4.7 5.7 Operating income (loss) 3.6 3.1 2.3 (0.9) 2.7 2.6 2.1 (0.9) Interest expense, net 0.8 0.5 0.7 0.6 0.4 0.4 0.5 0.5 Net income (loss) 1.8 1.6 1.0 (0.9) 1.4 1.4 1.0 (0.9)
5 12 CMC Industries, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The Company's quarterly operating results have fluctuated due to a number of factors, including the mix of manufacturing projects, capacity utilization, price competition, the timing of orders from major customers, the timing of expenditures in anticipation of increased sales, customer product delivery requirements, costs associated with the commencement of new turnkey or consignment manufacturing projects, increased cost and shortages of turnkey manufacturing components or qualified labor, and economic conditions generally and within the telecommunications, data networking and computer industries. The Company's gross margin was adversely impacted in the fourth quarter of fiscal 1997 by a pre-tax charge of $989,000 taken by the Company to write off remaining inventory balances relating to certain customers. See "Results of Operations for the Year Ended July 31, 1997 versus 1996." The Company's operating income was adversely impacted in the fourth quarter of 1998 by a pre-tax charge of $975,000 to settle certain claims of age discrimination resulting from a September 1995 reduction in force. This charge is in addition to approximately $300,000 of legal costs incurred during the year to defend the Company's position. Without admitting any liability, the Company has agreed to enter into a Conciliation Agreement with the EEOC to settle claims related to this matter and limit future litigation costs. See "Results of Operations for the Year Ended July 31, 1998 versus 1997." During the first and second quarters of fiscal 1998, the Company experienced an increase in sales to Micron and certain other products for which demand would typically increase during the holiday buying season. The manufacturing relationship with Micron has been discontinued and there can be no assurance, with respect to other products and services provided by the Company, that any seasonal trend resulting in revenues and operating profit being the highest in the first two quarters of the fiscal year will continue in future fiscal years, or that if it does continue, it will not be offset by a decrease in sales and operating profits of other products. FORWARD-LOOKING STATEMENTS This annual report contains certain forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of certain of the risk factors set forth below and elsewhere in this document. In addition to the other information contained and incorporated by reference in this document, the following factors should be considered carefully in evaluating the Company and its business. FACTORS THAT MAY AFFECT THE COMPANY Potential Fluctuations in Operating Results. The Company's operating results are affected by a number of factors, including the timing and mix of manufacturing 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 customers, fluctuations in demand for customer products, the timing of expenditures in anticipation of increased sales, customer product delivery requirements, increased costs and shortages of components or labor and economic conditions generally. All of these factors can cause substantial fluctuations in the Company's operating results. The Company's expenditures (including, but not limited to, equipment, inventory and labor) are based, in part, on its expectations as to future revenues and, to a large extent, are fixed in the short term. Accordingly, the Company has in the past and may in the future be unable to adjust spending in a timely manner to compensate 6 CMC Industries, Inc. and Subsidiaries 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) for any unexpected shortfall in revenues, and any significant shortfall of demand in relation to the Company's expectations or any material delay or cancellation of customer orders could have an almost immediate material adverse effect on the Company's operating results. As a result, it is possible that in some future period, the Company's operating results could fail to meet the expectations of public market analysts or investors. In such events, or in the event that adverse conditions prevail or are perceived to prevail generally or with respect to the Company's business, the trading price of Company's Common Stock could drop significantly. The Company's gross profit as a percentage of sales in future periods may be materially adversely affected by various factors associated with the Company's production of new product lines, acquisition of new manufacturing equipment and continued dependence on turnkey contracts (and the inventory risks inherent therein). Expansion of capacity will result in a higher fixed cost structure which will require increased revenue and/or significant improvements in operating efficiencies in order to maintain historical gross margins. Additionally, the commencement of production of new products typically involves significant startup costs, lower yields and other inefficiencies. New products do not generate gross margins as high as products which have been in volume production for several months. The Company also expects that competition may continue to intensify, which could also result in lower gross margins. Customer Concentration; Dependence on Industry Trends. A small number of customers are currently responsible for a significant portion of the Company's net sales. In the fiscal years ended July 31, 1998, 1997 and 1996, the Company's four largest customers in such periods accounted for approximately 56%, 61% and 63%, respectively, of consolidated net sales. Sales to Micron Electronics, Inc. accounted for approximately 24% and 21% of the Company's revenues for the fiscal years ended July 31, 1998 and July 31, 1997, respectively. As previously disclosed, the relationship with Micron has been discontinued and the Company's business and results of operations may be materially adversely affected by such loss in future quarters. Any other material delay, cancellation or reduction of orders from these or other customers could have a material adverse effect on the Company's results of operations. 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 could have a material adverse effect on the Company's results of operations. In addition, customer contracts can be canceled and volume levels can be materially changed or delayed. The timely replacement of canceled, delayed or reduced contracts with new business cannot be assured. These risks are exacerbated because the Company's sales are to customers in segments of the electronics industry subject to rapid technological change and product obsolescence. The factors affecting these industries in general, or any of the Company's major customers in particular, could have a material adverse effect on the Company's results of operations. 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, which evaluate the Company's capabilities against the merits of manufacturing products internally. The Company competes with different companies depending on the type of service or geographic area. Certain of the Company's competitors have broader geographic breadth. They also may have greater manufacturing, financial, research and development and marketing resources than the Company. The Company believes that the primary basis of competition in its targeted markets is manufacturing technology, quality, responsiveness, and the provision of value-added services and price. 7 14 CMC Industries, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) 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. Shortages of Electronics Components. Most of the Company's net sales are derived from turnkey manufacturing services in which the Company procures components from third-party suppliers and bears the risk of component shortages. The electronics industry has been characterized by shortages from time to time in semiconductor and other components, which shortages have led to allocations by third-party suppliers. The Company's inability to procure desired supplies of certain components has in the past led, and may in the future lead, to some delays in shipments by the Company to its customers. These delays to date have not had a material adverse effect on the Company's results of operations. If these component shortages persist or intensify, however, the Company may not be able to secure quantities required to fulfill customer orders, which could result in delays in shipments, or cancellation or delays in customer orders, each of which could have a material adverse effect on the Company's results of operations. Management of Growth. There can be no assurance that the Company will successfully manage the integration of new business and the growth, if any, of the Company's operations. In addition, the Company may experience certain inefficiencies as it manages geographically dispersed operations. The Company has made a significant investment to expand manufacturing operations into Mexico. There can be no assurance that volumes of orders will be sufficient to fully recover this investment. Should the Company increase its expenditures in anticipation of a future level of sales that does not materialize, its results of operations could be materially adversely affected. On occasion, customers may require rapid increases in production which can place an excessive burden on the Company's resources. There can be no assurance that the Company will be capable of meeting the demands placed upon the Company's resources by these or any other customers. 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. In this regard, see "Legal Proceedings." Risk of Defects. The electronics products manufactured for customers by the Company are highly complex and may at times contain undetected design and/or manufacturing errors or failures. Such defects have been discovered in the past, and there can be no assurance that, despite the Company's quality control and quality assurance efforts, such defects will not occur in the future. If such defects occur in quantities or too frequently, the Company's business and operating results may be materially and adversely affected. Dependence on Key Personnel and Skilled Employees. The Company's continued success depends to a large extent upon the efforts and abilities of key managerial and technical employees. The loss of services of certain key personnel could have a material adverse effect on the Company. The Company's business also depends upon its ability to continue to attract and retain senior managers and sales representatives and other skilled employees. Failure to do so could have a material adverse effect on the Company's operations. 8 CMC Industries, Inc. and Subsidiaries 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Possible Volatility of Market Price of Common Stock. The trading price of the Company's Common Stock is subject to significant fluctuations in response to variations in quarterly operating results, general conditions in the electronics manufacturing services industry as well as the industries of the Company's customers, and other factors. In addition, the stock market is subject to price and volume fluctuations which affect the market price for many high technology companies in particular, and which may or may not be unrelated to operating performance. There can be no assurance as to the trading price of the Company's Common Stock at any time in the future. LIQUIDITY AND CAPITAL RESOURCES The Company's bank credit facility is comprised of a revolving credit line of $25.0 million, a $6.0 million term loan amortizing over fifty-six months beginning in October 1996 and a $3.8 million equipment line. The loan agreement contains financial covenants related to the Company's net worth and debt service coverage and restricts capital expenditures. At July 31, 1998, total borrowings under this facility were $18.1 million under the revolving credit line and $3.6 million under the term loan. The Company leases certain manufacturing facilities and equipment using both capital and operating lease arrangements. At July 31, 1998, future minimum lease payments under the noncancelable portion of lease agreements were $21.7 million, of which $7.8 million is scheduled for payment in fiscal 1999. In January 1998, the Company completed a private placement of an aggregate of 500,000 shares of its Common Stock, raising approximately $3.6 million. The purpose of the offering was principally to provide the Company additional financial flexibility to take advantage of business opportunities as they arise. The Company's cash and cash equivalents increased from $4.3 million to $5.3 million during the year ended July 31, 1998. Cash from operations was provided by net income before depreciation and amortization of $4.8 million, a decrease in inventories of $9.6 million, a decrease in accounts receivable of $3.3 million and an increase in accrued expenses, deferred taxes and other current liabilities of $2.0 million which was offset by a decrease in accounts payable of $14.6 million, an increase in other assets of $1.6 million and capitalized start-up costs of $1.2 million. The Company used cash of $9.5 million in investing activities during fiscal 1998 including $6.4 million in payments associated with the purchase of a 4.4-acre tract of land in Hermosillo, Mexico and the construction and start-up of the Company's new facility at that site. The Company also expended $3.1 million for other equipment acquisitions and facility leasehold improvements. Cash flow from financing activities during fiscal 1998 totaled $8.2 million, net of $1.7 million used to pay long-term debt and capital lease obligations. During the year, cash of $5.3 million was provided by increased borrowings under the Company's revolving credit line and $3.6 million from the private equity placement described above. During fiscal 1998, approximately 78,000 shares of the Company's Common Stock were issued pursuant to the Company's Employee Stock Purchase Plan, resulting in net proceeds to the Company of $608,000. Also during the fiscal year, options to purchase approximately 85,000 shares of the Company's Common Stock were exercised, resulting in net proceeds to the Company of $342,000. 9 16 CMC Industries, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) In July 1998, the Company converted certain older accounts receivable from Cortelco totaling $2.0 million into a note receivable. Under the terms of the note, Cortelco agrees to pay the balance over a three-year term with monthly payments of $50,000 plus interest and a final installment of $200,000 due at the end of the three-year period. Interest accrues on the note at a rate of 9.0% per annum. The Company continues to provide credit for manufacturing services sold to Cortelco in the form of trade receivables. The Company's needs for financing in the next twelve months may include increases in working capital to support sales growth, if any, and expansion of capacity (plant and equipment). The Company plans to complete the construction of its new 110,000 square foot manufacturing plant in Hermosillo, Mexico in the first quarter of fiscal 1999. The Company estimates that the total additional cost to complete this project will be approximately $800,000 (although there can be no assurance as to what the actual cost will in fact be) and expects to finance the remaining costs of this project and to meet its other short-term liquidity requirements generally through net cash provided by operations, vendor credit terms, operating lease arrangements and short-term borrowings under its lines-of-credit. The Company from time to time evaluates possible business acquisitions, facility additions and expansion of surface mount and BGA technology capabilities. The Company may seek additional financing as needed to pursue growth opportunities, including any expansion of capacity; however, there can be no assurance that such financing will be available on terms acceptable to the Company, if at all. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's manufacturing equipment, computer programs or computer hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to operate equipment, process transactions, send invoices, or engage in similar normal business activities. Based on recent assessments, the Company determined that it will be required to modify or replace only insignificant portions of hardware and software so that those systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with minor modifications of existing hardware and software, the Year 2000 Issue can be mitigated. The Company's plan to resolve the Year 2000 Issue involves four phases; assessment, remediation, testing and implementation. To date the Company has fully completed its assessment of all material systems that could be affected by the Year 2000 Issue. The completed assessment indicated that most of the Company's significant information technology systems and software and hardware used in manufacturing equipment (hereafter also referred to as operating equipment) would not be materially affected. Further, the Company does not conduct a significant portion of its vendor purchase transactions through systems that interface directly with suppliers. For its information technology exposures, the Company believes that it has completed a substantial portion of the remediation phase for all material systems and is scheduled to complete software reprogramming and replacement by November 30, 1998. After completing the reprogramming and replacement 10 CMC Industries, Inc. and Subsidiaries 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) of software, the Company's plans call for testing and implementing its information technology systems. To date, the Company has completed approximately one-half of its testing and has implemented approximately one-half of its remediated systems. The Company has currently scheduled the testing phase to be complete by December 31, 1998, with all remediated systems fully implemented by January 31, 1999; however, there can be no assurance that such schedules will be met. For its operating equipment exposures, the Company believes that it has completed in excess of one-half of the remediation phase of the resolution process. Testing of this equipment is more difficult than its information technology systems and the Company is in the early stages of this task. The Company is scheduled to complete its remediation efforts by November 30, 1998, and testing and implementation of affected equipment by March 31, 1999; however, there can be no assurance that such schedules will be met. With respect to third parties, the Company currently has no material systems that interface directly with significant vendors. The Company plans to query its important suppliers regarding Year 2000 readiness but to date is not aware of any problems that would materially impact results of operations, liquidity or capital resources. However, the Company has no means of ensuring that these third parties will be Year 2000 ready and any inability of those parties to complete their Year 2000 resolution process could materially impact the Company. The Company will primarily utilize internal resources to reprogram, to replace, test and implement, as needed, the software and operating equipment for Year 2000 modifications. The total cost of the Year 2000 project is not expected to materially affect the Company's business or results of operations. However, there can be no guarantee that unexpected events will not occur and actual results could be materially adversely affected. Specific factors that might cause such material adverse effects include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes and similar uncertainties. EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS The Accounting Standards Executive Committee has issued Statement of Position ("SOP") 98-5, Reporting on the Costs and Start-up Activities, effective for fiscal years beginning after December 15, 1998 (fiscal 2000 for the Company). SOP 98-5 requires the costs of start-up activities and organization costs to be expensed as incurred. In fiscal 1998, the Company capitalized $1.2 million of start-up costs incurred to begin manufacturing operations in Hermosillo, Mexico. The Company plans to amortize 20%, or $240,000, in fiscal 1999 and expense the balance of $960,000 in fiscal 2000 upon adoption of SOP 98-5. 11 18 CMC Industries, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
July 31, ----------------------- 1998 1997 ------ ------ ASSETS Current assets Cash and cash equivalents .............................................. $ 5,281 $ 4,298 Trade accounts receivable, less allowance for doubtful accounts of $82 and $75, respectively ...................................... 31,282 32,533 Accounts and notes receivable from affiliates .......................... 5,678 9,186 Inventories ............................................................ 20,275 29,900 Other current assets ................................................... 2,000 1,196 -------- -------- Total current assets ................................................... 64,516 77,113 Property, plant and equipment, net ..................................... 18,790 11,498 Investment in preferred stock of affiliate ............................. 5,884 5,884 Note receivable from affiliate ......................................... 1,400 -- Goodwill, net of accumulated amortization of $285 and $233, respectively ...................................................... 718 770 Other assets ........................................................... 3,297 1,278 -------- -------- $ 94,605 $ 96,543 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Notes payable under lines of credit .................................... $ 18,111 $ 12,792 Current portion of capital lease obligations ........................... 846 428 Current portion of long-term debt ...................................... 1,300 1,300 Trade accounts payable ................................................. 21,365 35,936 Accrued compensation and related benefits .............................. 1,941 2,284 Accrued expenses and other current liabilities ......................... 4,591 1,854 Deferred tax liabilities ............................................... 769 1,884 -------- -------- Total current liabilities ......................................... 48,923 56,478 Capital lease obligations .............................................. 10 832 Long-term debt ......................................................... 2,258 3,558 Other noncurrent liabilities ........................................... 105 149 Deferred tax liabilities ............................................... 1,364 682 -------- -------- Total liabilities ................................................. 52,660 61,699 -------- -------- Commitments and contingencies (Notes 6 and 14) Stockholders' equity Common stock, $.01 par value; 15,000,000 shares authorized; 7,554,816 and 6,892,211 shares issued and outstanding, respectively ...................................................... 76 69 Additional paid-in capital ............................................. 36,157 31,594 Treasury stock (42,500 shares at cost) ................................. (441) (441) Retained earnings ...................................................... 6,153 3,622 -------- -------- Total stockholders' equity ............................................. 41,945 34,844 -------- -------- $ 94,605 $ 96,543 ======== ========
The accompanying notes are an integral part of these financial statements. 12 CMC Industries, Inc. and Subsidiaries 19 CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data)
Year Ended July 31, ------------------------------------ 1998 1997 1996 -------- -------- -------- Net sales Non-affiliates ........................ $275,519 $183,173 $126,686 Affiliates ............................ 26,436 31,312 38,025 -------- -------- -------- Total net sales ............................ 301,955 214,485 164,711 -------- -------- -------- Cost of sales Non-affiliates ........................ 259,507 172,274 118,973 Affiliates ............................ 24,321 28,807 34,983 -------- -------- -------- Total cost of sales ........................ 283,828 201,081 153,956 -------- -------- -------- Gross profit ............................... 18,127 13,404 10,755 Selling, general and administrative expenses 12,697 9,454 8,251 Restructuring charge ....................... -- -- 792 -------- -------- -------- Operating income ........................... 5,430 3,950 1,712 Interest expense ........................... 1,384 1,350 1,512 -------- -------- -------- Income before income taxes ................. 4,046 2,600 200 Income tax provision ....................... 1,515 994 95 Net income ................................. $ 2,531 $ 1,606 $ 105 ======== ======== ======== Net income per share Basic ................................. $ 0.35 $ 0.24 $ 0.02 ======== ======== ======== Diluted ............................... $ 0.34 $ 0.22 $ 0.02 ======== ======== ======== Weighted average shares outstanding Basic ................................. 7,205 6,757 6,235 ======== ======== ======== Diluted ............................... 7,553 7,167 6,449 ======== ======== ========
The accompanying notes are an integral part of these financial statements. 13 20 CMC Industries, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (In thousands, except share data)
Common Retained Treasury Shares Capital Earnings Stock Other Total --------- --------- -------- --------- ----- ------- Balance, July 31,1995 ...... 6,097,902 $ 27,360 $1,911 $ -- $(933) $28,338 Net income ................. 105 105 Issuance of shares ......... 436,037 2,364 2,364 Issuance of warrants ....... 44 44 Exercise of stock options .. 128,840 314 314 Minimum pension liability .. (63) (63) --------- ------- ------ ----- ------ ------- Balance, July 31, 1996 ..... 6,662,779 30,082 2,016 -- (996) 31,102 Net income ................. 1,606 1,606 Exercise of warrants ....... 168,963 1,267 1,267 Exercise of stock options .. 60,469 314 314 Minimum pension liability .. 996 996 Purchase of treasury stock . (441) (441) --------- ------- ------ ----- ------ ------- Balance, July 31, 1997 ..... 6,892,211 31,663 3,622 (441) -- 34,844 Net income ................. 2,531 2,531 Exercise of stock options .. 84,580 342 342 Employee stock purchase plan 78,025 608 608 Private placement .......... 500,000 3,620 3,620 --------- -------- ------ ----- ------ ------- Balance, July 31, 1998 ..... 7,554,816 $ 36,233 $6,153 $(441) $ -- $41,945 ========= ======== ====== ===== ====== =======
The accompanying notes are an integral part of these financial statements. 14 CMC Industries, Inc. and Subsidiaries 21 CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Year Ended July 31, -------------------------------------- 1998 1997 1996 -------- -------- -------- Cash flows from operating activities: Net income ............................................................ $ 2,531 $ 1,606 $ 105 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred income taxes ............................................. (433) 1,409 (718) Depreciation and amortization ..................................... 2,235 1,805 1,746 (Gain) loss on disposition of assets .............................. (9) -- 10 Bad debt expense .................................................. 20 -- -- Changes in assets and liabilities: Receivables ..................................................... 3,339 (17,087) (914) Inventories ..................................................... 9,625 (8,682) 4,788 Other assets .................................................... (2,823) (842) 1,379 Trade accounts payable .......................................... (14,571) 20,399 2,246 Accrued expenses and other current liabilities ........................................... 2,394 (614) 693 Other liabilities ............................................... (44) 15 (166) -------- -------- ------- Net cash provided by (used in) operating activities ................... 2,264 (1,991) 9,169 -------- -------- ------- Cash flows from investing activities: Capital expenditures .............................................. (9,504) (2,388) (5,669) Proceeds from disposition of assets ............................... 38 -- 126 -------- -------- ------- Net cash used in investing activities ................................. (9,466) (2,388) (5,543) -------- -------- ------- Cash flows from financing activities: Net borrowings (repayments) under lines of credit ........................................... 5,319 5,966 (3,477) Proceeds from longterm debt ....................................... -- -- 1,596 Principal payments on longterm debt ............................... (1,300) (1,300) (1,347) Principal payments on capital leases .............................. (404) (547) (232) Proceeds from exercise of stock options and issuance of stock and warrants .................................. 3,962 1,581 2,722 Proceeds from employee stock purchase plan ........................ 608 -- -- -------- -------- ------- Net cash provided by (used in) financing activities ................... 8,185 5,700 (738) -------- -------- ------- Net increase in cash and cash equivalents ............................. 983 1,321 2,888 -------- -------- ------- Cash and cash equivalents Beginning of year ................................................. 4,298 2,977 89 -------- -------- ------- End of year ....................................................... $ 5,281 $ 4,298 $ 2,977 ======== ======== ======= Supplemental Information: Income taxes paid (refunded) .......................................... $ 628 $ (206) $ 488 Interest paid ......................................................... $ 1,368 $ 1,360 $ 1,697
The accompanying notes are an integral part of these financial statements 15 22 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- ORGANIZATION AND BASIS OF PRESENTATION Description of Business CMC Industries, Inc. and its subsidiaries (the "Company") provide contract manufacturing services primarily to original equipment manufacturers ("OEMs") in the computer and telecommunications industries. Over 90% of the Company's manufacturing contracts are for turnkey services and include procurement of materials in addition to manufacturing. NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of estimates and assumptions 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 certain assets and liabilities, disclosure of contingencies at the date of the financial statements and the related reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Cash and cash equivalents Cash on hand and in banks, together with other highly liquid investments with original maturities of three months or less, are classified as cash equivalents. Revenue recognition In addition to providing contract manufacturing services on a turnkey basis, the Company performs assembly services on a consignment basis where the customer typically procures the components used in the process. The Company recognizes revenue upon shipment for both turnkey and consignment contracts. Inventories Inventories are stated at the lower of cost or market. Cost has been determined by the last-in, first-out ("LIFO") method for 100% and approximately 77% of inventories as of July 31, 1998 and 1997, respectively. Property, plant and equipment Property, plant and equipment are stated at cost less accumulated depreciation. The Company provides for depreciation using the straightline method for financial reporting purposes and accelerated methods for income tax reporting purposes. 16 CMC Industries, Inc. and Subsidiaries 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Goodwill The excess of purchase price over net tangible assets of businesses acquired is carried as goodwill. The Company amortizes such amounts on a straight-line basis over a twenty-year period. The Company recorded amortization expense of $52,000 for years ended July 31, 1998, 1997 and 1996, respectively, related to the purchase of a subsidiary in fiscal 1994. Impairment of long-lived assets At each balance sheet date, the Company assesses whether there has been an impairment in the value of long-lived assets by determining whether projected undiscounted cash flows generated by the applicable asset exceeds its net book value as of the assessment date. At July 31, 1998, there were no impairments of the Company's assets. Deferred loan costs Loan origination fees paid in connection with new borrowings are amortized using a method which approximates the effective rate method over the terms of the related borrowing. Amortization is included in interest expense. Preoperating costs Preoperating and start-up costs incurred in connection with the construction and preparation of the Company's new Mexico manufacturing facility have been capitalized and will be amortized over a five-year period. Capitalized preoperating and start-up costs included in other assets total $1,200,000 as of July 31, 1998. In 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-5, Reporting on the Costs of Start-up Activities. This SOP is effective for the Company in fiscal 2000 and requires companies to expense such costs as incurred. Pursuant to this SOP, the Company will be required to expense the remaining unamortized balance of the aforementioned cost in the first quarter of fiscal 2000. Medical care and disability benefit plans The Company is self-insured with respect to certain medical care and disability benefit plans for 70% of employees. The costs for such plans are charged against earnings in the period incurred. The liability for health care claims was $447,000 and $397,000 as of July 31, 1998 and 1997, respectively, and the related expense incurred was $2,847,048, $3,331,000 and $3,078,000 for the years ended July 31, 1998, 1997 and 1996, respectively. The Company does not provide benefits under these plans to retired employees. Translation of foreign currencies The functional currency of the Mexico operation is the U.S. dollar. Foreign currency gains and losses associated with Mexico operations are included in determining net income. As of July 31, 1998, the operation was in the start-up mode and had not incurred any such transaction gains or losses. Income taxes The Company accounts for income taxes under Statement of Financial Accounting Standards ("SFAS") No. 109 ("FAS 109"), Accounting for Income Taxes. FAS 109 is an asset and liability approach that requires 17 24 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, the Company generally considers all expected future events other than enactments of changes in the tax law or rates. Net income per share Net income per share is calculated in accordance with SFAS No. 128, Earnings per Share, which requires the presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity (see Note 12). Financial instruments Financial instruments are evaluated pursuant to SFAS No. 107, Disclosures about Fair Value of Financial Instruments. The following methods and assumptions were used to estimate the fair value of each class of financial instrument: cash, receivables and payables - the carrying amounts approximate fair value because of the short maturity of those instruments; investment in preferred stock of affiliate - the carrying amount is based upon the present value of cash flows as of August 1993 (date of the restructure of the Company). Although the period has shortened, management does not believe that there has been an appreciable difference in the value of their security since the date received. Long-term debt - the fair value of the Company's long-term debt is estimated based on the current borrowing rates available to the Company for bank loans with similar terms and average maturities. The carrying amounts approximate fair value thereof because borrowings bear interest at a variable interest rate. Presentation Certain fiscal 1997 and 1996 balances have been reclassified to conform to the current year presentation. NOTE 3 -- MAJOR CUSTOMERS AND CREDIT RISK CONCENTRATIONS A substantial portion of the Company's sales are generated from contract manufacturing agreements with domestic OEMs and from sales to domestic distributors of telecommunication products. Sales and related accounts receivable attributable to customers representing 10% or more of total net sales are as follows (in millions):
Net Sales Receivable at Year Ended July 31, July 31, ----------------------------- -------------------- 1998 1997 1996 1998 1997 ------- ------- ------- ------- ------- Micron ......... $ 71.4 $ 45.4 $ -- $ -- $ 6.5 Global Village.. 32.8 29.6 21.3 4.4 8.2 Reltec ......... 36.4 24.2 3.7 5.7 4.3
The Company's credit risk principally relates to trade accounts receivable and receivables from Cortelco, a related party. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. 18 CMC Industries, Inc. and Subsidiaries 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 4 -- INVENTORIES Inventories consist of the following (in thousands):
July 31, -------------------- 1998 1997 ------- ------- Raw materials and purchased components $17,868 $26,205 Work-in-process ...................... 1,637 2,874 Finished goods ....................... 770 821 ------- ------- $20,275 $29,900 ======= =======
The carrying value of inventories at July 31, 1998 and 1997 approximated replacement cost. NOTE 5 -- PROPERTY, PLANT AND EQUIPMENT The components and useful lives of property, plant and equipment are as follows (in thousands):
July 31, Useful life ---------------------- (years) 1998 1997 ----------- -------- ------- Machinery and equipment .. 3 -10 $ 17,269 $15,992 Building ................. 30 4,622 -- Furniture and fixtures ... 5 -15 2,933 1,465 Leasehold improvements ... 5 1,575 484 Computer software ........ 5 -- 457 Construction in progress . 151 56 Land ..................... 798 -- -------- ------- 27,348 18,454 Less - Accumulated depreciation (8,558) (6,956) -------- ------- $ 18,790 $11,498 ======== =======
During fiscal 1998, the Company acquired fixed assets totaling $6,395,000 for its operation in Mexico. Depreciation expense was $2,183,000, $1,753,000 and $1,694,000 for fiscal 1998, 1997 and 1996, respectively. Property, plant and equipment include assets under capital leases with a cost of $1,595,000 as of July 31, 1998 and 1997 and accumulated amortization of $560,000 and $400,000 as of July 31, 1998 and 1997, respectively. NOTE 6 -- BUILDINGS AND EQUIPMENT UNDER LEASE The Company leases its primary manufacturing facility and certain equipment and computer software under capital leases. Certain office, warehouse, other manufacturing facilities and equipment are leased under operating leases. These lease agreements generally include renewal options at varying terms. Future minimum lease payments under the noncancelable portion of capital and operating leases at July 31, 1998 are as follows (in thousands): 19 26 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Operating Capital Fiscal Year Leases Leases - ---------------------------------------------- --------- ------- 1999.......................................... $ 6,981 $852 2000.......................................... 5,562 5 2001.......................................... 3,675 5 2002.......................................... 2,652 5 2003.......................................... 1,958 5 --------- ---- Future minimum lease payments................. $ 20,828 872 ========= Less - Amount representing interest........... 16 Present value of future minimum lease payments 856 Less - Current portion........................ 846 ---- Long - term portion........................... $ 10 ====
Rent expense relating to operating leases totaled approximately $5,428,000, $3,450,000 and $1,555,000 for fiscal 1998, 1997 and 1996 respectively. The capital lease payments due in 1999 include balloon payments related to two equipment leases. The Company has the option to renew the leases for an additional year with payments totaling $43,000 per month. The Company intends to exercise the renewal option. NOTE 7 -- BORROWINGS On September 26, 1996, the Company entered into a Loan and Security Agreement with a financial institution which provides the Company with a total credit facility of $35 million including the following: - Revolving credit facility totaling $25 million including letters of credit, bearing interest, at the Company's option, at either the prime lending rate or an Adjusted Eurodollar Rate (as defined in the Credit Agreement). The Company had $18.1 million and $12.8 million outstanding at weighted average interest rates of 8.0% and 8.6% at July 31, 1998 and 1997, respectively. - Term loan totaling $6 million, payable in 55 monthly installments of $108,333 and a final installment of $91,667, commencing October 1, 1996, and bearing interest, at the Company's option, at either the prime lending rate or an Adjusted Eurodollar Rate (as defined in the Credit Agreement). At July 31, 1998, the Company had outstanding $3.6 million at an average interest rate of 7.74%. At July 31, 1997, the Company had outstanding $4.9 million at an average interest rate of 8.43%. - Commitment to lend up to $3.8 million for machinery and equipment purchases in the form of installment loans, bearing interest, at the Company's options, at either the prime lending rate or an Adjusted Eurodollar Rate (as defined in the Credit Agreement). Outstanding borrowings under this financing arrangement are secured primarily by the Company's accounts receivable, inventories, machinery and equipment. This financing arrangement expires in October 1998. 20 CMC Industries, Inc. and Subsidiaries 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Loan and Security Agreement contains certain restrictive covenants which limit the activities of the Company with respect to, among other things, mergers and acquisitions, additional borrowings and leases, investments and the payment of dividends. The Loan and Security Agreement includes the following financial covenants: - to maintain minimum tangible net worth of an agreed upon amount on a consolidated basis; - to not permit the ratio of total liabilities to stockholders' equity to exceed an agreed upon amount; - to limit capital expenditures to agreed upon levels; - to maintain debt service coverage ratio, as defined, of an agreed upon level. Maturities of long-term debt The aggregate annual maturities of long-term debt are as follows (amounts in thousands): 1999............................... $1,300 2000............................... 1,300 2001............................... 958
NOTE 8 -- CAPITAL STOCK Private Placement In 1998, the Company issued 500,000 shares of stock to two members of the board of directors in a private placement. Proceeds from the issuance totaled $3,620,000. The purchase price equaled the fair market value of the stock issued. Recapitalization On May 16, 1996, the Company issued 436,037 shares of common stock with detachable warrants that entitle the holders to purchase 168,963 shares of common stock at a price of $7.50 per share. The total proceeds for the shares and warrants issued were $2,464,000 and $44,000, respectively. Due to the Company meeting specified levels of financial performance, the warrants were called during fiscal 1997. Total proceeds from the exercise of the warrants were $1.3 million. Stock purchase plan On November 15, 1996, the Stockholders' approved the Employee Stock Purchase Plan ("ESPP"). The ESPP allows eligible employees the right to purchase common stock on a semi-annual basis at the lower of 85% of the market price at the beginning or end of each offering period. As of July 31, 1998, there were 483,197 shares of common stock reserved for the ESPP. During fiscal 1998, employees purchased 78,025 shares under the ESPP. As of July 31, 1998, a liability of $302,408 has been recorded for ESPP withholdings not yet applied towards the purchase of common stock. 21 28 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) STOCK OPTION PLAN The Company's board of directors has authorized 1,900,104 shares of the Company's common stock for issuance in connection with a stock option plan. The stock option plan provides for the granting of options to purchase shares of the Company's common stock at not less than 85% of fair market value on the date of grant. The plan is designed to allow for granting incentive stock options, nonstatutory stock options, stock bonuses and the issuance of restricted stock. At July 31, 1998, 409,166 shares had been exercised under the plan and 342,541 shares for which options were granted had terminated. Options outstanding at July 31, 1998 expire in 1999 through 2008. A summary of activity in the plan follows:
1998 1997 1996 ------------------------- ---------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price --------- -------- ------- -------- ------- -------- Outstanding at beginning of year 872,819 $ 4.99 642,689 $ 4.06 467,502 $ 3.24 Granted ........................ 716,500 $ 8.80 348,500 $ 7.13 346,500 $ 3.83 Exercised ...................... (84,580) $ 4.04 (60,469) $ 5.18 (128,840) $ 0.51 Canceled ....................... (64,555) $ 8.53 (57,901) $ 7.40 (42,473) $ 3.96 --------- ------- ------- Outstanding at end of year ..... 1,440,184 $ 6.78 872,819 $ 4.99 642,689 $ 4.06 ========= ======= ======= Exercisable at end of year ..... 626,471 $ 4.94 461,567 $ 4.30 322,500 $ 4.19 ========= ======= =======
22 CMC Industries, Inc. and Subsidiaries 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table summarizes information about fixed stock options outstanding at July 31, 1998:
Options Outstanding Options Exercisable ---------------------------------------------- ----------------------- Weighted Average Remaining Weighted Weighted Number Contractual Average Number Average Range of Outstanding Life Exercise Exercisable Exercise Exercise Prices At 7/31/98 (in years) Price At 7/31/98 Price - ---------------------- ------------ ----------- -------- ----------- --------- $ 0.42 to $ 3.00 97,333 4.88 $ 2.07 90,997 $ 2.02 3.72 3.72 250,000 7.21 3.72 229,166 3.72 4.00 4.50 29,167 6.86 4.02 22,048 4.02 5.87 5.87 151,151 8.02 5.87 72,151 5.87 5.88 7.50 232,501 7.10 6.79 102,084 5.60 7.87 8.00 208,803 8.72 7.95 77,715 7.92 8.25 8.37 20,000 8.75 8.36 6,082 8.35 9.00 9.00 302,500 9.80 9.00 0 0.00 9.56 10.13 130,000 9.23 10.08 22,500 10.13 10.50 10.50 18,729 9.29 10.50 3,728 10.50 - ------ ------ --------- ---- ------ ------- ------ $ 0.42 $10.50 1,440,184 8.11 $ 6.78 626,471 $ 4.94 ====== ====== ========= ==== ====== ======= ======
The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretation in accounting for its plan. Accordingly, no compensation expense has been recognized for its stock-based compensation plan. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant date for awards in fiscal 1998, 1997 and 1996 consistent with the method prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, the Company's net earnings for fiscal 1998, 1997 and 1996 would have been reduced by approximately $737,298, $364,000 and $175,000, respectively. Basic and diluted earnings per share would have been reduced by $0.10, $0.05 and $0.03 for fiscal 1998, 1997 and 1996, respectively. These pro forma results will not be representative of the impact on future years because only grants made in fiscal 1998, 1997 and 1996 were considered. The weighted average grant-date fair value of options granted during fiscal 1998, 1997 and 1996 was $8.90, $4.68 and $2.66, respectively. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions for fiscal 1998, 1997 and 1996, respectively: dividend yields of 0% each year; average expected volatility of 72%, 55% and 56%; risk-free interest rates of 5.51%, 6.75% and 6.50%; and an average expected life of 4.69 years. 23 30 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 9 -- INCOME TAXES The provision for income taxes comprised the following (amounts in thousands):
Year Ended July 31, ----------------------------------------------- 1998 1997 1996 -------- --------- -------- Current: Federal..................... $ 1,492 $ (330) $ 610 State....................... 456 (85) 203 -------- --------- -------- 1,948 (415) 813 -------- --------- -------- Deferred: Federal..................... (192) 1,329 (622) State....................... (241) 80 (96) -------- --------- -------- (433) 1,409 (718) -------- --------- -------- $ 1,515 $ 994 $ 95 ======== ========= ========
Deferred tax liabilities (assets) comprised the following (amounts in thousands):
July 31, ------------------------- 1998 1997 ------- ------- Deferred tax liabilities: Inventories............................................................. $ 2,674 $ 2,674 Plant and equipment..................................................... 1,942 1,655 Other................................................................... -- 267 ------- ------- 4,616 4,596 ------- ------- Deferred tax assets: Accrued liabilities..................................................... (1,181) (776) Minimum tax credit...................................................... (594) (594) Other................................................................... (708) (660) ------- ------- (2,483) (2,030) ------- ------- Net deferred tax liability $ 2,133 $ 2,566 ======= ======= The net deferred tax liability is classified as follows: Current liability....................................................... $ 769 $ 1,884 Noncurrent liability.................................................... 1,364 682 ------- ------- $ 2,133 $ 2,566 ======= =======
At July 31, 1998, the Company has certain net operating loss carryforwards which are available to reduce income taxes. These carryforwards total approximately $6,080,000 for state income tax purposes, and expire during the period 2010 through 2012. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of carryforwards which can be utilized. 24 CMC Industries, Inc. and Subsidiaries 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:
---------------------------- Year Ended July 31, ---------------------------- 1998 1997 1996 ---- ---- ---- Statutory federal rate ...................... 35.0% 35.0% 35.0% State income tax, net of Federal benefit .... 3.7 (0.1) 54.0 Other, net .................................. (1.3) 3.3 (41.5) ---- ---- ---- Effective rate .............................. 37.4% 38.2% 47.5% ==== ==== ====
NOTE 10 -- RELATED PARTY TRANSACTIONS Under a manufacturing services agreement which expired in fiscal 1998, the Company provided manufacturing services to Cortelco on a turnkey basis with prices based on cost plus 8% for telephone products and cost plus 10% for telecommunications systems products. Included in net sales for fiscal 1998, 1997 and 1996 were sales to Cortelco totaling $26,436,000, $31,312,000 and $38,025,000, respectively. Total cost of sales for the periods relating to these sales to Cortelco were $24,321,000, $28,807,000 and $34,983,000, respectively. The Company continues to provide services to Cortelco with prices negotiated on a per contract basis. The Company had an agreement in 1996 with Cortelco to provide certain products and related support services to customers of Cortelco. The Company was required to pay a commission to Cortelco in the amount of 10% of sales of these products under this agreement. During fiscal 1996, the Company incurred $341,000 in commissions under this agreement. In July of 1998, the Company converted certain accounts receivable from Cortelco totaling $2,000,000 into a note receivable. Under the terms of the note, Cortelco agrees to pay the balance over a three-year term with monthly payments of $50,000 plus interest. Interest accrues on the note at a rate of 9.0% per annum. The Company continues to provide credit for manufacturing services sold to Cortelco in the form of trade receivables. The Cortelco preferred stock is nonvoting, has a liquidation preference of $12.50 per share and entitles the Company to dividends which are non-cumulative until August 1995 and thereafter cumulative at $.75 per share for each year in which Cortelco earns net income of $2 million or more. The Company may, subject to certain restrictions, require Cortelco to redeem the preferred stock, on a pro rata basis, over a five-year period beginning August 1999. The Company recorded the preferred stock at fair value, $5.9 million, based on the discounted cash flow of the redemption requirements. The excess cost basis of the net assets over the fair value of the preferred shares received was recorded as a distribution of capital to the Company's stockholders. A director of the Company has an ownership interest in a customer which purchased goods during fiscal 1996 totaling $1,731,000 at a cost of $1,697,000. As of July 31, 1996, the Company had an accounts receivable balance of $491,000 from this customer. During 1997, the Company settled the then outstanding balance of $441,000 with this customer through receipt of Company common stock with a fair value of the same amount. 25 32 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 11 -- EMPLOYEE BENEFITS Savings plan The Company maintains a profit-sharing savings plan (the "Savings Plan") for employees of CMC Industries, Inc. Under the terms of the Savings Plan, employees may contribute from 2% to 16% of compensation and an additional elective amount. Effective June 30, 1994, the Company terminated matching employee contributions. The Company may also elect to make an additional discretionary profit-sharing contribution. Effective January 1, 1996, the Savings Plan eligibility requirements were amended to include all full-time employees with one hour of service. The Company recorded no contributions for fiscal 1998, 1997 and 1996. Retirement benefits The Company maintains a defined benefit pension plan (the "Pension Plan") which covers certain hourly employees at the Mississippi division. Retirement benefits under the Pension Plan are based on an employee's length of service and a benefit formula based on year of hire. The benefit formula does not include a provision for increases in future compensation levels. Contributions to the Pension Plan are primarily based on the projected unit actuarial cost method. The Pension Plan's assets consist principally of short-term U.S. government instruments and pooled fixed income, debt and equity investment funds with a financial institution. Effective June 1, 1994, the Company terminated the future service payments for employees. The following table sets forth changes in the projected benefit obligation and changes in the fair value of Plan assets (amounts in thousands):
July 31, -------------------- 1998 1997 ------- ------- Change in projected benefit obligation Benefit obligation at beginning of year ............... $ 7,238 $ 7,442 Service cost .......................................... -- -- Interest cost ......................................... 612 582 Benefits paid ......................................... (678) (555) Loss due to census changes ............................ 540 -- Revaluation gain ...................................... -- (231) ------- ------- Benefit obligation at end of year ................. $ 7,712 $ 7,238 ======= ======= Change in plan assets Fair value of plan assets at beginning of year ........ $ 7,375 $ 7,145 Actual return on plan assets .......................... 671 785 Employer contributions ................................ 513 -- Benefits paid ......................................... (678) (555) ------- ------- Fair value of plan assets at end of year .......... $ 7,881 $ 7,375 ======= ======= Funded status ......................................... $ 169 $ 137 Unrecognized loss ..................................... 1,261 878 ------- ------- Prepaid benefit cost .................................. $ 1,430 $ 1,015 ======= =======
26 CMC Industries, Inc. and Subsidiaries 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The components of net periodic pension cost and related assumptions were as follows (amounts in thousands):
Year Ended July 31, ----------------------------- 1998 1997 1996 ----- ----- ----- Service cost ...................... $ -- $ -- $ -- Interest cost ..................... 612 582 579 Return on plan assets ............. (671) (785) (422) Net amortization and deferral ..... 157 270 (65) ----- ----- ----- Net periodic pension expense ...... $ 98 $ 67 $ 92 ===== ===== ===== Discount rate ..................... 8.25% 8.25% 8.00% Long-term rate of return .......... 8.00% 8.25% 8.00%
Under FAS 87, the portion of deferred gains and losses in excess of 10% of the projected benefit obligation is amortized as a component of net periodic pension cost. If amortization is required, the period used is the average remaining service period of active employees, which was approximately 13.67 years as of July 31, 1998. NOTE 12 -- NET INCOME PER SHARE A reconciliation of basic earnings per share to diluted earnings per share follows (in thousands, except per share data):
Year Ended ------------------------------------------------------------------------------ July 31, 1998 July 31, 1997 July 31, 1996 ------------------------- ------------------------ ------------------------- Per-Share Per-Share Per-Share Income Shares Amount Income Shares Amount Income Shares Amount ------ ------ ------ ------ ------ ------ ------ ------ ------ Basic EPS Income available to common stockholders $2,531 7,205 $0.35 $1,606 6,757 $0.24 $105 6,235 $0.02 Effect of Dilutive Securities Stock options -- 348 -- -- 410 -- -- 214 -- ------ ----- ----- ------ ----- ----- ---- ----- ----- Diluted EPS Income available to common stockholders plus assumed conversions $2,531 7,553 $0.34 $1,606 7,167 $0.22 $105 6,449 $0.02 ====== ===== ===== ====== ===== ===== ==== ===== =====
Options to purchase 400,191 shares of the Company's common stock were outstanding during the year ended July 31, 1998 but were not included in the computation of diluted EPS because the exercise price was greater than the average market price of common shares. These options were still outstanding as of July 31, 1998. 27 34 CMC Industries, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) NOTE 13 -- RESTRUCTURING CHARGE In October 1995, the Company expensed $792,000 in non-recurring charges related to the restructuring of the Company's business. Of this amount, $241,000 related to the relocation of the Company's corporate offices and California operations to a new facility. The remaining amount represented one-time charges related to severance costs resulting from a reduction in overhead staffing at the Company's Mississippi operations. The Company reduced employment levels to reflect the transition of the Company's business away from hand assembly work towards more advanced surface mount technology operations. NOTE 14 -- COMMITMENTS AND CONTINGENCIES In connection with the restructuring of the Company in August 1993, certain deferred income tax liabilities have been assumed by Cortelco. Although the LIFO method of inventory accounting is employed, a portion of this deferred income tax liability attributable to differing financial reporting and tax reporting bases of inventories may become payable in the foreseeable future based on certain rulings made in the U.S. federal tax courts. Although the Company has received indemnification from this affiliate with respect to such liability, the Company would be liable for this tax in the event Cortelco is unable to meet its obligation. The total amount of this deferred income tax liability assumed by Cortelco was approximately $2.2 million as of July 31, 1993. In fiscal 1994, the Company incurred a non-recurring charge included in selling, general and administrative expenses of approximately $170,000 related to the costs of environmental clean-up at a former manufacturing site. The Company's original estimate of its cost of the clean-up was approximately $320,000 which was recorded prior to July 1994. In fiscal 1995, an environmental expert concluded that the cost of a full study combined with short and long-term remediation of the site may cost between $3 and $4 million. During fiscal 1996, the Company was excluded as a potentially responsible party ("PRP") by the State of Tennessee's Department of Environment and Conservation in relation to the former facility; however, Alcatel, Inc., a PRP named by the State of Tennessee's Department of Environment and Conservation and a former owner of the Company, is seeking indemnification from the Company. Management believes Alcatel's assertion to be without merit and has responded as such. As of July 31, 1998, no claims have been filed by Alcatel. In connection with the fiscal 1996 staff reduction discussed in Note 13, certain of the terminated employees subsequently claimed that the Company had engaged in age discrimination in their dismissal and sought damages of varying amounts. The Company defended the actual and threatened claims vigorously during fiscal 1998 incurring approximately $275,000 in legal costs over the course of the year. On August 6, 1998, a judgment was rendered in the favor of one plaintiff in the amount of $127,000 which the Company is reviewing for possible appeal. A second plaintiff's claim for $53,000 has also been filed. The EEOC has negotiated with the Company to reach a monetary settlement for other potential claimants. The Company has agreed to enter into a Conciliation Agreement with the EEOC and pay approximately $500,000 to settle all such claims. As a result of these events and the significant ongoing costs to defend these claims, in October 1998, the Company concluded that its interest would be best served to settle all such matters. The Company has reserved $975,000 to resolve all such claims which represents its best estimate of funds to ultimately be paid to such claimants. This charge has been recorded as of July 31, 1998. In addition to the above, the Company is a defendant in several legal actions involving certain matters arising in the normal course of business. Management believes that the aggregate loss, if any, resulting from the final outcome of these proceedings will not be material to the financial position or results of operations of the Company. No additional accrual has been recorded for these pending matters. 28 CMC Industries, Inc. and Subsidiaries 35 REPORT OF INDEPENDENT ACCOUNTANTS [PRICEWATERHOUSE COOPERS LOGO] To the Board of Directors and Stockholders of CMC Industries, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of changes in stockholders' equity and of cash flows present fairly, in all material respects, the financial position of CMC Industries, Inc. and its subsidiaries at July 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Pricewaterhouse Coopers LLP Memphis, Tennessee August 21, 1998, except as to Note 14, which is as of October 9, 1998 EX-21.1 3 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT. CMC Inmuebles, S.A. de C.V., a Mexico Corporation CMC Industrias Hermosillo, S.A. de C.V., a Mexico Corporation Servicos y Administracion de Sonora, S.A. de C.V., a Mexico Corporation CMC Industries, Inc. Taiwan Branch (U.S.A.), a Taiwan Corporation EX-23.1 4 CONSENT OF INDEPENDENT ACCOUNTANTS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No, 33-80234 and 333-19705) of CMC Industries, Inc. of our report dated August 21, 1998 (except as to Note 14, which is as of October 9, 1998) appearing on page 35 of the Annual Report to Shareholders which is incorporated in this Annual Report on Form 10-K. PRICEWATERHOUSECOOPERS LLP Memphis, Tennessee October 28, 1998 EX-27.1 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AT JULY 31, 1998 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE YEAR ENDED JULY 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 YEAR JUL-31-1998 AUG-01-1997 JUL-31-1998 5,281 0 36,960 0 20,275 64,516 18,790 0 94,605 48,923 0 0 0 76 41,869 94,605 301,955 301,955 283,828 283,828 12,697 0 1,384 4,046 1,515 2,531 0 0 0 2,531 .35 .34
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