ITEM 1. BUSINESS
As used herein, the terms "Company" and "PCD," unless otherwise indicated or the context otherwise requires, refer to PCD Inc., a Massachusetts corporation, and its subsidiaries, including Wells Electronics, Inc. and its subsidiaries ("Wells"). However, all financial information for periods ended before December 26, 1997, unless otherwise indicated or the context otherwise requires, is for PCD Inc. and its subsidiaries, excluding Wells.
THE COMPANY
PCD Inc. (the "Company") designs, manufactures and markets electronic connectors for use in integrated circuit ("IC") package interconnect applications, industrial equipment and avionics. Electronic connectors, which enable an electrical current or signal to pass from one element to another within an electronic system, range from minute individual connections within an IC to rugged, multiple lead connectors that couple various types of electrical/electronic equipment. Electronic connectors are used in virtually all electronic systems, including data communications, telecommunications, computers and computer peripherals, industrial controls, automotive, avionics and test and measurement instrumentation. The electronic connector market is both large and broad. Bishop & Associates, a leading electronic connector industry market research firm, estimates the total 1997 worldwide market at $23.4 billion with more than 2,000 manufacturers.
The Company markets over 6,800 electronic connector products in three product categories, each targeting a specific market. These product categories are IC package interconnects, industrial interconnects and avionics terminal blocks and sockets. IC package interconnects are specially designed electro-mechanical devices that connect ICs to printed circuit boards during the various stages of the IC's production and application in electronic systems. These stages are test, burn-in, development and production. Industrial interconnects are used in industrial equipment systems both internally, as input/output ("I/O") connectors to link the rugged electrical environment of operating equipment to the electronic environment of controllers and sensors, and externally, to facilitate the interface between discrete factory wiring and cabling for standard computer interconnects. Avionics terminal blocks and sockets perform similar functions as industrial connectors, but are designed and built to operate in the harsher environment and meet the more
critical performance requirements of avionics applications. Representative customers of the Company include Altera Corporation, The Boeing Company, Micron Technology, Inc., Rockwell International Corp. (through its subsidiary, the Allen- Bradley Company) and Siemens AG.
The Company believes it is benefiting from three trends affecting the electronics industry: (i) the increasing complexity of ICs and corresponding evolution of IC package designs, which favor growth in PCD's IC package interconnect market; (ii) the global nature of semiconductor manufacturers, which requires suppliers with global design, manufacturing and marketing capabilities; and (iii) the use of increasingly complex electronic controllers and sensors in industrial and avionics applications, which creates opportunities in PCD's industrial equipment and avionics markets.
The Company has maintained a consistent strategy over the past five years to identify and expand into selected electronic connector markets where it can establish a position of leadership. There are five key elements of the Company's strategy: selection of key markets - market selection has contributed to the compound annual growth in sales of the Company (excluding Wells) of approximately 23.8% since 1993, and, after giving effect to the Wells acquisition, the Company's net sales in 1997, on a pro forma basis, were $71.4 million; total customer solution - the Wells acquisition and the creation of the Control Systems Interconnect division are examples of broadening the Company's product offerings within targeted markets; customer responsiveness/short delivery cycle - the Company believes it is among the most responsive to customer needs including product design and production lead times in the markets it serves, and its strategy is to maintain and exploit its leadership position; best cost producer - the Company (excluding Wells) has experienced an improvement in gross profit as a percentage of net sales from 33.1% in 1993 to 49.3% in 1997; and penetration of worldwide markets - international sales of the Company (excluding Wells) increased from 7.7% of net sales in 1993 to 35.8% in 1997, and, with the addition of operations of Wells in Europe and Asia, the Company expects that international sales will account for a significant portion of its revenues for the foreseeable future.
The Company was incorporated in Massachusetts on November 9, 1976 under the name Precision Connector Designs, Inc. In February 1996, the Company changed its name to PCD Inc.
MARKETS
The electrical and electronic systems which utilize connectors have become increasingly widespread and complex, in part, as a result of the increased automation of business systems and manufacturing equipment. Consequently, the electronic connector industry has grown in size and electronic connectors have become more sophisticated. Demand for smaller yet more powerful products has resulted in continued improvements in electronic systems in general and electronic connectors in particular. Product cycles continue to shorten and, as time to market becomes increasingly important, equipment manufacturers seek to reduce inventory and contend with pressures to keep up with new product innovations. The growing demand for electronic connector complexity, coupled with reduced product development cycles and delivery lead times, create a need for closer cooperation between connector suppliers and equipment manufacturers, often leading to new connector requirements and market opportunities.
The electronic connector market is both large and broad. Bishop & Associates estimates the total 1997 worldwide market at $23.4 billion. This market is highly fragmented with over 2,000 manufacturers. While many of these companies produce connectors which are relatively standard and often produced in large quantities, a substantial portion of the industry is comprised of companies which produce both proprietary and standard products in relatively low volumes for specialized applications. Fleck Research has identified over 1,100 separate electronic connector product lines presently offered in the marketplace.
PCD focuses its products and sales efforts in the selected key markets listed below.
IC PACKAGE INTERCONNECT MARKET: In the fabrication and use of ICs, there are four stages in which sockets may be used: test, burn-in, development and production. It is the Company's objective to provide a total solution for selected IC packages encompassing all four stages. By providing a total solution, the Company believes it will be able to forge closer customer relationships and gain acceptance by new customers.
The Company's market position varies by market. TEST - Through the Wells acquisition, the Company gained entrance to the IC package test market with a program, which is in its early stage and is designed to penetrate the test market. BURN-IN - The Company believes that the combination of the burn-in product lines of PCD and Wells makes the Company one of the worldwide leaders in the burn-in market. DEVELOPMENT - The Company has been active in the development market for a number of years, primarily
with a product line that it sells to Altera Corporation. PRODUCTION - The Company has recently entered the production market with the introduction of its Z-Lok(TM) BGA socket.
TEST - Test sockets are used primarily in semiconductor foundries. After silicon wafers have been cut into individual chips and packaged, certain electrical tests are performed to detect packaging defects and to grade/sort the chips based on various performance characteristics. Test sockets are designed for specific packages and must withstand hundreds of thousands of rapid insertions and withdrawals while offering high reliability. Because of their intensive use, test sockets have a relatively short useful life.
BURN-IN - Most leading-edge microprocessors, logic and memory ICs undergo an extensive reliability screening and stress testing procedure known as burn-in. The burn-in process screens for early failures by operating the IC at elevated voltages and temperatures, usually at 125 degree symbolC (257 degree symbolF), for periods typically ranging from 12 to 48 hours. During burn-in, the IC is secured in a socket, an electro-mechanical interconnect, which is a permanent fixture on the burn-in printed circuit board. The socket is designed to permit easy insertion and removal of the IC before and after burn-in. Further, these sockets must be able to withstand up to 10,000 insertions and withdrawals under extreme thermal cycle conditions.
DEVELOPMENT - The main purpose of the development socket is to provide flexibility for the designer in performing diagnostics of electronic design layouts and programming of programmable logic devices ("PLDs") in the prototype and early production stages of these layouts.
PRODUCTION - Production sockets provide an electro-mechanical interface between the printed circuit board and the IC package. Printed circuit boards form the backbone of all electronic systems. The use of sockets allows a detachable interconnection between the IC and printed circuit board and benefits both the systems manufacturer and end consumer. Sockets provide flexibility in production by allowing manufacturers to produce the printed circuit board with unpopulated sockets, then populate the board with ICs at a later date. Sockets also make upgrading easier and more flexible for the consumer by allowing for the replacement of a chip on a printed circuit board without disturbing or damaging other elements of the board.
The worldwide semiconductor market has grown in five of the last six years and is projected by Integrated Circuit Engineering Corporation, a leading research company in the semiconductor field, to grow at a compound annual growth rate over the next five years in excess of 15%.
INDUSTRIAL INTERCONNECT MARKET: The industrial interconnect market is comprised of a broad range of control, measurement and manufacturing equipment. Terminal blocks are most commonly used in this equipment to provide an electrical link between discrete functions, such as monitoring and measuring, and controlling devices, such as programmable logic controllers ("PLCs"), stand- alone PCs and single function controllers. The use of terminal blocks has increased as electronic controllers and sensors in the industrial environment have evolved to control more complex, multi- function activities. In addition to increasing in number, these controllers and their connectors are becoming smaller and are being configured in increasing variations.
Increased sophistication in industrial and process control equipment has led to a demand for flexible, modular interconnection and interface products. Control systems are used to facilitate the interface of discrete factory wiring and cable systems with standard computer interconnects. These interface systems allow industrial customers to reduce installation time and decrease cabinet space, thereby improving their overall system costs.
PCD is benefiting from the proliferation of factory automation and the embedded electronics which control manufacturing processes. This trend has spurred demand not only for increased unit volume of terminal blocks but also for interface modules with higher density and greater diversity of configurations.
Within the industrial interconnect market, the Company focuses its sales and marketing efforts on North America. Bishop & Associates forecasts sales of industrial interconnect products in North America to grow at a 6.2% compound annual growth rate, from $891 million in 1997 to $1.2 billion in 2002.
AVIONICS MARKET: The avionics market requires a diverse range of electronic connectors that are designed and manufactured specifically for avionics applications. Over the last few years, commercial aircraft applications have represented an increasingly important part of this market. The Company participates in selected areas of the avionics market with terminal blocks and sockets that perform similar functions as its industrial connectors but are designed to operate in the harsher environment and meet the more critical performance requirements of avionics applications.
The world fleet of commercial transport aircraft, which includes all aircraft with 50 seats or more, is projected by The Boeing Company to grow from 11,500 airplanes at the end of 1996 to almost 17,000 airplanes in 2006. Over the next ten years, The Boeing Company estimates that more than 7,300 new commercial jets will enter service worldwide. The majority of these airplanes will meet industry demand for growth, while the remainder will replace the 1,900 airplanes that are projected to be removed from service. According to The Boeing Company, many of these airplanes are expected to be removed from service due to the International Civil Aviation Organization ("ICAO") requirement that in the United States all airplanes must comply with the ICAO Stage 3 noise standard as of December 31, 1999. Of the 1,900 airplanes projected to be removed from service between 1997 and 2006, three out of four are expected to be removed during the next five years.
STRATEGY
Before the Wells acquisition, both PCD and Wells shared similar strategies, and the Company has developed a unified strategy for the future. The Company's goal is to identify and expand into selected electronic connector markets where it can establish a position of leadership. The Company intends to increase its presence in the markets in which it participates through internal investment in product development and potential strategic acquisitions. The key elements of the Company's strategy are:
SELECTION OF KEY MARKETS: The Company actively identifies and pursues areas of the electronic connector market which have the following characteristics: demand for electronic connectors with relatively high engineering content, high degree of customer interface, changing technology, significant growth opportunities and a market size appropriate to the Company's resources. The Company focuses on the IC package, industrial and avionics interconnect markets. The recent acquisition of Wells emphasizes the Company's strategy of selection of key markets by expanding its share of the IC package interconnect market. Similarly, the Company recently formed its Control Systems Interconnect division in order to enter the interface module market which the Company believes is a rapidly growing segment of the interconnect market.
TOTAL CUSTOMER SOLUTION: The Company seeks to anticipate evolving market requirements and capitalize on its design capabilities to rapidly develop products that meet those needs. PCD has increased its product offerings and design
capabilities to provide a total product solution to its customers. These customers are increasingly seeking a solution to an expanding array of product requirements and services, resulting in the establishment of closer strategic relationships between PCD and its customers. The Company believes its total solution approach meets these customer needs by shortening the new product development cycle, helping them to meet their time-to-market requirements and providing product specific expertise.
CUSTOMER RESPONSIVENESS/SHORT DELIVERY CYCLE: The Company believes that responding quickly to customer needs is a critical competitive factor in the markets in which it participates. Increasing emphasis by customers on time to market with new designs, inventory reduction and shorter, and more frequent production runs has created the need for more responsive, innovative vendors. The Company believes it is among the most responsive to its customer needs including product design and production lead times for product development and delivery in the markets it serves, and the Company's strategy is to maintain and leverage this leadership position.
BEST COST PRODUCER: In the markets in which the Company competes, high quality is a prerequisite. The Company's goal is to be the low cost producer for comparable product designs in each of these markets. The Company strives for continuous cost reduction and monitors its progress closely throughout the year. As part of this program, engineering and manufacturing work closely together from the inception of all new product programs.
PENETRATION OF WORLDWIDE MARKETS: The Company has recently placed great emphasis on marketing its products on a worldwide basis and currently sells to its foreign customers both directly and through U.S. and foreign distributors. According to Bishop & Associates, non-U.S. sales accounted for over 60% of 1997 sales in the world connector market. International sales of the Company (excluding Wells) as a percentage of net sales increased from 7.7% in 1993 to 35.8% in 1997. As a result of the Wells acquisition, the Company now has an operating subsidiary in Japan ("Wells Japan"), and sales or technical support operations in England, Germany, South Korea, Malaysia and Singapore, which the Company believes will expand its ability to serve the global semiconductor market.
PRODUCTS AND APPLICATIONS
The Company markets over 6,800 electronic connector products in three product categories, each targeting a specific market. These product categories are: IC package interconnects, industrial interconnects and avionics terminal blocks and sockets. The products offered within each product category can be characterized as either proprietary, application specific or industry standard, as described below.
PROPRIETARY connectors are unique Company designs that are introduced and sold to a broad market rather than a single customer.
APPLICATION-SPECIFIC interconnects are products which are designed and developed for a specific application, typically for one customer. These products can be subsequently developed into proprietary product lines.
INDUSTRY STANDARD connectors are normally produced in accordance with a relatively detailed industry or military design and performance specification and sold to the broad market to which that specification relates.
IC PACKAGE INTERCONNECTS
ICs (which before being packaged are frequently referred to as dies) are generally encased in a plastic or ceramic package to protect the device and facilitate its connection with other system components. The IC package industry offers a wide variety of evolving package designs. New package designs are driven by the need to accommodate the increasing complexity and higher lead count ICs. Each unique IC package configuration requires a socket that corresponds to the package's specific characteristics.
ICs are constantly increasing in functionality while generally decreasing in unit cost. This leads to an increase in IC product application, thereby driving IC unit growth. This unit growth and the proliferation of sizes and packages drives the demand for IC sockets.
Based on industry reports, unit demand for major package types are expected to increase at a compound annual growth rate of 8.1% from 1996 to 2001. The Company offers products within all package families, however, the Company primarily focuses on the Small Outline ("SO") Package Sockets, Quad Flat Pack ("QFP") Sockets, Pin Grid Array ("PGA") Sockets and Ball Grid Array ("BGA") Sockets. Based on industry reports, the projected compound annual growth rates for SO, QFP, PGA and BGA package families are 8.5%, 16.7%, 8.3% and 59.3%, respectively, from 1996 to 2001.
SMALL OUTLINE PACKAGE SOCKETS: The SO is a plastic, rectangular package with leads on two sides, running along either pair of opposite edges. With lead counts from 8 to 64 leads, the SO houses simple logic, memory and linear dies. Most SO packages are 44 leads and below. Devices tend to transition to the QFP above this lead count. The small size, low price and surface mount design of the SO makes it a highly desirable package. The Company currently produces 170 distinct sockets to accommodate a variety of SO packages.
QUAD FLAT PACK SOCKETS: The QFP is a plastic package with leads on four sides. It is used for high lead count surface mount applications and is characterized by lead counts typically ranging between 40 and 208 leads. The QFP is currently a predominant and rapidly growing technology for packaging of leading edge ICs used in microprocessor, communication and memory applications. The Company currently produces over 37 distinct sockets to accommodate a wide variety of QFP packages.
PIN GRID ARRAY SOCKETS: The PGA is a square or rectangular through-hole device that affects routing through all layers of the printed circuit board. The pins are generally placed on the package before insertion of the die. The differentiating feature of the PGA is that the contacts are placed in an array over the bottom of the packaged device, rather than protruding from the sides of the device in a perimeter pattern, as with the QFP. As a result, the PGA offers greater lead density and smaller overall profile. This makes the PGA ideal for devices with high lead counts, in excess of 208, the upper range in which the QFP becomes difficult to handle.
BALL GRID ARRAY SOCKETS: Similar to the PGA, the BGA uses an underlying substrate, rather than a lead frame, for die attachment. The die is then encapsulated and solderballs are attached to the underside of the substrate. The solderballs ultimately attach the package to the printed circuit board. The die is placed in the package prior to the attachment of the solderballs to ensure a flat surface for the die during processing. In some cases, the packaged BGA is referred to as the BGA Chip-Scale Package ("BGA/CSP") because the package is only slightly larger (i.e. less than 20% larger) than the die itself. Whereas the PGA contacts the printed circuit board at all layers using through-hole connection, the BGA contacts the printed circuit board only at the surface. This allows the BGA to achieve a lower profile, lighter weight and smaller area on the printed circuit board due to surface mounting.
INDUSTRIAL INTERCONNECTS
The Company's product areas in this market are industrial terminal blocks and interface modules. Terminal blocks are most commonly used in industrial equipment to provide an electrical link between discrete functions, such as monitoring and measuring, and a controlling device. Interface modules facilitate the interface between discrete factory wiring and cabling for standard computer interconnects. The Company's industrial interconnects are targeted at the industrial and process control markets and affiliated markets and applications such as environmental control systems, food and beverage preparation, motor controls, machine tools, robotics, instrumentation and test equipment.
TERMINAL BLOCKS: Terminal blocks are used in applications where I/O power or signal wires are fed into a PLC or similar (and often simpler) control system, and a connector is required to interface between the electrical environment of relatively heavy wires and the electronic environment of controllers and sensors. The Company's terminal blocks connect to and capture the wires in screw-clamp terminations, and interface with printed circuit boards in a variety of manners. The Company concentrates on four major product lines within this market: pluggable terminal blocks, fixed mount terminal blocks, edgecard terminal blocks, and application -specific terminal blocks. Application-specific terminal blocks are developed for customers who are of strategic importance to the Company, represent significant potential volume and are recognized market leaders.
INTERFACE MODULES: Interface modules are interconnect devices that incorporate terminal blocks, high density connectors and often additional electronic components and are used to form the interconnection between a system I/O card and field equipment. Often these interconnections require several discrete wire and standard computer connector interconnects. The interface module simplifies the interconnection by incorporating both the discrete wire and standard computer interconnects into a rail mounted printed circuit board assembly consisting of terminal blocks, additional connectors and possibly other electronic devices. Interface modules are typically application-specific and may contain electronic components for signal conditioning, fusing and various other electronic requirements.
AVIONICS TERMINAL BLOCKS AND SOCKETS
Avionics terminal blocks perform similar functions as industrial terminal blocks, linking discrete wires that are individually terminated to a connector. However, avionics terminal blocks are designed to withstand the harsher environment and far more critical operating requirements to which they are subject. The primary differences are that: contacts are gold plated; wires are terminated by the crimped (metal deformation) technique rather than screw clamps; and individual wires are installed and removed from the connector through use of spring- actuated locking devices. The avionics connectors are normally completely environmentally sealed through use of a silicon elastomer sealing grommet or are designed to operate in a sealed compartment.
The Company concentrates on three major product lines in the avionics market:
RELAY SOCKETS: Relay sockets are used throughout aircraft as a means to facilitate installation, repair and maintenance of electro-mechanical relays which are utilized for a wide variety of control purposes ranging from main control circuits to landing gear.
JUNCTION MODULES: Junction modules are environmentally sealed, airborne terminal blocks.
APPLICATION-SPECIFIC AVIONICS CONNECTORS: Application -specific junction modules have been developed in conjunction with Boeing Commercial Aircraft for use on the 737-747-757 -767 series of commercial aircraft; and with Douglas Aircraft Company for the MD11 and C17 aircraft. Application-specific relay sockets are marketed to Boeing subcontractors for the 777 commercial aircraft program and to Douglas for the MD11 and C17 aircraft.
PRODUCT DEVELOPMENT
Currently, the Company markets over 6,800 products in a wide variety of product lines. The Company seeks to broaden its product lines and to expand its technical capabilities in order to meet its customers' anticipated needs. Through the Wells acquisition, the Company anticipates improved project design capacity resulting from focusing new product development resources and eliminating project duplication. The Company's product development strategy is to introduce new products into markets where the Company has already established a leadership position and to develop next generation products for other
markets in which the Company wishes to participate. The following product lines were introduced in 1997: high density terminal blocks, production BGA Z-Lok(TM) sockets, test sockets and Flexiplug(TM), and a number of application-specific products for major market leaders in the IC package interconnect, industrial equipment and avionics markets, including Micron, AMD, Groupe Schneider and Rockwell International Corp. (through its subsidiary Allen-Bradley).
The Company's current product development projects in the IC package interconnect market target new package device designs such as BGA, TSOP and CSP burn-in, test and BGA production packages. The Company believes, based on industry trends, that BGA will become the preferred package for high-lead count IC packages (in excess of 300 leads). The Company also believes, based on industry trends, that SOP and CSP will be the preferred package for high-volume, high-density small outline IC devices. In the industrial equipment market, the Company is scheduled to introduce a series of multi-tier fixed terminal blocks in the first half of 1998. The initial interface modules were introduced in January 1998, and a number of custom designs are expected to follow during the year. New application-specific products are also being developed. Among these products is a product similar to the Company's Flexiplug(TM) product being developed for Rockwell International Corp. (Allen-Bradley Company), which is projected to go into production in the second half of 1998. For Groupe Schneider, the Company has developed a number of standard and application-specific fixed terminal blocks, which are projected to be introduced in the second quarter of 1998.
SALES AND MARKETING
The Company distributes its products through a combination of its own dedicated direct sales forces, a worldwide network of manufacturers representatives and authorized distributors. The Company maintains separate sales forces for the IC package interconnect markets and for the industrial equipment and avionics markets. For the IC package interconnect markets, the Company employs a global direct sales force with offices in England, Germany, Japan, South Korea, Malaysia, Singapore and the United States, augmented with sales representatives in smaller markets. The Company has integrated the Wells sales force with PCD's sales force for the IC package interconnect markets. For the industrial equipment and avionics markets, the Company generally uses its direct sales forces and manufacturer representatives for large customers, new product introductions and application-specific products and uses its authorized distributors for smaller and medium-sized customers of standard
and proprietary products. The Company's sales and marketing program is focused on achieving and maintaining close working relationships with its customers early in the design phase of the customer's own product development.
CUSTOMERS
In 1997, products of the Company (excluding Wells) were sold to over 1,300 customers in a wide range of industries and applications. The top five customers of the Company (excluding Wells) in 1997 accounted for 42.7% of net sales. Altera Corporation accounted for 14.5%, 17.4% and 16.6% of net sales of the Company (excluding Wells) in 1997, 1996 and 1995, respectively, and TNT Distributors, Inc. accounted for 12.7%, and 13.4% of net sales of the Company (excluding Wells) in 1997 and 1995, respectively. In 1997, principal end users of products of Wells included Advanced Micro Devices, Inc., Micron Technology, Inc. and Siemens AG. Sales to customers located outside the United States, either directly or through U.S. and foreign distributors, accounted for approximately 35.8%, 22.1% and 28.1% of the net sales of the Company (excluding Wells) in the years ended 1997, 1996 and 1995, respectively.
Examples of end users of the Company's products, by category, are presented below:
MANUFACTURING AND ENGINEERING
The Company is vertically integrated from the initial concept stage through final design and manufacturing with regard to the key production processes which the Company believes are critical to product performance and service. These processes include precision stamping, plastic injection molding and automated assembly. The Company believes that this vertical integration allows the Company to respond to customers quickly, control quality and reduce the time to market for new product development.
The Company seeks to reduce costs in its manufacturing fabrication and assembly operations through formalized cost savings programs. Complementary programs are dedicated to maximizing the return on capital investments and reducing overhead expense.
The Company believes it is a leader in delivery responsiveness in its target markets. The introduction of just-in-time ("JIT") manufacturing, inventory control techniques and quick-change, in- house production tooling have substantially reduced delivery lead times. Production cells operate under a JIT pull system, with customer orders assembled as received. PCD carries minimal finished goods inventory. An additional advantage of JIT manufacturing is the almost complete elimination of rework. Shop floor orders are not handled in bulk and are relatively small, and problems are resolved as they occur, rather than continuing through an extended production run.
Wells Japan subcontracts all of its product manufacturing and final assembly operations to approximately six Japanese vendors. In calendar year 1997, Wells derived $15.1 million (or approximately 21.1% of the Company's pro forma 1997 revenues) from Wells Japan. The Company does not subcontract any other final product assembly. In addition, the Company subcontracts a portion of its labor-intensive product subassembly to a U.S.- based subcontractor with a manufacturing facility in Mexico. The Company is not contractually obligated to do business with any subcontractor, could substitute other subcontractors without significant additional cost or delay, and could perform assembly itself if the need were to arise.
INTELLECTUAL PROPERTY
The Company seeks to use a combination of patents and other means to establish and protect its intellectual property rights in various products. The Company intends to vigorously defend its intellectual property rights against infringement or
misappropriation. Due to the nature of its products, the Company believes that intellectual property protection is less significant than the Company's ability to further develop, enhance and modify its current products. The Company believes that its products do not infringe on the intellectual property rights of others. However, many of the Company's competitors have obtained or developed, and may be expected to obtain or develop in the future, patents or other proprietary rights that cover or affect products that perform functions similar to those performed by products offered by the Company. There can be no assurance that, in the future, the Company's products will not be held to infringe patent claims of its competitors, or that the Company is aware of all patents containing claims that may pose a risk of infringement by its products.
COMPETITION
The markets in which PCD operates are highly competitive, and the Company faces competition from a number of different manufacturers. The Company has experienced significant price pressure with respect to certain products, including its TSOP product. The principal competitive factors affecting the market for the Company's products include design, responsiveness, quality, price, reputation and reliability. The Company believes that it competes favorably on these factors.
Generally, the electronic connector industry is competitive and fragmented, with over 2,000 manufacturers worldwide. Competition in the IC package interconnect market, however, is highly concentrated among a small number of significant competitors. Competition among manufacturers of application- specific connectors in the industrial terminal blocks market depends greatly on the customer, market and specific nature of the requirement. Competition is fragmented in the avionics market, but there are fewer competitors due to the demanding nature of the military and customer specifications which control much of the markets and the cost and time required to tool and qualify military standard parts. In each of the markets in which the Company participates, the Company's significant competitors are much larger and have substantially broader product lines and greater financial resources than the Company. There can be no assurance that the Company will compete successfully, and any failure to compete successfully could have a material adverse effect on the financial condition, results of operations and business of the Company.
BACKLOG
The Company defines its backlog as orders that are scheduled for delivery within the next 12 months. The Company estimates that its backlog of unfilled orders was approximately $11.9 million (including Wells) at December 31, 1997, all of which the Company expects to fill in 1998, and $7.3 million (excluding Wells) at December 31, 1996. The level and timing of orders placed by the Company's customers vary due to customer attempts to manage inventory, changes in manufacturing strategy and variations in demand for customer products due to, among other things, introductions of new products, product life cycles, competitive conditions or general economic conditions. The Company generally does not obtain long-term purchase orders or commitments but instead seeks to work closely with its customers to anticipate the volume of future orders. Based on anticipated future volumes, the Company makes other significant decisions regarding the level of business it will accept, the timing of production and the levels and utilization of personnel and other resources. A variety of conditions, both specific to the individual customer and generally affecting the customer's industry, may cause customers to cancel, reduce or delay purchase orders that were either previously made or anticipated. Generally, customers may cancel, reduce or delay purchase orders and commitments without penalty. For these reasons, backlog may not be indicative of future demand or results of operations.
ENVIRONMENTAL
The Company is subject to a wide range of environmental laws and regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during its manufacturing process. A failure by the Company to comply with present or future laws and regulations could subject it to future liabilities or the suspension of production. Such laws and regulations could also restrict the Company's ability to expand its facilities or could require the Company to acquire costly equipment or incur other significant expenses.
EMPLOYEES
As of December 31, 1997, the Company had 367 employees and 18 contract workers. The Company's 385 employees and contract workers include 311 in manufacturing and engineering, 45 in sales and marketing and 29 in administration. Of the Company's U.S. employees, 53 are represented by the International Brotherhood of Electrical Workers, Local 1392. The Company believes that its relations with its employees and their union are good. The current collective bargaining agreement expires on February 18, 2000.
RECENT DEVELOPMENTS
WELLS ACQUISITION
On December 26, 1997, the Company completed the acquisition (the "Wells acquisition") of Wells Electronics, Inc. ("Wells"). Wells designs, develops, manufactures and markets a broad line of test and burn-in sockets and plastic carriers for the global semiconductor industry. In combining the existing burn-in business of PCD with that of Wells, the Company now supports complete design, development, manufacturing and marketing of test and burn-in sockets in two of the world's largest IC package interconnect markets: the United States and Japan. The Company believes that benefits of the combination of PCD and Wells include: (i) complementary product lines that together provide an extensive product offering of burn-in sockets as well as test, development and production sockets; (ii) complementary major customers with little overlap; and (iii) improved project design capacity resulting from focusing new product development resources and eliminating project duplication.
Over the last three years, Wells has employed a similar strategy to that of the Company. From fiscal 1995 (52 weeks ended June 3, 1995), to fiscal 1997 (53 weeks ended May 3, 1997), the net sales of Wells increased from $18.6 million to $27.5 million. With the inclusion of the net sales of Wells, consolidated pro forma net sales and income from operations (before deducting the non-recurring write-off relating to the Wells acquisition of acquired in-process research and development) for the Company totaled $71.4 million and $21.9 million, respectively, in 1997.
PUBLIC OFFERING
On February 12, 1998, the Company filed a Registration Statement on Form S-1 (Registration No. 333-46137)(the "Registration Statement") with the Securities and Exchange Commission with respect to the possible sale of 2,000,000 shares of its Common Stock. The Company amended the Registration Statement on March 20, 1998. There can be no assurance that the offering of shares contemplated by the Registration Statement will be completed.
NEW CREDIT FACILITY, SUBORDINATED DEBENTURE AND WARRANT
On December 26, 1997, the Company entered into a new credit agreement with Fleet National Bank as agent for itself and other lenders ("Credit Facility") consisting of an aggregate $70.0 million in term loans and a $20.0 million revolving credit loan. On the same date, the Company also issued a $25.0 million
Subordinated Debenture (the "Debenture") and a common stock purchase warrant (the "Emerson Warrant") to Emerson Electric Co. For further discussion of the Credit Facility, Debenture, and the Emerson Warrant see Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources appearing in Item 7 hereof and Notes 8 and 9 of Notes to the Company's Consolidated Financial Statements appearing in Item 8 hereof.
FORWARD LOOKING INFORMATION
Statements in this report concerning the future revenues, profitability, financial resources, product mix, market demand, product development and other statements in this report concerning the future results of operations, financial condition and business of the PCD Inc. are "forward-looking" statements as defined in the Securities Act of 1933 and Securities Exchange Act of 1934. Investors are cautioned that the Company's actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company's operations and business environment, including:
DEPENDENCE ON IC PACKAGE INTERCONNECT AND SEMICONDUCTOR INDUSTRIES. The Company's semiconductor or integrated circuit ("IC") package interconnect sockets are used by producers and testers of ICs and original equipment manufacturers ("OEMs"). For the year ended December 31, 1997, the Company (excluding Wells) derived 42.3% of its net sales from these products. The Company's future success will depend in substantial part on the vitality of the semiconductor and the related IC package interconnect industries. The Company's recent acquisition of Wells Electronics, Inc. ("Wells"), a supplier of IC package interconnects, significantly increases the Company's dependence on the IC package interconnect industry. Historically, the IC package interconnect industry has been driven by both the technology requirements and unit demands of the semiconductor industry. Depressed general economic conditions and cyclical downturns in the semiconductor industry have had an adverse economic effect on the IC package interconnect market. In addition, the product cycle of existing IC package designs and the timing of new IC package development and introduction can affect the demand for IC package interconnect sockets. Reduced demand for semiconductors and their related packages would have a material adverse effect on the financial condition, results of operations and business of the Company.
DEPENDENCE ON PRINCIPAL CUSTOMERS. Altera Corporation ("Altera"), a provider of high performance, high density programmable logic devices, has been the largest customer of the Company (excluding Wells) since 1994. Altera accounted for 14.5%, 17.4% and 16.6% of the net sales of the Company (excluding Wells) for the years ended December 31, 1997, 1996 and 1995, respectively. Sales to TNT Distributors, Inc. ("TNT"), a semiconductor equipment distributor, accounted for 12.7% and 13.4% of net sales for the years ended December 31, 1997 and 1995, respectively. Sales by Wells to Advanced Micro Devices, Inc. ("AMD"), Dynavision, Inc. ("Dynavision") and Micron Technology, Inc. ("Micron") accounted for 12.0%, 11.6% and 29.6%, respectively, of net sales by Wells for the pro forma calendar year ended December 31, 1997. The Company does not have written agreements with any of its customers, including Altera, AMD, Dynavision, Micron or TNT, and therefore, no customer has any minimum purchase obligations. Accordingly, there can be no assurance that any of the Company's customers will purchase the Company's products beyond those covered by released purchase orders. The loss of, or significant decrease in, business from Altera, AMD, Dynavision, Micron or TNT, for any reason, would have a material adverse effect on the financial condition, results of operations and business of the Company.
ACQUISITIONS AND INDEBTEDNESS. The Company acquired all of the capital stock of Wells, a manufacturer of IC package interconnect products, on December 26, 1997. Wells currently operates as a wholly-owned subsidiary of the Company. Subject to compliance with the Company's credit facility ("Senior Credit Facility") with Fleet National Bank and other lenders, the Company may from time to time pursue the acquisition of other companies, assets, products or technologies. The Company has limited experience in integrating acquired companies or technologies into its operations. Therefore, there can be no assurance that the Company will operate Wells or other acquired businesses profitably in the future. Acquisitions involve a number of operating risks that could materially adversely affect the Company's operating results, including the diversion of management's attention to assimilate the operations, products and personnel of the acquired companies, the amortization of acquired intangible assets and the potential loss of key employees of the acquired companies. There can be no assurance that the Company will be able to manage acquisitions successfully or that the Company will be able to integrate the operations, products or personnel gained through any such acquisitions without a material adverse effect on the financial condition, results of operations and business of the Company. Accordingly, operating expenses associated with acquired businesses may have a material adverse effect on the financial condition, results of operations and business of the Company.
The Company incurred substantial indebtedness in connection with the Wells acquisition and, subject to compliance with the terms of the Senior Credit Facility, may incur additional indebtedness in connection with future acquisitions. The incurrence of substantial amounts of debt could increase the risk of the Company's operations. If the Company's cash flow and existing working capital are not sufficient to fund its general working capital requirements or to service its indebtedness, the Company would have to raise additional funds through the sale of its equity securities, the refinancing of all or part of its indebtedness or the sale of assets or subsidiaries. There can be no assurance that any of these sources of funds would be available in amounts sufficient for the Company to meet its obligations, if at all. The cost of debt financing may also impair the ability of the Company to maintain adequate working capital or to make future acquisitions. In addition, the issuance of additional shares of Common Stock in connection with acquisitions could be dilutive to existing investors.
INTERNATIONAL SALES AND OPERATIONS. Sales to customers located outside the United States, either directly or through U.S. and foreign distributors, accounted for approximately 35.8%, 22.1% and 28.1% of the net sales of the Company (excluding Wells) in the years ended December 31, 1997, 1996 and 1995, respectively, and the Company believes that, with the addition of Wells, international sales will account for a significant portion of its revenues for the foreseeable future. International revenues are subject to a number of risks, including: longer accounts receivable payment cycles; exchange rate fluctuations; difficulty in enforcing agreements and intellectual property rights and in collecting accounts receivable; tariffs and other restrictions on foreign trade; withholding and other tax consequences; economic and political instability; and the burdens of complying with a wide variety of foreign laws. Sales made to foreign customers or foreign distributors may be denominated in either U.S. dollars or in the currencies of the countries where sales are made. The Company has not to date sought to hedge the risks associated with fluctuations in foreign exchange rates and does not currently plan to do so. The Company's foreign sales and operations are also affected by general economic conditions in its international markets. A prolonged economic downturn in its foreign markets could have a material adverse effect on the Company's business. As a result of the Wells acquisition, the Company now has an operating subsidiary in Japan, and sales or technical support operations in England, Germany, South Korea, Malaysia and Singapore. Recent and continuing volatility in the Asian economies and financial and currencies markets may have a material adverse effect on the Company's current and planned sales and operations in that region, particularly with respect to
the Company's IC package interconnect business. In addition, the laws of certain countries do not protect the Company's products and intellectual property rights to the same extent as do the laws of the United States. There can be no assurance that the factors described above will not have an adverse effect on the Company's future international revenues and, consequently, on the financial condition, results of operations and business of the Company.
RESTRICTIVE COVENANTS UNDER SENIOR CREDIT FACILITY. The agreement governing the Senior Credit Facility contains numerous financial and operating covenants. There can be no assurance that the Company will be able to maintain compliance with these covenants, and failure to meet such covenants would result in an event of default under the Senior Credit Facility. Among these covenants are restrictions that the Company (i) must maintain John L. Dwight, Jr. as chief executive officer of the Company or obtain the consent of the lenders under the Senior Credit Facility to any replacement of Mr. Dwight; (ii) may not, without the prior consent of such lenders, acquire the assets of or ownership interests in, or merge with, other companies; and (iii) may not, without the prior consent of such lenders, pay cash dividends.
FLUCTUATIONS IN OPERATING RESULTS. The variability of the level and timing of orders from, and shipments to, major customers may result in significant fluctuations in the Company's quarterly results of operations. The Company generally does not obtain long-term purchase orders or commitments but instead seeks to work closely with its customers to anticipate the volume of future orders. Generally, customers may cancel, reduce or delay purchase orders and commitments without penalty. Cancellations, reductions or delays in orders by a customer or groups of customers could have a material adverse effect on the financial condition, results of operations and business of the Company. In addition to the variability resulting from the short-term nature of its customers' commitments, other factors have contributed, and may in the future contribute, to such fluctuations. These factors may include, among other things, customers' and competitors' announcement and introduction of new products or new generations of products, evolutions in the life cycles of customers' products, timing of expenditures in anticipation of future orders, effectiveness in managing manufacturing processes, changes in cost and availability of labor and components, shifts in the Company's product mix and changes or anticipated changes in economic conditions. In addition, it is not uncommon in the electronic connector industry for results of operations to display a seasonal pattern of declining revenues in the third quarter of the calendar year. Although the Company's results of
operations did not display this pattern in 1997 and 1995, it did occur in 1996 and is likely to occur in the future. Because the Company's operating expenses are based on anticipated revenue levels and a high percentage of the Company's operating expenses are relatively fixed, any unanticipated shortfall in revenue in a quarter may have a material adverse impact on the Company's results of operations for the quarter. Results of operations for any period should not be considered indicative of the results to be anticipated for any future period.
TECHNOLOGICAL EVOLUTION. The rapid technological evolution of the electronics industry requires the Company to anticipate and respond rapidly to changes in industry standards and customer needs and to develop and introduce new and enhanced products on a timely and cost-effective basis. In particular, the Company must target its development of IC package interconnect sockets based on which next generation IC package designs the Company expects to be successful. The Company must manage transitions from products using present technology to those that utilize next generation technology in order to maintain or increase sales and profitability, minimize disruptions in customer orders and avoid excess inventory of products that are less responsive to customer demand. Any failure of the Company to respond effectively to changes in industry standards and customer needs, develop and introduce new products and manage product transitions would have a material adverse effect on the financial condition, results of operations and business of the Company.
MANAGEMENT OF GROWTH. The Company has grown rapidly in recent years, in particular through the Wells acquisition in December 1997. A continuing period of rapid growth could place a significant strain on the Company's management, operations and other resources. The Company's ability to manage its growth will require it to continue to invest in its operational, financial and management information systems, and to attract, retain, motivate and effectively manage its employees. The inability of the Company's management to manage growth effectively would have a material adverse effect on the financial condition, results of operations and business of the Company.
PROPRIETARY TECHNOLOGY AND PRODUCT PROTECTION. The Company's success depends in part on its ability to maintain the proprietary and confidential aspects of its products as they are released. The Company seeks to use a combination of patents and other means to establish and protect its proprietary rights. There can be no assurance, however, that the precautions taken by the Company will be adequate to protect the Company's technology. In addition, many of the Company's competitors have obtained or developed, and may be expected to obtain or develop in the
future, patents or other proprietary rights that cover or affect products that perform functions similar to those performed by products offered by the Company. There can be no assurance that, in the future, the Company's products will not be held to infringe patent claims of its competitors, or that the Company is aware of all patents containing claims that may pose a risk of infringement by its products. The inability of the Company for any reason to protect existing technology or otherwise acquire such technology could prevent distribution of the Company's products, having a material adverse effect on the financial condition, results of operations and business of the Company.
PATENT LITIGATION. On August 21, 1995, the Company's wholly- owned subsidiary, CTi Technologies, Inc. ("CTi"), filed an action in the United States District Court for the District of Arizona against Wayne K. Pfaff, an individual residing in Texas ("Pfaff"), and Plastronics Socket Company, Inc., a corporation affiliated with Pfaff, alleging and seeking a declaratory judgment that two United States patents issued to Pfaff and relating to certain burn-in sockets for "leadless" IC packages (the "Pfaff Leadless Patent") and ball grid array ("BGA") IC packages (the "Pfaff BGA Patent") (collectively, the "Pfaff Patents") are invalid and are not infringed by CTi, the products of which include burn-in sockets for certain "leaded" packages (including Quad Flat Paks) (the "CTi Leaded Products") and BGA packages (the "CTi BGA Products") (collectively, the "CTi Products"). Pfaff has filed a counterclaim alleging that CTi infringes the "Pfaff Leadless Patent" and has requested an award of damages; the counterclaim does not allege infringement of the Pfaff BGA Patent. Pfaff has also sought a permanent injunction against further infringement by CTi of the Pfaff Leadless Patent. That action has been stayed pending resolution of another action, described below, involving the Pfaff Leadless Patent.
In litigation between Wells and Pfaff concerning the Pfaff Leadless Patent, the United States Court of Appeals for the Federal Circuit has found all of the individual descriptions of the invention (the "Claims" of the patent) of the Pfaff Leadless Patent which were at issue in that case to be invalid. Certain other Claims of the patent were not at issue in that case and their validity was not decided by the court, because Pfaff did not allege that products of Wells infringed such Claims. The United States Supreme Court has accepted an appeal by Pfaff in that case. Unless overturned, the Court of Appeals decision as to the invalidity of such Claims of the Pfaff Leadless Patent will be binding in the CTi v. Pfaff action in the District of Arizona, and the reasoning of that decision could support CTi's position that the remaining Claims of that patent are invalid. There can be no assurance, however, that the decision will not be
overturned or that the Company will not be required to engage in further costly litigation regarding the Pfaff Patents.
In addition, there can be no assurance that the Company, CTi or Wells will prevail in any pending or future litigation. A final court determination that CTi or Wells has infringed the Pfaff Leadless Patent could have a material adverse effect on the Company. Such adverse effect could include, without limitation, the requirement that CTi or Wells pay substantial damages for past infringement and an injunction against the manufacture or sale in the United States of such products as are found to be infringing. Approximately 18.5% of the revenues of the Company (excluding Wells) for 1997 and approximately 7.0% of the revenues of Wells for calendar year 1997 were derived from the sale of products potentially at issue in the Pfaff cases. There can be no assurance that the CTi and Wells litigation will be resolved without material adverse effect on the financial condition, results of operations and business of the Company.
COMPETITION. The electronic connector industry is highly competitive and fragmented, with more than 2,000 manufacturers worldwide. The Company believes that competition in its targeted segments is primarily based on design, responsiveness, quality, price, reputation and reliability. The Company has experienced significant price pressure with respect to certain products, including its thin, small outline package ("TSOP") product. The Company's significant competitors are much larger and have substantially broader product lines and greater financial resources than the Company. There can be no assurance that the Company will compete successfully, and any failure to compete successfully would have a material adverse effect on the financial condition, results of operations and business of the Company.
CONTROL BY EXISTING STOCKHOLDERS. Upon the completion of this offering, the current officers, directors and Emerson Electric Co. ("Emerson"), the Company's largest stockholder, will beneficially own approximately 41.5% of the outstanding shares of the Common Stock of the Company based on the number of shares of Common Stock outstanding as of January 31, 1998. Accordingly, such persons, if they act together, will have effective control over the Company through their ability to control the election of directors and all other matters that require action by the Company's stockholders, irrespective of how other stockholders may vote. Such persons could prevent or delay a change in control of the Company which may be favored by a majority of the remaining stockholders. Such ability to prevent or delay such a change in control of the Company also may have an adverse effect on the market price of the Company's
Common Stock.
DEPENDENCE ON KEY PERSONNEL. The Company is largely dependent upon the skills and efforts of John L. Dwight, Jr., its Chairman of the Board, President and Chief Executive Officer, Richard J. Mullin, its Vice President and President, Wells - CTI Division, Michael S. Cantor, its Vice President and General Manager, Industrial/Avionics Division, Jeffrey A. Farnsworth, its Vice President and General Manager, Wells - CTI Phoenix, and other officers and key employees. The Company does not have employment agreements with any of its officers or key employees providing for their employment for any specific term or noncompetition agreements prohibiting them from competing with the Company after termination of their employment. The loss of key personnel or the inability to hire or retain qualified personnel could have a material adverse effect on the financial condition, results of operations and business of the Company.
DEPENDENCE UPON INDEPENDENT DISTRIBUTORS. Sales through independent distributors accounted for 38.7%, 28.1% and 35.7% of the net sales of the Company (excluding Wells) for the years ended December 31, 1997, 1996 and 1995, respectively. The Company's agreements with its independent distributors are nonexclusive and may be terminated by either party upon 30 days written notice, provided that if the Company terminates the agreement with an independent distributor, the Company will be obligated to purchase certain of such distributor's pre- designated unsold inventory shipped by the Company within an agreed-upon period prior to the effective date of such termination. The Company's distributors are not within the control of the Company, are not obligated to purchase products from the Company, and may also sell other lines of products. There can be no assurance that these distributors will continue their current relationships with the Company or that they will not give higher priority to the sale of other products, which could include products of competitors. A reduction in sales efforts or discontinuance of sales of the Company's products by its distributors could lead to reduced sales and could materially adversely affect the Company's financial condition, results of operations and business. The Company grants to certain of its distributors limited inventory return and stock rotation rights. If the Company's distributors were to increase their general levels of inventory of the Company's products, the Company could face an increased risk of product returns from its distributors. There can be no assurance that the Company's historical return rate will remain at a low level in the future or that such product returns will not have a material adverse effect on the Company's financial condition, results of operations and business.
YEAR 2000 COMPLIANCE COSTS. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. To distinguish 21st century dates from 20th century dates, these date code fields must be able to accept four digit entries. The Company utilizes a significant number of computer software programs and operating systems across its entire organization, including applications used in manufacturing, product development, financial business systems and various administrative functions. The Company believes that, with the exception of the South Bend, Indiana location of Wells-CTI ("Wells-CTI South Bend"), its computer systems will be able to manage and manipulate all material data involving the transition from 1999 to 2000 without functional or data abnormality and without inaccurate results related to such data. However, there can be no assurances that potential systems interruptions or the cost necessary to update software would not have a material adverse effect on the Company's financial condition, results of operations or business. In addition, the Company has limited information concerning the compliance status of its suppliers and customers. In the event that any of the Company's significant suppliers or customers do not successfully and timely achieve Year 2000 compliance, the Company's financial condition, results of operations and business could be materially and adversely affected.
The Company believes that, within the next nine months, it will have to replace the current systems at Wells-CTI South Bend with new systems that are Year 2000 compliant. Failure to replace such systems could result in the generation of erroneous data or system failure. Significant uncertainty exists concerning the potential effects associated with Year 2000 compliance, and Year 2000 issues involving systems of Wells-CTI South Bend could have a material adverse effect on the Company's financial condition, results of operations or business. The cost of replacing computer systems of Wells-CTI South Bend is currently estimated to be up to $900,000.
PRODUCT LIABILITY. The Company's products provide electrical connections between various electrical and electronic components. Any failure by the Company's products could result in claims against the Company. Except with respect to avionics products, the Company does not maintain insurance to protect against possible claims associated with the use of its products. A successful claim brought against the Company could have a material adverse effect on the financial condition, results of operations and business of the Company. Even unsuccessful claims could result in the Company's expenditure of funds in litigation and management time and resources. There can be no assurance that the Company will not be subject to product liability claims.
ENVIRONMENTAL COMPLIANCE. The Company is subject to a wide range of environmental laws and regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during its manufacturing process. A failure by the Company at any time to comply with environmental laws and regulations could subject it to liabilities or the suspension of production. Such laws and regulations could also restrict the Company's ability to expand its facilities or could require the Company to acquire costly equipment or incur other significant expenses.
POSSIBLE VOLATILITY OF STOCK PRICE. The stock market historically has experienced volatility which has affected the market price of securities of many companies and which has sometimes been unrelated to the operating performance of such companies. The trading price of the Common Stock could also be subject to significant fluctuations in response to variations in quarterly results of operations, announcements of new products by the Company or its competitors, other developments or disputes with respect to proprietary rights, general trends in the industry, overall market conditions and other factors. In addition, there can be no assurance that an active trading market for the Common Stock will be sustained.
POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS. The Company's Board of Directors has the authority without action by the Company's stockholders to fix the rights and preferences of and to issue shares of the Company's Preferred Stock, which may have the effect of delaying, deterring or preventing a change in control of the Company. At present the Company has no plans to issue any shares of Preferred Stock. The Company's Board of Directors also has the authority without action by the Company's stockholders to impose various procedural and other requirements that could make it more difficult for stockholders to effect certain corporate actions. In addition, the classification of the Company's Board of Directors and certain provisions of Massachusetts law applicable or potentially applicable to the Company, could have the effect of delaying, deterring or preventing a change in control of the Company. These statutory provisions include a requirement that directors of publicly-held Massachusetts corporations may only be removed for "cause," as well as a provision not currently applicable to the Company that any stockholder who acquires beneficial ownership of 20% or more of the outstanding voting stock of a corporation may not vote such stock unless the stockholders of the corporation so authorize.
ITEM 2.
ITEM 2. FACILITIES
PCD, headquartered in Peabody, Massachusetts, operates leased production facilities in Peabody, Massachusetts (60,000 square feet) and Phoenix, Arizona (24,000 square feet). In conjunction with the Wells acquisition, production facilities were added in South Bend, Indiana (50,000 square feet), Yokohama, Japan (6,600 square feet) and Harrisburg (Swatara), Pennsylvania (7,000 square feet). The Peabody facility is responsible for assembly, manufacturing automation development and quality assurance functions relating to industrial terminal blocks and avionics terminal blocks. The Phoenix facility is responsible for assembly and quality assurance functions relating to burn-in, development and production sockets, as well as related product design and development. The South Bend and Yokohama facilities are responsible for design, assembly, manufacturing automation development and quality assurance for burn-in sockets. Stamping and molding fabrication of components for both Peabody and Phoenix are handled at the Peabody facility. The Harrisburg (Swatara) facility handles stamping for production in South Bend. The Company also maintains distribution and technical sales support facilities in Northhampton, England; Regensburg, Germany; Seoul, South Korea; Singapore and Penang, Malaysia. The Company believes that its facilities are adequate for its operations for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On August 21, 1995, the Company's wholly-owned subsidiary, CTi Technologies, Inc. ("CTi"), filed an action in the United States District Court for the District of Arizona against Wayne K. Pfaff, an individual residing in Texas ("Pfaff"), and Plastronics Socket Company, Inc., a corporation affiliated with Pfaff, alleging and seeking a declaratory judgment that two United States patents issued to Pfaff and relating to certain burn-in sockets for "leadless" IC packages (the "Pfaff Leadless Patent") and ball grid array ("BGA") IC packages (the "Pfaff BGA Patent") (collectively, the "Pfaff Patents") are invalid and are not infringed by CTi, the products of which include burn-in sockets for certain "leaded" packages (including Quad Flat Paks) (the "CTi Leaded Products") and BGA packages (the "CTi BGA Products") (collectively, the "CTi Products"). Pfaff has filed a counterclaim alleging that CTi infringes the Pfaff Leadless Patent and has requested an award of damages; the counterclaim does not allege infringement of the Pfaff BGA Patent. Pfaff has also sought a permanent injunction against further infringement by CTi of the Pfaff Leadless Patent. That action has been stayed pending resolution of another action, described below, involving the Pfaff Leadless Patent.
In litigation between Wells and Pfaff concerning the Pfaff Leadless Patent, the United States Court of Appeals for the Federal Circuit has found all of the individual descriptions of the invention (the "Claims" of the patent) of the Pfaff Leadless Patent which were at issue in that case to be invalid. Certain other Claims of the patent were not at issue in that case, and their validity was not decided by the court, because Pfaff did not allege that products of Wells infringed such Claims. The United States Supreme Court has accepted an appeal on that case. Unless overturned, the Court of Appeals decision as to the invalidity of such Claims of the Pfaff Leadless Patent will be binding in the CTi v. Pfaff action in the District of Arizona, and the reasoning of that decision could support CTi's position that the remaining Claims of that patent are invalid.
The Company believes, based on the advice of counsel (Brown & Bain, P.A., as to CTi and Baker & Daniels as to Wells), that CTi and Wells have meritorious defenses against any allegations of infringement under the Pfaff Patents, and, if necessary, CTi and Wells will vigorously litigate their positions. There can be no assurance, however, that the Company, CTi or Wells will prevail in any pending or future litigation, and a final court determination that CTi or Wells has infringed the Pfaff Leadless Patent could have a material adverse effect on the Company. Such adverse effect could include, without limitation, the requirement that CTi or Wells pay substantial damages for past infringement and an injunction against the manufacture or sale in the United States of such products as are found to be infringing. Approximately 18.5% of the revenues of the Company (excluding Wells) for 1997 and approximately 7.0% of the revenues of Wells for calendar year 1997 were derived from the sale of products potentially at issue in the Pfaff cases.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth quarter of 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the executive officers of the Company and their ages as of December 31, 1997 and positions held with the Company, as follows:
Mr. Dwight has served as Chairman of the Board, Chief Executive Officer, President and a director of the Company since November 1980, when he purchased a controlling interest in PCD. Mr. Dwight was previously Vice President - International of Burndy Corporation, an electronic connector manufacturer. Mr. Dwight has 27 years of management and operating experience in the connector industry.
Mr. Mullin has served as Vice President and President, Wells - CTI Division since December 1997. From June 1993 to December 1997, he was President and Chief Executive Officer of Wells. From May 1983 to June 1993, Mr. Mullin was Executive Vice President and Chief Financial Officer of Wells. Before joining Wells, Mr. Mullin was a CPA with Peat Marwick Mitchell & Co. for nine years.
Mr. Cantor has served as Vice President and General Manager, Industrial/Avionics Division since February 1998. From July 1988 to February 1998, he was Vice President, Sales and Marketing. Mr. Cantor joined the Company in 1983 and has held various positions in management. From 1980 to 1983, Mr. Cantor was President - U.S. Operations for Balteau S.A. and from 1972 to 1980, Director of Regional Operations at Burndy Corporation. Mr. Cantor has 37 years of experience in the connector industry.
Mr. Farnsworth has served as Vice President and the General Manager, Wells - CTI Phoenix since December 1997. From October 1993 to December 1997, he was Vice President and General
Manager - CTi. Mr. Farnsworth was a founder of Component Technologies, Inc. in 1983, and remained with the Company, in various positions in sales and marketing, following the acquisition of Component Technologies, Inc. by the Company in 1988. Mr. Farnsworth has 22 years of experience in the connector industry.
Ms. Mandarino has served as Vice President, Finance and Administration, Chief Financial Officer and Treasurer since 1989. Ms. Mandarino joined the Company in 1986 and has held several positions of increasing responsibility in finance. Prior to joining PCD, Ms. Mandarino held various financial positions with American Brands, Inc. and Dresser Industries, Inc.
Mr. Powers has served as Vice President, Operations since he joined the Company in 1983. Previously, he was the General Manager of the Incon Division of Transitron, which was acquired by PCD.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) The Company's Common Stock is traded on the Nasdaq National Market of the Nasdaq Stock Market, Inc. The following table sets forth the reported high and low sale prices for the Common Stock, under the symbol "PCDI," for the periods indicated:
(a) Initial public offering price per share.
On March 18, 1998, the last reported sale price for the Common Stock on the Nasdaq National Market was $22.00 per share. As of January 31, 1998, there were approximately 800 holders of record of Common Stock.
The Company has never declared or paid any cash dividends on the Common Stock. The Company currently intends to retain future earnings, if any, to fund the development and growth of its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. The Board of Directors of the Company intends to review this policy from time to time, after taking into account various factors such as the Company's financial condition, results of operation, current and anticipated cash needs and plans for expansion. The Senior Credit Facility contains a covenant that prohibits the Company from paying cash dividends.
On December 26, 1997, the Company issued to Emerson Electric Co. a subordinated debenture with a principal amount of $25 million (convertible under certain circumstances into Common Stock) and Common Stock purchase warrants for the purchase of up to 525,000 shares of Common Stock at an exercise price of $1.00 per share. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" appearing in Item 7 hereof. No underwriters were engaged in connection with the foregoing sales of securities. Such sales were made in reliance upon the exemption from registration set forth in Section 4(2) of the Securities Act.
(b) The Company's registration statement on Form S-1 (Commission file no. 333-1266) relating to the initial public offering of shares of the Company's common stock was declared effective by the Securities and Exchange Commission on March 26, 1996. On July 3, 1997, the Company filed an amendment to its initial report on Form S-R covering the six-month period ended June 26, 1997. On December 26, 1997, the Company applied all of the net proceeds from its initial public offering ($11,253,000) towards payment of the purchase price of Wells Electronics, Inc. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Wells Acquisition appearing in Item 7 hereof. None of such payment was made directly or indirectly to directors or officers of the Company or their associates, or to persons owning 10 percent or more of any class of equity securities of the Company, or to affiliates of the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
The following table contains certain selected consolidated financial data for PCD and its subsidiaries (excluding Wells and its subsidiaries, except as noted). The selected consolidated financial data for each of the years ended December 31, 1997, 1996, 1995, 1994 and 1993 have been derived from the Company's Consolidated Financial Statements, which have been audited by Coopers & Lybrand L.L.P., independent public accountants. The pro forma statement of operations data for the year ended December 31, 1997 give effect to the Wells acquisition assuming such transaction occurred on January 1, 1997 and have been derived from the Unaudited Pro Forma Condensed Consolidated Statement of Operations included elsewhere in this Prospectus. The Pro Forma Consolidated Statement of Operations Data are not necessarily indicative of the actual results that would have been achieved had the Wells acquisition occurred at the beginning 1997, nor do they purport to indicate the results of operations of the Company for any future period. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto of the Company and of Wells appearing elsewhere in this Report.
- ---------- (1) Gives effect to the Wells acquisition assuming such transaction had occurred on January 1, 1997 and the elimination of the related non-recurring acquired in-process research and development expense and the addition of the annual amortization of acquired intangible assets so that the pro forma and the pro forma includes only recurring costs. See "Unaudited Pro Forma Condensed Consolidated Statement of Operations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(2) Before deducting the additional interest expense for the value of the exercisable portion of the Emerson Warrant, pro forma net income was approximately $6,849,000, pro forma net income per share - basic was $1.15 (based on a weighted average number of shares outstanding of 5,954,657) and pro form net income per share - diluted was $1.01 (based on a weighted average number of common and common equivalent shares outstanding of 6,769,479).
(3) Net loss for the year ended December 31, 1997 includes a non-recurring write-off relating to the Wells acquisition for acquired in-process research and development. Before deducting the write-off, net income per share - basic was $1.04 (based on a weighted average number of shares outstanding of 5,954,657), and net income per share - diluted was $0.94 (based on a weighted average number of common and common equivalent shares outstanding of 6,634,125).
(4) See Note 2 to the Company's Consolidated Financial Statements for an explanation of the basis used to Calculate net income (loss) per share.
(5) Earnings before interest, taxes, depreciation and amortization ("EBITDA") includes income from operations before deducting the non-recurring write-off relating to the Wells acquisition for acquired in-process research and development adjusted to exclude depreciation and
amortization of intangible assets. EBITDA margin is EBITDA reflected as a percentage of net sales. The Company believes that EBITDA and EBITDA margin provide additional information to assist investors in determining its ability to meet future debt service requirements. However, EBITDA is not a defined term under generally accepted accounting principles ("GAAP"), is not indicative of operating income or cash flow from operations as determined under GAAP and may not be comparable to similarly titled measures reported by other companies.
(6) Net cash provided by operating activities was $8.1 million, $7.8 million, $5.5 million, $1.6 million and $1.5 million for 1997, 1996, 1995, 1994 and 1993, respectively. Net cash used in investing activities was $132.9 million, $1.9 million, $2.5 million, $1.4 million and $1.4 million for 1997, 1996, 1995, 1994 and 1993, respectively. Net cash (used in) provided by financing activities was $108.3 million, $10.7 million, $0.004 million, $(0.09) million and $(0.4) million for 1997, 1996, 1995, 1994 and 1993, respectively.
WELLS ELECTRONICS, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
The following table contains certain selected consolidated financial data for Wells Electronics, Inc. The selected consolidated financial data for each of the periods 34 weeks ended December 26, 1997, 48 weeks ended April 27, 1996, and 52 weeks ended June 3, 1995, have been derived from the Wells Consolidated Financial Statements, which have been audited by KPMG Peat Marwick, independent public accountants. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto of Wells appearing elsewhere in this Prospectus.
- ---------- (1) See Note 2 of Notes to Wells' Consolidated Financial Statements for an explanation of the basis used to calculate net income (loss) per share.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
On December 26, 1997, pursuant to the Share Purchase Agreement dated November 17, 1997, the Company acquired all of the outstanding common stock of Wells Electronics, Inc. ("Wells") for approximately $130 million in cash. The Company also incurred approximately $1.2 million in acquisition related costs resulting in a total purchase price of approximately $131.2 million. The acquisition was financed by a combination of a new bank credit facility of $90 million of which the Company borrowed approximately $83 million upon consummation of the acquisition and a $25 million subordinated debenture issued to Emerson.
The acquisition is being accounted for as a purchase, and the Company has allocated the purchase price based on the fair value of assets acquired and liabilities assumed. A significant portion
of the purchase price has been allocated as intangible assets using proven valuation procedures and techniques, including approximately $44 million of acquired in-process research and development.
The accompanying Unaudited Pro Forma Condensed Consolidated Statement of Operations for the 12 months ended December 31, 1997 assumes that the acquisition of Wells took place on January 1, 1997.
The accompanying pro forma information is presented for illustrative purposes only and is not necessarily indicative of the financial position or results of operations which would actually have been reported had the acquisition been in effect during the periods presented, or which may be reported in the future.
The accompanying Unaudited Pro Forma Condensed Consolidated Statement of Operations should be read in conjunction with the historical financial statements and related notes thereto for PCD and for Wells that appear elsewhere in this report.
- ---------- (1) Before deducting the additional interest expense for the value of the exercisable portion of the Emerson Warrant, pro forma net income combined was approximately $6,849,000, pro forma net income combined per share-basic was $1.15 (based on a weighted average number of shares outstanding of 5,954,657) and pro forma net income combined per share-diluted was $1.01 (based on a
weighted average number of common and common equivalent shares outstanding of 6,769,479).
(2) Reflects the elimination of non-recurring acquired in-process research and development relating to the Wells acquisition so that the pro forma combined statement of operations includes only recurring costs.
(3) Includes amortization of intangible assets as a result of the Wells acquisition consisting of 20 years for goodwill, trademarks and tradenames and 9 years for patented technologies to reflect a full year's charge.
(4) Represents a reduction of interest income as a result of utilizing cash and cash equivalents for the Wells acquisition.
(5) Includes interest expense on debt issued to finance the Wells acquisition, at an assumed weighted average rate of 8.96% for the Senior Credit Facility and at 10% for the subordinated debenture and additional interest expense of $2.1 million representing the interest expense of the exercisable portion of the Emerson Warrant. A 1/8 percent change in the interest rate of the Senior Credit Facility results in a change of $103,750.
(6) Reflects the related tax effect of adjustments (2) through (5). A portion of the approximately $44 million of in-process research and development charge is not deductible in Japanese tax jurisdictions. The remainder of the adjustments are included at a 39% rate.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, without limitation, those set forth under "Business - Forward Looking Information" in Item 1 hereof and elsewhere in this report.
As used herein, the terms "Company" and "PCD," unless otherwise indicated or the context otherwise requires, refer to PCD Inc. and its subsidiaries, including Wells Electronics, Inc. and its subsidiaries ("Wells"). However, all financial information for periods ended before December 26, 1997, unless otherwise indicated or the context otherwise requires, is for PCD Inc. and its subsidiaries, excluding Wells.
OVERVIEW
PCD designs, manufactures and markets electronic connectors for use in integrated circuit ("IC") package interconnect applications, industrial equipment and avionics. Electronic connectors, which enable an electrical current or signal to pass from one element to another within an electronic system, range from minute individual connections within an IC to rugged, multiple lead connectors that couple various types of electrical/electronic equipment.
The Company was founded in 1976 and the current chairman, John L. Dwight, Jr., acquired a controlling interest in 1980. Over the years, the Company has made a number of strategic acquisitions and investments to both bolster existing product lines and expand into selected key markets. The most significant of these acquisitions were: (i) the 1997 acquisition of the common stock of Wells Electronics, Inc. ("Wells") from UL America, Inc., an indirect wholly-owned subsidiary of Siebe plc; (ii) the 1988 acquisition of the assets of Component Technologies, Inc.; and (iii) the 1983 acquisition of the Appleton Electronics product line from Emerson Electric Co. In 1996, the Company completed an initial public offering of its Common Stock.
In 1995, net sales of the Company (excluding Wells) were $25.6 million and grew to $29.8 million in 1997, and after giving effect to the Wells acquisition the Company's net sales in 1997 were $71.4 million on a pro forma basis. The Company (excluding Wells) realized approximately 46.7% of its net sales in 1997 from products introduced in the last five years. The Company distributes its products through a combination of its own dedicated direct sales forces, a worldwide network of manufacturers representatives and authorized distributors. Sales to customers located outside the United States, either directly or through U.S. and foreign distributors, accounted for approximately 35.8%, 22.1% and 28.1% of the net sales of the Company in the years ended December 31, 1997, 1996 and 1995, respectively, and the Company believes that, with the addition of Wells, international sales will account for a significant portion of its revenues for the foreseeable future.
The following table sets forth the relative percentages of the total net sales of the Company attributable to each of the Company's product categories for the periods indicated.
The accompanying notes are an integral part of the consolidated financial statements
PCD Inc. CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
PCD Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share amounts)
The accompanying notes are an integral part of the consolidated financial statements
PCD Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
The accompanying notes are an integral part of the consolidated financial statements
PCD INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business:
PCD Inc. ("the Company") is engaged principally in designing, manufacturing and marketing electronic connectors for use in and integrated circuit ("IC") package interconnect applications, industrial equipment and avionics. Electronic connectors are used in virtually all electronic systems, including data communications, telecommunications, computers and computer peripherals, industrial controls, automotive, avionics and test and measurement instrumentation. As further discussed in Note 3, on December 26, 1997 the Company acquired all of the outstanding stock of Wells Electronics, Inc. ("Wells"). Wells designs, develops and markets a broad line of test and burn-in sockets and related carriers for the global IC package interconnect industry. The effect of the purchase is recorded in the financial statements.
2. Summary of Significant Accounting Policies:
Basis of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated.
Revenue Recognition
Revenue is recognized upon shipment to customers. The Company grants to certain of its distributors limited return and stock rotation rights. Historically, the Company's return rate has been insignificant.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or fewer to be cash equivalents. The Company invests excess cash in a money market fund and indirect obligations of the United States government. The Company had all its cash in interest bearing accounts at December 31, 1997. Approximately $16.1 million was invested in such cash equivalents at December 31, 1996. The Company classifies its investments as available for sale; however at December 31, 1996, cost approximates fair value.
Concentrations of Credit Risk and Estimates
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash investments and trade receivables. The Company invests primarily in high quality securities with short lives. Accordingly, these investments are subject to minimal credit and market risk. Collateral is not required for trade receivables, but ongoing credit evaluations of customer's financial condition are performed. As a result of the Wells acquisition, a greater portion of the Company's accounts receivable will be concentrated in the IC package interconnect and semiconductor industries. The Company has not experienced significant losses related to receivables from individual customers or groups of customers in the IC package interconnect and semiconductor industries or by geographic region. Additionally, the Company maintains reserves for potential credit losses. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by management to be inherent in the Company's accounts receivables.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates included in these financial statements are allowances for uncollectible accounts, allowances for inventory valuation, goodwill, intangible assets and deferred taxes.
Inventory
Inventories are stated at the lower of cost, determined on a first-in, first-out method, or market.
Research and Development
Research and development costs are charged to expense as incurred.
Net Income Per Common Share
In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, Earnings Per Share ("FAS 128"). FAS 128 requires dual presentation of basic and diluted earnings per share on the face
of the income statement for all entities with complex capital structures. Basic earnings per share is computed using the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed using the weighted average number of shares of common stock outstanding plus the effect of the additional number of common shares that would have been outstanding if the dilutive potential common shares had been outstanding. Under FAS 128, the computation of the basic earnings per share does not assume the conversion, exercise, or contingent issuance of securities that have an anti-dilutive effect on earnings per share. The Company has issued a subordinated debenture, described in Note 9, that has a conversion feature to common stock upon the occurrence of certain events of default.
In accordance with SFAS No. 128, the following tables reconcile net income (loss) and weighted average shares outstanding to the amounts used to calculate basic and diluted earnings (loss) per share for each of the years ended December 31, 1997, 1996 and 1995.
In 1997, Common Stock equivalents of 679,468 shares were not included in the calculation of diluted EPS.
Equipment and Improvements
Equipment and improvements are recorded at cost. Maintenance and repairs which neither materially add to the value of the property nor appreciably prolong its life are charged to expense as incurred. Upon retirement or other disposition, the cost and related accumulated depreciation are eliminated from the accounts and the resulting gain or loss is included in the results of operation
Depreciation of equipment and improvements is computed using the straight-line method over the estimated useful lives of the assets as follows:
Income Taxes
The Company utilizes the asset and liability approach of accounting for income taxes. Under the asset and liability approach, deferred taxes are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax expense (benefit) represents the change in the deferred tax asset or deferred tax liability balance. Tax credits are treated as reductions of income taxes in the year in which the credits become available for tax purposes.
Goodwill
Goodwill is accounted for in accordance with Accounting Principles Board ("APB") No. 17, Intangible Assets. Goodwill represents costs in excess of net assets of the business acquired and is amortized on a straight-line basis over the expected periods to be benefited, which is currently 20 years. The Company's policy is to assess the goodwill based on an evaluation of such factors as the occurrence of a significant adverse event or change in the environment in which the business operates. An impairment loss would be recorded in the period such determination is made based on the undiscounted cash flows of the related businesses. No impairment losses have been recognized in any of the periods presented.
Intangible Assets
Intangible assets are accounted for in accordance with SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Intangible assets are stated at cost and are amortized using the straight-line method. Loan acquisition fees are amortized over the life of the applicable indebtedness. Trademarks and trade names are amortized over 20 years, consistent with industry norms. Patented technologies are amortized over 9 years.
3. ACQUISITION OF WELLS ELECTRONICS, INC.:
On December 26, 1997, pursuant to the Share Purchase Agreement dated November 17, 1997, the Company acquired all of the outstanding common stock of Wells Electronics, Inc. Wells is a manufacturer of IC package interconnect products. The acquisition was financed by a combination of a new bank credit facility of $90 million of which the Company borrowed approximately $83 million upon consummation of the acquisition and a $25 million subordinated debenture. The acquisition is being accounted for as a purchase in accordance with APB Opinion No. 16.
In accordance with APB Opinion No. 16, the Company has allocated the purchase price based on the fair value of assets acquired and liabilities assumed. Acquired intangible assets consist of trade names and trademarks and patented technologies valued at approximately $10.4 million and $3.1 million, respectively. A portion of the purchase price was allocated to these intangible assets using a risk adjusted discounted cash flow approach. These intangibles are being amortized over their estimated useful lives of 9 and 20 years, respectively. Additionally, a portion of the purchase price was allocated to purchased research and development projects that were identified as having no alternative future value and had not yet reached technological feasibility. Purchased research and development that had not reached technological feasibility and that had no alternative future use was valued under a risk adjusted cash flow model, under which future cash flows were discounted taking into consideration risks relating to existing and future markets. This analysis resulted in an allocation of approximately $44 million to acquired in-process research and development expense. This amount was charged to operations at the acquisition date. A final allocation of the purchase price will be completed in 1998 based on determination of the final purchase price. The purchase price is subject to adjustment by the amount, if any, by which the net worth, with certain adjustments, of Wells as of the closing date, as agreed to by the Company and the seller, is less than or more
than the corresponding net worth as of September 30, 1997. The adjustment is expected to be favorable to the Company, but is not expected to be material. The final allocation is not expected to differ materially from amounts previously reported.
The aggregate purchase price of $131,184,000, includes acquisition costs. Acquisition costs consist of approximately $500,000 of financial advisory fees and $684,000 of professional fees. The aggregate purchase price was allocated as follows:
5. Equipment and Improvements:
Equipment and improvements consisted of the following at December 31:
6. INTANGIBLE ASSETS AND GOODWILL:
Goodwill is accounted for in accordance with APB 17, Intangible Assets. The Company assesses the realizability of intangible assets in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of when events or changes in circumstances indicate that the carrying amount may not be recoverable. Goodwill is stated at cost and amortized on a straight line basis over the estimated future periods to be benefited, which is currently 20 years. The Company's policy is to assess the goodwill based on an evaluation of such factors as the occurrence of a significant adverse event or change in the environment in which the business operates. An impairment loss would be recorded in the period such determination is made based on the undiscounted cash flows of the related businesses. No impairment losses have been recognized in any of the periods presented. Intangible assets are amortized on a straight-line basis, based on their estimated lives, as follows:
7. ACCRUED LIABILITIES:
Accrued liabilities consisted of the following at December 31:
8. LINE OF CREDIT AND LONG-TERM DEBT:
Prior to the acquisition of Wells discussed in Note 3, the Company had unsecured lines of credit with a bank. The agreement provided for up to $5,250,000 in a revolving credit line with interest payable monthly at the bank's base lending rate until June 30, 1998. As of December 31, 1996, no amounts were outstanding under this line of credit.
On December 26, 1997, in connection with the Wells acquisition discussed in Note 3, the Company entered into a secured $20,000,000 Revolving Credit Agreement ("Revolver") with several banks replacing the previous $5,250,000 agreement described above, a $30,000,000 Secured Term Loan Agreement A and a $40,000,000 Secured Term Loan Agreement B (collectively referred to as the "Senior Credit Facility"). The Revolver provides for direct borrowings or letters of credit and expires December 31, 2003; Term Loan Agreement A expires December 31, 2003; and Term Loan Agreement B expires December 31, 2004. The Senior Credit Facility is collateralized by all of the assets of PCD and Wells. In conjunction with the Senior Credit Facility, PCD and Wells each entered into a stock pledge agreement with these banks pledging all or substantially all of the stock of the subsidiaries of PCD and Wells. Each of PCD, Wells and certain of their subsidiaries also entered into a security agreement and certain other collateral or conditional assignments of assets. Borrowings under the Senior Credit Facility bear interest, at the Company's option, at either: (i) the higher of the lender's base rate, or a rate equal to 1/2 of 1% per annum above the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, plus between 25 and 200 basis points based on the ratio of senior indebtedness to the Company's earnings before interest, taxes, depreciation and amortization ("EBITDA"), or (ii) a periodic fixed rate equal to LIBOR plus between 150 and 325 basis points based on the ratio of senior indebtedness to EBITDA. The Company is required to pay a quarterly commitment fee ranging from 0.35% to 0.50% per annum, based on a certain financial ratio of the Company, of the unused commitment under the Revolver. There are no prepayment fees on the Senior Credit Facility. At December 31, 1997, borrowings of $83,000,000 were outstanding under the Senior Credit Facility at a weighted average interest rate of 8.96%.
The Agreement governing the Senior Credit Facility contains numerous financial and operating covenants that are effective as of the quarter ending March 28, 1998. Among these covenants are restrictions that the Company (i) must maintain John L. Dwight, Jr. as chief executive officer of the Company or obtain the
consent of the lenders under the Senior Credit Facility to any replacement of Mr. Dwight; (ii) may not, without the prior consent of such lenders, acquire the assets of or ownership interest in, or merge with, other companies; and (iii) may not, without the prior consent of such lenders, pay cash dividends. The Senior Credit Facility also requires the Company to maintain certain financial covenants, including minimum fixed charge coverage ratio, as defined, minimum quick ratio, as defined, maximum ratio of total senior debt to EBITDA, maximum ratio of total indebtedness for borrowed money to EBITDA, minimum interest coverage ratio, maximum capital expenditures, as defined, during the terms of the Senior Credit Facility. However, there can be no assurance that the Company will be able to maintain compliance with these covenants, and failure to meet such covenants would result in an event of default under the Senior Credit Facility. In addition, the Company estimates that the fair value of the loans approximates the carrying value in the financial statements.
Long-term debt consists of the following:
Maturities of long-term debt are as follows:
The components of the net deferred tax asset consisted of the following at December 31, 1997 and 1996:
The deferred tax consequences of temporary differences in reporting items for financial statement and income tax purposes are recognized, if appropriate. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including the Company's ability to generate taxable income. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not.
The analysis of the variance of income taxes as reported from income taxes compiled at the U.S. statutory federal income tax rate for continuing operations is as follows:
11. COMMITMENTS AND CONTINGENCIES:
Litigation:
On August 21, 1995, the Company's wholly-owned subsidiary, CTi Technologies, Inc. ("CTi"), filed an action in the United States District Court for the District of Arizona against Wayne K. Pfaff, an individual residing in Texas ("Pfaff"), and Plastronics
Socket Company, Inc., a corporation affiliated with Pfaff, alleging and seeking a declaratory judgment that two United States patents issued to Pfaff and relating to certain burn-in sockets for "leadless" IC packages (the "Pfaff Leadless Patent") and ball grid array ("BGA") IC packages (the "Pfaff BGA Patent") (collectively, the "Pfaff Patents") are invalid and are not infringed by CTi, the products of which include burn-in sockets for certain "leaded" packages (including Quad Flat Paks) (the "CTi Leaded Products") and BGA packages (the "CTi BGA Products") (collectively, the "CTi Products"). Pfaff has filed a counterclaim alleging that CTi infringes the Pfaff Leadless Patent and has requested an award of damages; the counterclaim does not allege infringement of the Pfaff BGA Patent. Pfaff has also sought a permanent injunction against further infringement by CTi of the Pfaff Leadless Patent. That action has been stayed pending resolution of another action, described below, involving the Pfaff Leadless Patent.
In litigation between Wells and Pfaff concerning the Pfaff Leadless Patent, the United States Court of Appeals for the Federal Circuit has found all of the individual descriptions of the invention (the "Claims" of the patent) of the Pfaff Leadless Patent which were at issue in that case to be invalid. Certain other Claims of the patent were not at issue in that case, and their validity was not decided by the court, because Pfaff did not allege that products of Wells infringed such Claims. The United States Supreme Court has accepted an appeal on that case. Unless overturned, the Court of Appeals decision as to the invalidity of such Claims of the Pfaff Leadless Patent will be binding in the CTi v. Pfaff action in the District of Arizona, and the reasoning of that decision could support CTi's position that the remaining Claims of that patent are invalid.
The Company believes, based on the advice of counsel, that CTi and Wells have meritorious defenses against any allegations of infringement under the Pfaff Patents, and, if necessary, CTi and Wells will vigorously litigate their positions. There can be no assurance, however, that the Company, CTi or Wells will prevail in any pending or future litigation, and a final court determination that CTi or Wells has infringed the Pfaff Leadless Patent could have a material adverse effect on the Company. Such adverse effect could include, without limitation, the requirement that CTi or Wells pay substantial damages for past infringement and an injunction against the manufacture or sale in the United States of such products as are found to be infringing.
Leases:
The Company leases office and production facilities in Peabody, Massachusetts, Wormleysburg, Pennsylvania, and Phoenix, Arizona. These rentals are subject to escalation in real estate taxes and operating expenses. Rental expense for the years ended December 31, 1997, 1996 and 1995 was $480,000, $498,000, and $500,000 respectively.
In conjunction with the Wells acquisition, leased production facilities in South Bend, Indiana, Yokohama, Japan and Swatara, Pennsylvania and leased distribution and technical sales support facilities in Northhampton, England; Regensburg, Germany; Seoul, South Korea; Singapore and Penang, Malaysia were added.
Minimum future rental commitments under leases with remaining terms in excess of one year are approximately as follows:
12. STOCKHOLDERS EQUITY:
Preferred Stock
The Board of Directors is authorized, subject to any limitations prescribed by law, from time to time to issue up to an aggregate of 1,000,000 shares of Preferred Stock, $0.10 par value per share, with such powers, designations, preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be determined by the Board of Directors in a resolution or resolutions providing for the issuance of such Preferred Stock.
Common Stock
In February 1996, the stockholders approved an increase in the authorized common stock of the Company to 25,000,000 shares, $0.01 par value per share, and the stockholders approved a twelve-for-one stock split effected in the form of a stock dividend. All references to the number of shares and per share amounts have been restated to reflect the split.
Treasury Stock
On January 30, 1996, the Board of Directors approved a resolution to restore any and all Common Stock of the Company which had been repurchased by the Company to the status of authorized but unissued shares.
Stock Options:
Directors Stock Plan
The Company's 1996 Eligible Directors Stock Plan (the "Directors Stock Plan") was approved by the Board of Directors on January 30, 1996 and thereafter by the Company's stockholders. Under the Directors Stock Plan, commencing with the 1997 annual meeting of stockholders, each director who is not an officer or employee of the Company or any subsidiary of the Company (an "outside director") who has not previously been granted an option to purchase shares of Common Stock will be granted, on the thirtieth day after such meeting, an option to purchase 3,000 shares of Common Stock at an exercise price equal to the fair market value on the date of grant. In addition, on the thirtieth day after such meeting, each outside director will be granted an option at each annual meeting of stockholders to purchase 1,500 shares of Common Stock at an exercise price equal to the fair market value on the date of grant. A total of 36,000 shares of Common Stock are available for awards under the Directors Stock Plan. Each option shall vest 6 months after, and expire 10 years from, the date of grant of such option. No options may be granted under the Directors Stock Plan after January 29, 2006.
1996 Stock Plan
The Company's 1996 Stock Plan was approved by the Board of Directors on January 30, 1996, and thereafter by the Company's stockholders. The 1996 Stock Plan provides for the grant or award of stock options, restricted stock and other performance awards which may or may not be denominated in shares of Common Stock or other securities (collectively, the "Awards"). Stock options granted under the 1996 Stock Plan may be either incentive stock
options or non-qualified options. The 1996 Stock Plan is administered by the Compensation Committee. Subject to the provisions of the 1996 Stock Plan, the Committee has the authority to designate participants, determine the types of Awards to be granted, the number of shares to be covered by each Award, the time at which each Award is exercisable or may be settled, the method of payment and any other terms and conditions of the Awards. While the Committee determines the prices at which options and other Awards may be exercised under the 1996 Stock Plan, the exercise price of an option shall be at least 100% of the fair market value (as determined under the terms of the 1996 Stock Plan) of a share of Common Stock on the date of grant. The aggregate number of shares of Common Stock available for awards under the Plan is 324,000. No option shall be exercisable with respect to any shares later than 10 years after the date of grant of such options or 5 years in the case of incentive options granted to the owner of stock possessing more than 10% of the value of all classes of stock of the Company. Vesting is determined in the sole discretion of the Compensation Committee of the Board of Directors. In connection with Committee's grants to date, it has fixed vesting in four approximately equal annual installments, the first of which vests on the date of grant. No awards may be made under the 1996 Stock Plan after January 29, 2006.
1992 Stock Option Plan
The Company's 1992 Stock Option Plan as amended on January 30, 1996 provides for the grant or award of stock options, which may be either incentive stock options or non-qualified stock options to key employees and directors. The aggregate number of shares of Common Stock reserved for issuance under the 1992 Stock Plan is 636,600 shares. No option shall be exercisable with respect to any shares later than 10 years after the date of grant of such options or 5 years in the case of incentive options granted to the owner of stock possessing more than 10% of the value of all classes of stock of the Company. Vesting is determined in the sole discretion of the Compensation Committee of the Board of Directors. In connection with Committee's grants to date, it has fixed vesting in four approximately equal annual installments, the first of which vests on the date of grant. The Compensation Committee administers the 1992 Stock Option Plan.
The following table summarizes the transactions from these plans:
Summarized information about stock options outstanding at December 31, 1997 is as follows:
For the years ended December 31, 1997, 1996 and 1995, options to purchase 630,685 shares, 740,049 shares and 825,000 shares, respectively, of Common Stock were exercisable with the remaining options becoming exercisable at various dates through December 26, 2002. The weighted average exercise price of outstanding options for the years ended December 31, 1996 and 1995 were $1.25 and $1.18, respectively. The Company has recorded deferred compensation of $239,000 for the difference between fair value and exercise price for options granted in 1995 and such deferred compensation is being amortized over the option vesting period.
Generally, when shares acquired pursuant to the exercise of incentive stock options are sold within one year of exercise or within two years from the date of grant, the Company derives a tax deduction measured by the amount that the fair market value exceeds the option price at the date the options are exercised. When nonqualified stock options are exercised, the Company derives a tax deduction measured by the amount that the fair market value exceeds the option price at the date the options are exercised.
Supplemental Disclosure for Stock Based Compensation:
The Company has three stock-based compensation plans, which are described above. In October 1995, the FASB issued SFAS 123, Accounting for Stock-Based Compensation. SFAS 123 is effective for periods beginning after December 15, 1995. SFAS 123 requires that companies either recognize compensation expense for grants of stock, stock options, and other equity instruments based on fair value, or provide pro forma disclosure of net income and earnings per share in the notes to the financial statements. The Company adopted the disclosure provisions of SFAS 123 in 1996 and has applied APB Opinion 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company's net income (loss) and earnings (loss) per share for the years ended December 31, 1997, 1996 and 1995 would have been reduced to the pro forma amounts indicated below:
Weighted average fair value of options granted at fair value at date of grant: 1997.......... $12.73 ====== 1996.......... $ 7.83 ======
Weighted average fair value of options granted below fair value at date of grant:
1995.......... $ 2.53 ======
The effect of applying SFAS 123 in this pro forma disclosure is not indicative of future amounts. The SFAS does not apply to awards made prior to 1995. Additional awards in future years are anticipated.
13. PROFIT SHARING PLAN:
Effective May 1, 1992, the Company adopted a Plan pursuant to Section 401 of the Internal Revenue Code (the "Code"), whereby employees may contribute a percentage of compensation, but not in excess of the maximum allowed under the Code. Employees are eligible for participation at the beginning of the calendar quarter following their one year anniversary. The Company makes matching contributions of fifty percent of employee contributions up to 6% of employee compensation; however, the Company's total contribution may not exceed 15% of the prior year's pre-tax income unless authorized by the Board of Directors. The Company's matching contributions were approximately $93,000, $80,000 and $82,000 for the years ended December 31, 1997, 1996, and 1995, respectively.
Wells Electronics, Inc. Deferred Compensation and Savings Plan (Salaried 401(k)) allows for salaried employees to contribute up to a maximum allowable under the Code. Wells makes matching
contributions of 25% of the employee contribution. Wells Electronics, Inc. Union Employees' 401(k) Plan allows for all union employees to contribute a minimum contribution ($0.19 per hour through February 18, 1998). For those employees who contribute at least the minimum, Wells matches $0.19 per hour through February 18, 1998. As part of the liabilities assumed as a result of the Wells acquisition, a liability was recorded for approximately $46,000.
14. SIGNIFICANT CUSTOMERS AND EXPORT SALES:
One customer accounted for approximately 14.5%, 17.4% and 16.6% of the Company's net sales in 1997, 1996 and 1995, respectively. A second customer accounted for approximately 12.7% and 13.4% of the Company's net sales in 1997 and 1995, respectively. The Company had export sales of approximately $3,876,000, $2,975,000 and $3,022,000 in 1997, 1996 and 1995, respectively. All export sales are in U.S. dollars. No one country or region accounted for greater than 10% of net sales.
15. SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED):
See accompanying notes to the consolidated financial statements.
WELLS ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR 53 WEEKS ENDED MAY 3, 1997; 48 WEEKS ENDED APRIL 27, 1996 AND 52 WEEKS ENDED JUNE 3, 1995 (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to the consolidated financial statements.
WELLS ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY FOR 53 WEEKS ENDED MAY 3, 1997; 48 WEEKS ENDED APRIL 27, 1996 AND 52 WEEKS ENDED JUNE 3, 1995 (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to the consolidated financial statements.
WELLS ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR 53 WEEKS ENDED MAY 3, 1997; 48 WEEKS ENDED APRIL 27, 1996 AND 52 WEEKS ENDED JUNE 3, 1995 (IN THOUSANDS)
See accompanying notes to the consolidated financial statements
WELLS ELECTRONICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 3, 1997 AND APRIL 27, 1996 (IN THOUSANDS)
1. NATURE OF BUSINESS
As of May 3, 1997 and for the year then ended (fiscal 1997), Wells Electronics, Inc. ("the Company"), an Indiana Corporation, was a wholly owned subsidiary of UL America, Inc., whose ultimate parent company, Siebe plc, is a publicly held corporation based in the United Kingdom. On April 24, 1989, UL America, Inc. acquired Wells Electronics, Inc., and for the eleven months ended April 27, 1996 (fiscal 1996) and the year ending May 31, 1995 (fiscal 1995), the Company was a wholly owned subsidiary of UL America, Inc.
The Company has two subsidiaries: Wells Electronics Asia Pte Ltd. in Singapore ("Wells Asia") which is a wholly owned subsidiary and Wells Japan Ltd. ("Wells Japan") in Japan which is approximately 98% owned by the Company. The remaining 2% is owned by a Japanese corporation.
The Company is principally engaged in designing, developing, manufacturing and marketing a broad line of burn-in/test sockets and plastic carriers for the global semiconductor industry. These products are employed in the handling and quality assurance phase of semiconductor manufacturing.
The Company's ultimate parent, Unitech plc, was acquired by Siebe plc, on May 2, 1996. Following the acquisition, a new basis of accounting was applied. The fair market revaluation of the Company's assets and liabilities resulted in an acquisition adjustment of $8,255, net of the related deferred tax liability of $5,962. As a result of the acquisition, property, plant and equipment was written up to appraised fair market value of $8,535 (net historical cost was $4,319). Additionally, trademarks and software were written up to appraised fair market value of $10,001 (net historical cost was $0) and goodwill of $708 was retained. There were no other significant accounting adjustments.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Wells Electronics, Inc. and its subsidiaries. Significant intercompany balances and transactions have been eliminated.
The consolidated financial statements are prepared in accordance with United States generally accepted accounting principles. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The most significant estimates included in these financial statements are allowance for uncollectible accounts, inventory reserves, and warranty reserves.
There are 53, 48, and 52 weeks in fiscal 1997, 1996 and 1995, respectively, due to the change in the fiscal year end subsequent to the Siebe plc acquisition.
REVENUE RECOGNITION
Sales and related cost of sales are recognized upon shipment of products to customers.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of trade receivables. The Company provides credit to customers in the normal course of business. Collateral is not required for trade receivables, but ongoing credit evaluations of customers' financial condition are performed. Additionally, the Company maintains reserves for potential credit losses. As of April 27, 1996 and May 3, 1997 the Company had no significant receivable write-offs. The Company operates in a single segment of the semiconductor industry.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred.
INVENTORIES
Inventories are stated at the lower of cost or market. The inventories are valued at standard cost which approximates the first-in, first-out (FIFO) cost method. Certain inventories are valued at the moving average cost method.
PROPERTY, PLANT AND EQUIPMENT
For fiscal 1997, property, plant and equipment are stated at fair value based upon independent appraisal. For fiscal 1996 and 1995, property, plant and equipment are stated on the basis of cost. Equipment under capital leases is stated at the present value of minimum lease payments at the inception of the lease.
Material, labor and overhead costs associated with the manufacture of molds are capitalized and classified as tooling. Acquisition cost is used to cost molds which are purchased from outside vendors.
Depreciation is provided using the straight-line method over the estimated useful lives of depreciable properties as follows: buildings and improvements, 10 to 33 years; machinery and equipment, 7 to 13 years; and tooling, 2 to 6 years.
Equipment held under capital leases and lease improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset.
INCOME TAXES
The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement bases and the tax bases of the Company's assets and liabilities using enacted statutory tax rates applicable to future years.
INTANGIBLE ASSETS
The straight-line method is used to amortize intangible assets. The goodwill and trademarks are amortized to expense over 20 years and computer software is amortized over 6 years.
FOREIGN CURRENCY TRANSLATION
The accounts of foreign subsidiaries are measured using local currency as the functional currency. For those operations, assets and liabilities are translated into US dollars at the end of period exchange rates and income and expenses are translated at
the average exchange rates. Net exchange gains or losses resulting from such translation are excluded from net income and accumulated in a separate component of shareholder's equity.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) Statement No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of, during fiscal 1997. This statement requires that long-lived assets, including associated goodwill, and certain identifiable intangibles to be held and used be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. It also requires that long-lived assets and certain intangible assets to be disposed be reported at the lower of carrying amount or fair value less costs to sell. Adoption of this statement did not have any impact on the Company's financial position, results of operations, or liquidity.
NET INCOME PER COMMON SHARE
Net income per common share is computed using the weighted average number of shares of common stock outstanding.
3. FOREIGN OPERATIONS
The Company's net income is affected by foreign currency exchange (gains) losses resulting from translating foreign currency denominated trade receivables and payables of Wells Japan and Wells Asia and other realized and unrealized foreign currency (gains) losses.
4. INVENTORIES
Inventories consist of the following:
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
6. INTANGIBLE ASSETS
Intangible assets consist of the following:
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued liabilities consist of the following:
8. DEBT
Short-term debt consists of the following:
Wells Japan has a Y125 million (approximately $985 at May 3, 1997) line of credit with a Japanese bank that was guaranteed by its ultimate parent. The interest rate at May 1997 was 2.375% per annum.
Long-term debt consists of the following:
Actual income tax expense differs from the amounts computed by applying the enacted US federal corporate rate to income before income taxes as a result of the following:
The tax effect of temporary differences that give rise to deferred tax (assets) and liabilities follow:
10. LEASES
The company leases certain of its manufacturing facilities, sales offices and equipment. Some leases include provisions for renewals and purchases at the Company's option.
Rental expense for all operating leases approximated $562, $241 and $233 in fiscal year 1997, 1996 and 1995, respectively.
Future minimum operating lease payments consist of the following at May 3, 1997:
11. PROFIT SHARING AND RETIREMENT PLANS
The Company has adopted a Plan ("401(k) Plan") pursuant to Section 401 of the Internal Revenue Code. Salaried employees may contribute a percentage of their compensation to the 401(k) Plan, but not in excess of the maximum allowed under the Code. Salaried employees are eligible for participation at their one year anniversary. The Company makes matching contributions of 25 percent of employee contributions but not in excess of the maximum allowed under the Code. In addition to any Employer 401(k) Contribution discussed above, the Company in any Plan Year, to the extent it has Net Profits or retained earnings, may make additional matching Employer 401(k) Contributions to the extent it deems appropriate at its complete discretion.
Effective February 19, 1997, the Company adopted a Retirement Income Plan for the hourly employees whereby the Company will make a contribution of $0.19 per hour for all hours worked into a retirement income plan, with the employees contributing a matching amount. The contribution will increase to $0.20 and $0.22 per all hours worked effective February 19, 1998 and 1999, respectively. The employee matching contribution will increase accordingly.
The Company's combined matching contributions for the 401(k) Plan and Retirement Income Plan were approximately $67, $63 and $61 in 1997, 1996 and 1995, respectively.
12. RELATED PARTY TRANSACTIONS
The Company was charged with corporate management fees of $25 in 1997, $193 in 1996, and $272 in 1995. Non-interest bearing long-term receivable due from affiliates was $3,231 at May 3, 1997. This consists of $2,550 from Siebe Inc. and $681 from UL America, Inc.
13. COMMITMENTS AND CONTINGENCIES
The Company has been party to ongoing litigation with Wayne K. Pfaff and an affiliated corporation regarding alleged patent infringements. Subsequent to the balance sheet date, the Federal Circuit Court of Appeals found in favor of the Company. Management believes that the likelihood of any future liability in this regard is remote and as such, has established no provision.
14. SUBSEQUENT EVENT
On November 17, 1997, UL America, Inc. agreed to sell all of the Company's issued and outstanding shares of common stock to PCD Inc. The purchase price of this transaction is $130 million.
15. SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in the integrated circuit connector industry which is a single industrial segment. One customer accounted for approximately 18%, 15% and 18% of the Company's sales in 1997, 1996 and 1995, respectively. The Company had no other single customer with sales greater than 10% of total sales.
Sales between geographic areas are at cost plus approximately 50% mark-up. The Company has significant operations in foreign countries. Information regarding operations by geographic area for fiscal 1997, 1996 and 1995 is as follows:
See accompanying notes to the consolidated financial statements.
WELLS ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY for 34 weeks ended December 26, 1997 (In thousands, except share data)
See accompanying notes to the consolidated financial statements.
WELLS ELECTRONICS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for 34 weeks ended December 26, 1997 and 35 weeks ended December 31, 1996 (Unaudited) (In thousands)
See accompanying notes to the consolidated financial statemen
WELLS ELECTRONICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 26, 1997 (In thousands)
1. Nature of Business
Wells Electronics, Inc. ("the Company"), an Indiana Corporation, was a wholly owned subsidiary of UL America, Inc., whose ultimate parent company, Siebe plc, is a publicly held corporation based in the United Kingdom.
The Company has two subsidiaries: Wells Electronics Asia Pte Ltd. in Singapore ("Wells Asia") which is a wholly owned subsidiary and Wells Japan Ltd. ("Wells Japan") in Japan which is approximately 98% owned by the Company. The remaining 2% is owned by a Japanese corporation.
The Company is principally engaged in designing, developing, manufacturing and marketing a broad line of burn-in/test sockets and plastic carriers for the global semiconductor industry. These products are employed in the handling and quality assurance phase of semiconductor manufacturing.
UL America, Inc.'s ultimate parent, Unitech plc, was acquired by Siebe plc, on May 2, 1996. Following the acquisition, a new basis of accounting was applied. The fair market revaluation of the Company's assets and liabilities resulted in an acquisition adjustment of $8,255, net of the related deferred tax liability of $5,962. As a result of the acquisition, property, plant and equipment was written up to appraised fair market value of $8,535 (net historical cost was $4,319). Additionally, trademarks and software were written up to appraised fair market value of $10,001 (net historical cost was $0) and goodwill of $708 was retained. There were no other significant accounting adjustments.
On December 26, 1997, UL America, Inc. sold all of the Company's issued and outstanding shares of common stock to PCD Inc. The purchase price of this transaction was $130 million.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Wells Electronics, Inc. and its subsidiaries. Significant intercompany balances and transactions have been eliminated. The consolidated financial statements are prepared in accordance with United States generally accepted accounting principles. The
preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates included in these financial statements are allowance for uncollectible accounts, inventory reserves, and warranty reserves.
Revenue Recognition
Sales and related cost of sales are recognized upon shipment of products to customers.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of trade receivables. The Company provides credit to customers in the normal course of business. Collateral is not required for trade receivables, but ongoing credit evaluations of customers' financial condition are performed. Additionally, the Company maintains reserves for potential credit losses. As of December 26, 1997 the Company had no significant receivable write-offs. The Company operates in a single segment of the semiconductor industry.
Research and Development
Research and development costs are charged to expense as incurred.
Inventories
Inventories are stated at the lower of cost or market. The inventories are valued at standard cost which approximates the first-in, first-out (FIFO) cost method. Certain inventories are valued at the moving average cost method.
Property, Plant and Equipment
Property, plant and equipment acquired on May 2, 1996 are stated at fair value based upon independent appraisal. Subsequent additions are recorded at cost. Equipment under capital leases is stated at the present value of minimum lease payments at the inception of the lease.
Material, labor and overhead costs associated with the manufacture of molds are capitalized and classified as tooling. Acquisition cost is used to cost molds which are purchased from outside vendors.
Depreciation is provided using the straight-line method over the estimated useful lives of depreciable properties as follows: buildings and improvements, 10 to 33 years; machinery and equipment, 7 to 13 years; and tooling, 2 to 6 years.
Equipment held under capital leases and lease improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement bases and the tax bases of the Company's assets and liabilities using enacted statutory tax rates applicable to future years.
Intangible Assets
The straight-line method is used to amortize intangible assets. The goodwill and trademarks are amortized to expense over 20 years and computer software is amortized over 6 years.
Foreign Currency Translation
The accounts of foreign subsidiaries are measured using local currency as the functional currency. For those operations, assets and liabilities are translated into US dollars at the end of period exchange rates and income and expenses are translated at the average exchange rates. Net exchange gain or losses resulting from such translation are excluded from net income and accumulated in a separate component of shareholder's equity.
Net Income Per Common Share
Net income per common share is computed using the weighted average number of shares of common stock outstanding.
3. Foreign Operations
The Company's net income is affected by foreign currency exchange (gains) losses resulting from translating foreign currency denominated trade receivables and payables of Wells Japan and Wells Asia and other realized and unrealized foreign currency (gains) losses.
4. Inventories
Inventories consist of the following:
5. Property, Plant and Equipment
Property, plant and equipment consist of the following:
6. Intangible Assets
Intangible assets consist of the following:
7. Accrued Expenses and Other Current Liabilities
Accrued liabilities consist of the following:
8. Income Tax Expense
Components of income tax expense (benefit) consist of:
Actual income tax expense differs from the amounts computed by applying the enacted US federal corporate rate to income before income taxes as a result of the following:
The tax effect of temporary differences that give rise to deferred tax assets and liabilities follows:
9. Leases
The Company leases certain of its manufacturing facilities, sales offices and equipment. Some leases include provisions for renewals and purchases at the Company's option.
Rental expense for all operating leases approximated $453 for the 34 weeks ended December 26, 1997
Future minimum operating lease payments consist of the following at December 26, 1997:
10. Profit Sharing and Retirement Plans
The Company has adopted a Plan ("401(k) Plan") pursuant to Section 401 of the Internal Revenue Code. Salaried employees may contribute a percentage of their compensation to the 401(k) Plan, but not in excess of the maximum allowed under the Code. Salaried employees are eligible for participation at their one year anniversary. The Company makes matching contributions of 25 percent of employee contributions but not in excess of the maximum allowed under the Code. In addition to any Employer 401(k) Contribution discussed above, the Company in any Plan Year, to the extent it has Net Profits or retained earnings, may make additional matching Employer 401(k) Contributions to the extent it deems appropriate at its complete discretion.
The Company has also adopted a Retirement Income Plan for the hourly employees whereby the Company will make a contribution of $0.19 per hour for all hours worked into a retirement income plan, with the employees contributing a matching amount. The contribution will increase to $0.20 and $0.22 per all hours worked effective February 19, 1998 and 1999, respectively. The employee matching contribution will increase accordingly.
The Company's combined matching contributions for the 401(k) Plan and Retirement Income Plan were approximately $72, for the 34 weeks ended December 26, 1997.
11. Commitments and Contingencies
The Company has been party to ongoing litigation with Wayne K. Pfaff and an affiliated corporation regarding alleged patent infringement.
In litigation between Wells and Pfaff concerning the Pfaff Leadless Patent, the United States Court of Appeals for the Federal Circuit has found all of the individual descriptions of the invention (the "Claims" of the patent) of the Pfaff Leadless Patent which were at issue in that case to be invalid. Certain other Claims of the patent were not an issue in that case, and their validity was not decided by the court, because Pfaff did not allege that products of Wells infringed such Claims. In March, 1998, the United States Supreme Court accepted an appeal on that case. Unless overturned, the Court of Appeals decision as to the invalidity of such Claims of the Pfaff Leadless Patent will be binding.
The Company believes, based on the advice of counsel, that the Company has meritorious defenses against any allegations of infringement under the Pfaff Patents, and, if necessary, the Company will vigorously litigate their positions. There can be no assurance, however, that the Company will prevail in any pending or future litigation, and a final court determination that the Company has infringed the Pfaff Leadless Patent could have a material adverse effect on the Company. Such adverse effect could include, without limitation, the requirement that the Company pay substantial damages for past infringement and an injunction against the manufacture or sale in the United States of such products as are found to be infringing.
12. Segment and Geographic Information
The Company operates in the integrated circuit connector industry which is a single industrial segment. There were three customers who accounted for approximately 30%, 12% and 11% of the Company's sales during the 34 weeks ended December 26, 1997. The Company had no other single customer with sales greater than 10% of total sales.
Sales between geographic areas are at cost plus approximately 50% mark-up. The Company has significant operations in foreign countries. Information regarding operations by geographic area for the 34 weeks ended December 26, 1997 is as follows:
13. Summarized Quarterly Financial Data (unaudited) for the:
(F1) A copy has been previously filed with the Company's registration statement on Form S-1 (Registration no. 333-1266), as filed on February 12, 1996, and amended on March 15 and March 21, 1996, and is incorporated in this document by reference.
(F2) A copy has been previously filed with the Company's annual report on Form 10-K (Commission file no. 0-27744), as filed on March 28, 1997, and is incorporated in this document by reference.
(F3) A copy has been previously filed with the Company's quarterly report on Form 10-Q, (Commission file no. 0-27744), as filed on September 27, 1997, and is incorporated in this document by reference.
(F4) A copy has been previously filed with the Company's current report on Form 8-K, (Commission file no. 0-27744), as filed on January 9, 1998, and as amended on March 11 and 24, 1998 and is incorporated in this document by reference.
(F5) A copy has been previously filed with the Company's registration statement on form S-1 (Registration No. 333-46137), as filed on February 12, 1998, and amended on March 20, 1998, and is incorporated in this document by reference.
Management Contracts and Compensatory Plans
- ---------- (F1) A copy has been previously filed with the Company's registration statement on Form S-1 (Registration no. 333-1266), as filed on February 12, 1996, and amended on March 15 and March 21, 1996, and is incorporated in this document by reference.
(F2) A copy has been previously filed with the Company's quarterly report on Form 10-Q, (Commission file no. 0-27744), as filed on September 27, 1997, and is incorporated in this document by reference.
(F3) A copy has been previously filed with the Company's registration statement on form S-1 (Registration No. 333-46137), as filed on February 12, 1998, and amended on March 20, 1998, and is incorporated in this document by reference.
B. Reports on Form 8-K
The Company filed no reports on Form 8-K during the fourth quarter of 1997.
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, thereto duly authorized.
PCD INC.
Dated: March 31, 1998 By: /s/ John L. Dwight, Jr. ----------------------------- John L. Dwight, Jr. Chairman of the Board, President and Chief Executive Officer
Dated: March 31, 1998 By: /s/ Mary L. Mandarino ---------------------------- Mary L. Mandarino Vice President - Finance and Administration, Chief Financial Officer, and Treasurer (principal financial and accounting officer)
Dated: March 31, 1998 By: /s/ Bruce E. Elmblad ---------------------------- Bruce E. Elmblad Director
Dated: March 31, 1998 By: /s/ Harold F. Faught ---------------------------- Harold F. Faught Director
Dated: March 31, 1998 By: /s/ C. Wayne Griffith ---------------------------- C. Wayne Griffith Director
Dated: March 31, 1998 By: /s/ Theodore C. York ---------------------------- Theodore C. York Director
EXHIBIT INDEX
(F1) A copy has been previously filed with the Company's registration statement on Form S-1 (Registration no. 333-1266), as filed on February 12, 1996, and amended on March 15 and March 21, 1996, and is incorporated in this document by reference.
(F2) A copy has been previously filed with the Company's annual report on Form 10-K (Commission file no. 0-27744), as filed on March 28, 1997, and is incorporated in this document by reference.
(F3) A copy has been previously filed with the Company's quarterly report on Form 10-Q, (Commission file no. 0-27744), as filed on September 27, 1997, and is incorporated in this document by reference.
(F4) A copy has been previously filed with the Company's current report on Form 8-K, (Commission file no. 0-27744), as filed on January 9, 1998, and as amended on March 11 and 24, 1998 and is incorporated in this document by reference.
(F5) A copy has been previously filed with the Company's registration statement on form S-1 (Registration No. 333-46137), as filed on February 12, 1998, and amended on March 20, 1998, and is incorporated in this document by reference.
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of PCD Inc. on Form S-8 (File Nos. 333-07393, 333-07403 and 333-07405) of our report dated February 11, 1998, except information included under the caption Litigation in Note 11, Commitments and Contingencies, as to which the date is March 18, 1998, on our audits of the consolidated financial statements of PCD Inc. as of December 31, 1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995 which report is included in this Annual Report on Form 10-K.
/s/ Coopers & Lybrand L.L.P
Coopers & Lybrand, L.L.P. Boston, Massachusetts March 30, 1998
EXHIBIT 23.2 CONSENT OF KPMG PEAT MARWICK LLP
We consent to the incorporation by reference in the Registration Statements of PCD Inc. on Form S-8 (File Nos. 333-07393, 333-07403 and 333-7405) of our report dated January 15, 1998, relating to the consolidated balance sheets of. Wells Electronics, Inc. and subsidiaries as of May 3, 1997 and April 27, 1996. and the related consolidated statements of income, shareholder's equity, and. cash flows for the 53 weeks ended May 3, 1997, the 48 weeks ended April 27, 1996 and the 52 weeks ended June 3, 1995, which report appears in the December 31, 1997, annual report on Form 10-K PCD Inc. We also consent to the inclusion of our report dated February 4, 1998 relating to the consolidated balance sheet of Wells Electronics Inc. and subsidiaries as of December 26, 1997 and the related consolidated statements of income, shareholder's equity, and cash flows for the 34 weeks then ended, which report also appears in the December 31, 1997, annual report on Form 10-K PCD Inc.
/s/ KPMG Peat Marwick LLP
Chicago, Illinois March 10, 1998