UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number 001-11098

 

SOLECTRON CORPORATION

(Exact name of Registrant as Specified in its Charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the Registrant’s Common Stock held by non-affiliates on October 31, 2006 was approximately $1.9 billion (based upon the last reported price of the Common Stock on the New York Stock Exchange on such date). Shares of Common Stock held by each officer, director, and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

As of October 31, 2006, there were approximately 903.0 million shares of the Registrant’s common stock outstanding including approximately 18.2 million shares of Solectron Global Services Canada, Inc., which are exchangeable on a one-to-one basis for the Registrant’s common stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The Registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on January 10, 2007, which Solectron will file with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this report, is incorporated by reference in Part III of this Form 10-K to the extent stated herein.

 

 

SOLECTRON CORPORATION

2006 FORM 10-K
ANNUAL REPORT

TABLE OF CONTENTS

 

 

Solectron and the Solectron logo are registered trademarks of Solectron Corporation. All other names are trademarks and/or registered trademarks of their respective owners.

 

Cautionary Statement Regarding Forward-Looking Statements

 

With the exception of historical facts, the statements contained in this annual report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are subject to the safe harbor provisions set forth in the Exchange Act. These forward-looking statements relate to matters including, but not limited to:

 

 

We intend that our forward-looking statements be subject to the safe harbors created by the Exchange Act. The forward-looking statements are generally accompanied by words such as “may,” “will,” “could,” “should,” “intend,” “anticipate,” “believe,” “estimate,” “expect,” “continue” and other similar words and statements. Our forward-looking statements are based on current expectations, forecasts and assumptions and are subject to risks, uncertainties and changes in condition, significance, value and effect, including those discussed under the heading “Risk Factors” in this report and in our other reports filed with the Securities and Exchange Commission. Such risks, uncertainties and changes in condition, significance, value and effect could cause our actual results to differ materially from our anticipated outcomes. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate. Therefore, we can give no assurance that the results implied by these forward-looking statements will be realized. The inclusion of forward-looking information should not be regarded as a representation by our company or any other person that the future events, plans or expectations contemplated by Solectron will be achieved. Furthermore, past performance in operations and share price is not necessarily indicative of future performance. We disclaim any intention or obligation to update or revise any forward-looking statements contained herein, whether as a result of new information, future events or otherwise.

 

The information contained in this business overview is qualified in its entirety by, and is subject to, the detailed information, consolidated financial statements and notes thereto contained within this document under the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Supplementary Data sections. Solectron’s financial reporting year ends on the last Friday in August. For purposes of presentation in this Form 10-K, Solectron has indicated its accounting year end as August 31.

 

Overview

 

We provide electronics manufacturing and supply chain services to original equipment manufacturers (OEMs) around the world. As a value-added contract manufacturing partner to OEMs, our customers contract with us to build their products or to obtain services related to product design, manufacturing and post-manufacturing requirements. We design, build, repair and service products that carry the brand names of our customers.

 

We serve several electronics products and technology markets. Much of our business is related to the following products:

 

 

Our customer base consists of many of the world’s leading technology companies, such as Cisco Systems, Ericsson, Hewlett-Packard, IBM, Lucent Technologies, Motorola, NEC, Nortel Networks, Pace, Sun Microsystems and Teradyne.

 

Our comprehensive range of services are designed to meet customer supply chain needs throughout the product life cycle. Our services include:

 

 

 

We customize these services to deliver integrated supply chain solutions to our customers. By utilizing our services, customers achieve cost, time and quality advantages that improve their competitiveness and enable them to focus on their core competencies of sales, marketing and research and development. Customers are also able to reduce or shift costs and risks associated with manufacturing and supply chain management. We provide the following benefits to OEMs:

 

Leading Manufacturing and Service Technologies:  Electronic products, electronics manufacturing and service technologies have become increasingly sophisticated and complex. This makes it difficult for OEMs to maintain the necessary expertise to manufacture and repair products internally. OEMs are motivated to work with us to gain access to our expertise in interconnect, test, process, repair and other technologies, such as lead-free manufacturing processes.

 

Faster Time-to-Market:  Due to intense competitive pressures in the electronics industry, shorter product life cycles require OEMs to reduce the time needed to bring a product to market. OEMs often reduce time-to-market by using our services, expertise and infrastructure. For example, OEMs partner with us during the early stages of product design to expedite the transition into high volume production in our manufacturing centers.

 

Lower Costs:  Our OEM customers realize lower costs as a result of several factors: our ability to perform services in the most cost-effective locations around the world; our ability to combine purchasing across our customer base; our ability to produce multiple products within a given facility; and our flexibility to adapt our operations to changing customer demand. Our flexibility and responsiveness enable us to support rapidly changing customer needs on a just-in-time value-added basis, adapting to the customer’s schedule and redirecting resources to allow for more seamless production transfers.

 

Consistent Quality:  Our customers rely on us to consistently provide complex products that meet exacting performance criteria. Leveraging the benefits of the Solectron Production System^tm, which combines the global capabilities of our Lean manufacturing advances with the continuous improvements derived from Six Sigma quality analysis, we reduce waste and variability throughout the supply chain, creating alignment between people, strategy, customers and processes.

 

Better Asset Utilization:  OEM supply chains, managed by Solectron, enable OEMs to lower their investment in property, plant and equipment, as well as systems and infrastructure. This lower investment can lead to better asset utilization and higher return on assets for our OEM customers.

 

Focused Resource Allocation:  As a result of market demands, many OEMs focus their resources on activities where they add the greatest value. By offering comprehensive electronics supply chain services, we allow OEMs to focus on their own core competencies, such as next-generation product development, marketing and sales.

 

Cost-Effective Global Capabilities:  We have facilities in Asia, the Americas and Europe. Through our global presence, we perform electronics supply chain services in locations to best address our customers’ objectives, including cost containment, compliance with local content regulations, proximity to end-markets and end-consumers, and the elimination or reduction of expensive freight costs, tariffs and time-consuming customs clearances.

 

Environmental Compliance:  We created a market-ready offering to help OEM customers meet Europe’s Restriction of Hazardous Substances (RoHS) and other regulatory requirements. Current legislation and compliance requirements in Europe, and pending legislation in other jurisdictions, impact or have the potential of impacting the entire supply chain, causing operational, business and product-reliability challenges. We partner with

our OEM customers to ensure a conversion plan and transition approach that effectively and efficiently addresses our customers’ compliance issues so their products meet regulatory requirements within appropriate deadlines.

 

Strategy

 

Our strategy is to increase sales and earnings growth by providing cost-effective and value-added services that unlock value and competitive advantage for customers by providing integrated supply chain solutions that leverage Solectron’s differentiated capabilities in collaborative design, lean manufacturing, and post-manufacturing services. To support this strategy we are committed to five specific areas:

 

Concentration on Core and Emerging Markets

 

We are extending our leadership and capabilities in our core markets, which include the communications, networking, computing and storage industries. The products we manufacture and the customers we serve in these markets represent a substantial portion of our revenues and reflect our strong expertise in these areas. In addition, we participate in several growth markets including the consumer, industrial, automotive, and medical industries where we can leverage our core strengths and earn increased margins.

 

Uncompromising Quality

 

Our goal is to provide our customers with high-quality, defect-free, and competitive products and on-time solutions. We have received many service and quality awards from internationally recognized quality organizations and customers, including IndustryWeek, Cisco Systems, Asyst Technologies, NCR and Sun Microsystems. In addition, substantially all of our manufacturing facilities are certified under ISO international quality standards for design, manufacturing and distribution management systems. The Solectron Production System^tm effectively applies Lean and Six Sigma quality operating principles and quality tools to identify and concentrate on value-added activities that improve time-to-market and quality for our customers. We implemented Lean Six Sigma standards in order to deliver exceptional quality improvements in all of Solectron’s operations. We operate under increasingly higher standards of quality as dictated by our customers.

 

Efficiency and Cost Competitiveness

 

We believe that a fundamental requirement for sustained growth and profitability in the Electronics Manufacturing Services (EMS) industry is to be an efficient and cost-competitive manufacturer. Therefore, we strive for efficiency throughout our organization, and have implemented several initiatives to reduce costs and increase our competitiveness. This includes implementation of Lean manufacturing and Six Sigma quality methods in our operations and throughout the company. By applying these methods, we intend to increase efficiencies and eliminate activities that do not add value, resulting in a significant competitive advantage.

 

Align Services to Improve Customer Supply Chains

 

With technologies becoming more complex and product life cycles times getting shorter, we expect that OEMs will outsource more of their electronics supply chain needs. OEMs will be looking for a trusted partner that provides these services on a seamless basis. Consequently, we are aligning our services to improve OEM supply chains and deliver lower costs, higher quality, improved flexibility and faster time-to-market. We believe these actions will position us to be the provider of choice to OEMs by delivering integrated supply chains that add value to their businesses.

 

Advanced Technology Processes

 

We offer customers access to advanced technology processes, including design, NPI and repair expertise. Our involvement with customers’ products during the early design stages can help reduce cost and product time-to-market, improve manufacturability and quality and enable a fast ramp to volume manufacturing. We use our design capabilities to partner with our customers. We have developed common tools for industrial, electrical, mechanical and manufacturing applications designed to shorten the design cycle and maintain cost effectiveness. Our repair expertise also spans a wide range of products and advanced technologies, from the system to the component level.

Global Footprint

 

Our footprint — or facilities location — strategy is to locate specific services and capabilities where we believe they can generate the greatest value at the lowest total cost. These decisions are made based on low-cost manufacturing options, proximity to our customers and prospective customers, proximity to end markets and end-users, and the location of specific resources needed to deliver value.

 

The majority of our manufacturing capabilities are found in low-cost locations, such as Mexico, Hungary, Romania, China, Malaysia and other parts of Asia. This reflects our belief that OEM customers will be driven by the cost advantages associated with these locations. We have announced a fiscal 2007 Restructuring Plan that will increase the utilization of our manufacturing capabilities in low-cost locations.

 

We identify other locations for services and other non-manufacturing capabilities based on how best to add value and the availability of the necessary personnel with the skills and experience we need to create solutions and deliver world-class services. For example, we have regional design centers in the Americas, Europe and Asia. This enables us to draw from a highly skilled labor market, with the infrastructure and proximity to immediately interact with customers at critical phases of the new product life cycle.

 

For certain of our post-manufacturing services, we operate repair and warranty centers based on proximity to transportation infrastructure and proximity to end-users. Solectron’s Global Services offerings help customers control costs by optimizing services and supply chains while improving turns throughout the product lifecycle.

 

Our ability to serve our customers effectively also depends upon our materials management and logistic capabilities. Our locations are served by a materials organization consisting of multiple groups across multiple locations and backed by information technology. The materials group is responsible for ordering, tracking and ensuring that the correct parts are delivered to the correct locations on a just-in-time basis to meet our customers’ needs.

 

Americas Region

 

Our U.S. facilities focus on higher value-added activities, such as design services; NPI; system integration and testing; product fulfillment; repair and logistics; and the manufacture of lower-volume, highly complex products. Our facilities in Latin America and South America support the North and Latin American markets, particularly for higher volume products. Mexico’s proximity to North America is useful for production where low-cost, time-to-market, or geographic diversity are particular concerns for OEMs. We operate facilities that provide design, manufacturing, and post-manufacturing services in the U.S., Canada, Mexico, Puerto Rico and Brazil.

 

Asia Region

 

Our operations in the Asia region offer high and low-volume and basic and high-complexity manufacturing to many geographic markets around the world. In addition to manufacturing, our facilities in Asia provide design services; NPI; system integration and testing; product fulfillment; repair and logistics.

 

Europe Region

 

Our locations in western Europe concentrate on higher value-added services, such as design; NPI; high-complexity, low-volume manufacturing; system integration and testing; product fulfillment; logistics and repair. Our eastern European locations provide lower-cost, higher-volume electronics manufacturing services for the western European markets.

 

Sales and Marketing

 

Sales and marketing are integrated processes involving direct salespersons, project managers and senior executives. Our sales and account management resources are organized in market segment teams. We direct our sales resources and activities at several management and staff levels within customer and prospective customer companies. We also use independent sales representatives in certain geographic areas. We receive customer inquiries resulting from referrals, advertising and public relations activities and through our direct sales efforts.

After evaluating these opportunities using our customer identification criteria, potential customer leads are assigned to direct salespersons or independent sales representatives, as appropriate.

 

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for customer sales information.

 

Backlog

 

Our OEM customers typically do not provide us firm purchase orders for delivery of products more than 30 to 90 days in advance. In addition, these customers may reschedule or cancel firm orders with only minor penalty. Therefore, we do not believe that the backlog of expected product sales covered by firm purchase orders is a meaningful determinant of future sales or current activity.

 

Competition

 

The EMS industry includes many companies, several of which have substantial market share. We also face competition from current and prospective customers that evaluate our capabilities against the merits of manufacturing products internally. Other EMS companies compete with us depending on the type of service or geographic area customers require. The basis of competition in our targeted markets is proven execution, reliability, superior manufacturing technology, price, flexibility, continuity of supply, quality, responsiveness, innovative and value-adding services and ability to serve global customers.

 

Associates

 

As of August 31, 2006, we employed approximately 59,000 associates worldwide, which included approximately 14,500 temporary associates.

 

Patents and Trademarks

 

We hold certain United States and foreign patents and patent licenses relating to certain of the processes and equipment used in our manufacturing technology, as well as certain of the products which we have designed and manufactured. In addition, we have registered trademarks (service marks) in the United States and various other countries throughout the world.

 

Although we do not believe that our trademarks, manufacturing processes, patents or license rights to which we have access infringe on the intellectual property rights of others, we cannot ensure that third parties will not assert infringement claims against us in the future. If such an assertion were to be made, it may become necessary or useful for us to enter into licensing arrangements or to resolve such an issue through litigation. However, we cannot ensure that such license rights would be available to us on commercially acceptable terms or that any such litigation would be resolved favorably. Any litigation could be lengthy and costly and, regardless of its outcome, could materially harm our consolidated financial condition.

 

Environmental Matters

 

We are required to comply with local, state, federal and international environmental laws and regulations relating to the treatment, storage, use, discharge, emission and disposal of hazardous materials used in our manufacturing and service processes. We are also required to comply with laws and regulations relating to occupational safety and health, product disposal and product content and labeling. In general, we are not directly responsible for compliance with laws like Waste Electrical and Electronic Equipment (WEEE) and Restriction of Hazardous Substances (RoHS). However, some customers may require that we take responsibility for the non-compliance risk of some or all of the components we procure for the customer product. Solectron requires all of its suppliers to comply with all hazardous substance laws and regulations and employs inventory management processes to mitigate non-compliance risk. Failing to have the capability of delivering products which comply with these present and future environmental laws and regulations could restrict our ability to expand facilities, or could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations, and could impair our relations with customers. Moreover, to the extent we are found non-compliant

with any environmental laws and regulations applicable to our activities, we may incur substantial fines and penalties. We are committed to maintaining compliance in all of our facilities and to continuously improving our environmental practices.

 

We are also required to obtain and maintain environmental permits for many of our facilities. These permits, which must be renewed periodically, are subject to revocation if we violate environmental laws. There can be no assurance that violations will not occur as a result of equipment failure, human error or other causes. If a violation of environmental laws occurs, we could be held liable for damages, fines and costs of remedial actions, and our permits could be revoked. Any such revocation could require us to cease or limit production at one or more of our facilities, and may adversely impact our results of operations.

 

We have been, and in the future may be, held liable for remediation of sites where our hazardous materials (or those of companies we have acquired or divested) have been disposed. We have environmental insurance in excess of reserves previously established to reduce potential environmental liability exposures posed by some of our current and former operations and facilities. To date, these liabilities have not been substantial or material to our business, consolidated financial condition and results of operations. We believe, based on our current knowledge, that the cost of any groundwater or soil clean-up that may be required at any of our facilities would not materially harm our business, consolidated financial condition and results of operations. However, it is costly to remediate contamination, and there can be no assurance that any future remediation costs would not harm our business, consolidated financial condition and results of operations.

 

Additional Information and NYSE Certification

 

Our Internet address is http://www.solectron.com. We posted on our Internet website, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Also, available on our website are printable versions of Solectron’s Corporate Governance Guidelines, Audit Committee charter, Executive Compensation and Resource Management Committee charter, Nominating and Governance Committee charter, and Code of Business Conduct and Ethics Guide. Information accessible through our website does not constitute a part of, and is not incorporated into, this annual report on Form 10-K or into any of our other filings with the Securities and Exchange Commission. Stockholders may request free copies of these documents from:

Solectron Corporation

847 Gibraltar Drive

Milpitas, CA 95035

Attention: Investor Relations

Telephone: (408) 957-8500

 

Solectron was first incorporated in California in August 1977 and was reincorporated in Delaware in February 1997. Our principal executive offices are at 847 Gibraltar Drive, Milpitas, California, 95035. Our main telephone number is (408) 957-8500.

 

On March 9, 2006, the Company submitted to the New York Stock Exchange (NYSE) the Annual CEO Certification required by Section 303A.12(a) of the NYSE Listed Company Manual, whereby the CEO of the Company, Mr. Cannon, certified without qualification that he is not aware of any violation by Solectron of the NYSE’s corporate governance listing standards as of the date of the certification.

 

The following risk factors should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that our management currently deems immaterial also may impair our business operations. If any of the risks described below were to occur, our business, operating results and consolidated financial condition could be materially adversely affected.

Most of our sales come from a small number of customers; if we lose any of these customers, our net sales could decline significantly.

 

Most of our annual sales come from a small number of our customers. Our ten largest customers accounted for approximately 61.4%, 61.6%, and 59.8% of net sales from continuing operations in fiscal years 2006, 2005, and 2004 respectively. One of these customers individually accounted for more than ten percent of our sales in each of fiscal years 2006, 2005 and 2004. Any material delay, cancellation or reduction of orders from these or other major customers could cause our sales to decline significantly, and we may not be able to reduce the accompanying expenses at the same time. We cannot guarantee that we will be able to retain any of our largest customers or any other accounts, or that we will be able to realize the expected revenues under existing or anticipated supply agreements with these customers. Our earnings per share, cash flow and results of operations will continue to depend significantly on our ability to obtain orders from new customers, retain existing customers, realize expected revenues under existing and anticipated agreements, as well as on the consolidated financial condition and success of our customers and their customers.

 

Our customers may cancel their orders, change production quantities or locations, or delay production.

 

To remain competitive, EMS companies must provide their customers increasingly rapid product turnaround, at increasingly competitive prices. We generally do not have long-term contractual commitments from our top customers. As a result, we cannot guarantee that we will continue to receive any orders or revenues from our customers. Customers may cancel orders at their sole discretion, change production quantities or delay production for a number of reasons outside of our control. Many of our customers have experienced from time to time significant decreases in demand for their products and services, as well as continual material price competition and sales price erosion. This volatility has resulted, and will continue from time to time to result, in our customers delaying purchases on the products we manufacture for them, and placing purchase orders for lower volumes of products than previously anticipated. Cancellations, reductions or delays by a significant customer or by a group of customers would seriously harm our results of operations by lowering, eliminating or deferring revenue without substantial offsetting reductions in our costs thereby reducing our profitability. In addition, customers may require that manufacturing of their products be transitioned from one of our facilities to another of our facilities to achieve cost reductions and other objectives. Such transfers, if unanticipated or not properly executed, could result in various inefficiencies and increased costs, including excess capacity and overhead at one facility and capacity constraints and related strains on our resources at the other, disruption and delays in product deliveries and sales, deterioration in product quality and customer satisfaction, and increased manufacturing and scrap costs all of which would have the effect of reducing our profits.

 

Our business has low operating margins and any increase in cost of sales or operating expenses could have a material adverse effect on our profitability.

 

Our business generates low operating margins. Increases in cost of sales or operating expenses without corresponding increases in net sales would have a material adverse effect on the profitability of the Company on a consolidated basis.

 

We may not be able to sell excess or obsolete inventory to customers or third parties, which could have a material adverse impact on our consolidated financial condition.

 

The majority of our inventory purchases and commitments are based upon demand forecasts that our customers provide to us. The customers’ forecasts, and any changes to the forecasts, including cancellations, may lead to on-hand inventory quantities and on-order purchase commitments that are in excess of the customers’ revised needs, or on-hand inventory that becomes obsolete. If our contracts with customers do not require our customers to purchase, or our customers do not comply with contractual obligations to purchase, excess or obsolete inventory, our results of operations could be materially harmed. In recent years some of our OEM customers have experienced declining revenue, large losses, negative cash flows, and bankruptcies or defaults on borrowing arrangements. There is a risk that, in the future, these or other customers may not purchase inventory back from us despite contractual obligations, which could harm our results of operations. In addition, enforcement of these supply agreements may result in material expenses, delays in payment for inventory or disruptions in our customer relationships.

In addition, we are generally responsible for excess and obsolete inventory resulting from inventory purchases in excess of inventory needed to meet customer demand forecasts at the time the purchase commitments were made, as well as any inventory purchases outside those provided for in our agreements. For inventory which is not the customer’s responsibility, provisions are made when required to reduce any such excess or obsolete inventory to its estimated net realizable value, based on the quantity of such inventory on hand, our customers’ latest forecasts of production requirements, and our assessment of available disposition alternatives such as use of components on other programs, the ability and cost to return components to the vendor, and our estimates of resale values and opportunities. These assessments are based upon various assumptions and market conditions which are subject to rapid change, or which may ultimately prove to be inaccurate. Any material changes in our assumptions or market conditions could have a significant effect on our estimates of net realizable value, could necessitate material changes in our provisions for excess and obsolete inventory, and could have a material adverse impact on our consolidated financial condition. In addition, in the normal course of business, bona fide disagreements may arise over the amount or timing of such claims, and in order to avoid litigation expenses, collection risks, or disruption of customer relationships, we may elect to settle such disputes for lesser amounts than we believe we should be entitled to recover. In these instances, we must bear the economic loss of any such excess or obsolete inventory, which could have a material adverse impact on our consolidated financial condition.

 

We are exposed to risks associated with operating internationally.

 

Approximately 69.0%, 70.1% and 72.3% of our net sales from continuing operations during fiscal years 2006, 2005, and 2004, respectively, are the result of services delivered and products manufactured in countries outside the United States. As a result of our foreign sales and facilities, our operations are subject to a variety of risks and costs that are unique to international operations, including the following:

 

 

We have been granted tax holidays, which are effective through 2012 and 2011, respectively, subject to some conditions, for our Malaysian and Singapore sites. It is possible that the current tax holidays will be terminated or modified or that future tax holidays that we may seek will not be granted. If the current tax holidays are terminated or modified, or if additional tax holidays are not granted in the future or when our current tax holidays expire, our future effective income tax rate could increase.

Possible fluctuation of operating results from quarter to quarter and factors out of our control could affect the market price of our securities.

 

Our quarterly earnings or stock price may fluctuate in the future due to a number of factors including the following:

 

 

If our operating results in the future are below the expectations of securities analysts and investors, the market price of our outstanding securities could be harmed.

 

If we incur more restructuring-related charges than currently anticipated, our consolidated financial condition and results of operations may suffer.

 

We incurred approximately $14.0 million of restructuring and impairment costs relating to continuing operations in fiscal 2006 and approximately $91.1 million during fiscal 2005, and we anticipate incurring approximately $50 to $60 million of restructuring and impairment costs in the next 12 months under the Fiscal 2007 Restructuring Plan. If our estimates about previous and currently contemplated restructuring charges prove to be incorrect, our consolidated financial condition and results of operations may suffer. While we believe our

capacity is appropriate for current revenue levels, we continue to evaluate our cost structure relative to future financial results and customer demand. If our estimates about future financial results and customer demand prove to be incorrect, our consolidated financial condition and consolidated results of operations may suffer.

 

Failure to attract and retain key personnel and skilled associates could hurt our operations.

 

Our continued success depends to a large extent upon the efforts and abilities of key managerial and technical associates. Losing the services of key personnel could harm us. Our business also depends upon our ability to continue to attract and retain key executives, senior managers and skilled associates. Our failure to attract and retain key personnel and a high rate of turnover could harm our business.

 

We depend on limited or sole source suppliers for critical components. The inability to obtain sufficient components as required, and under favorable purchase terms, would harm our business.

 

We are dependent on certain suppliers, including limited and sole source suppliers, to provide key components used in our products. We have experienced, and may continue to experience, delays in component deliveries, which in turn could cause delays in product shipments and require the redesign of certain products. In addition, if we are unable to procure necessary components under favorable purchase terms, including at favorable prices and with the order lead-times needed for the efficient and profitable operation of our factories, our results of operations could suffer. The electronics industry has experienced in the past, and may experience in the future, shortages in semiconductor devices, including application-specific integrated circuits, DRAM, SRAM, flash memory, certain passive devices such as tantalum capacitors, and other commodities that may be caused by such conditions as overall market demand surges or supplier production capacity constraints. The inability to continue to obtain sufficient components as and when required, or to develop alternative sources as and when required, could cause delays, disruptions or reductions in product shipments or require product redesigns which could damage relationships with current or prospective customers, and increase inventory levels and costs, thereby causing harm to our business.

 

We potentially bear the risk of price increases associated with shortages in electronics components.

 

At various times, there have been shortages of components in the electronics industry leading to increased component prices. One of the services that we perform for many customers is purchasing electronics components used in the manufacturing of the customers’ products. As a result of this service, we potentially bear the risk of price increases for these components if we are unable to purchase components at the pricing level anticipated to support the margins assumed in our agreements with our customers.

 

Our net sales could decline if our competitors provide comparable manufacturing services and improved products at a lower cost.

 

We compete with a number of different contract manufacturers, depending on the type of service we provide or the geographic locale of our operations. Our industry is intensely competitive and many of our competitors may have greater manufacturing, financial, R&D or marketing resources than we have. In order to compete, we may have to provide our manufacturing and other services at lower margins, or we may lose customers. In addition, we may not be able to offer prices as low as some of our competitors because those competitors may have lower cost structures as a result of their geographic location or the services they provide, or because such competitors are willing to accept business at lower margins in order to utilize more of their excess capacity. In that event, our net sales would decline. We also expect our competitors to continue to improve the performance of their current products or services, to reduce their current products or service sales prices and to introduce new products or services that may offer greater value-added performance and improved pricing. If we are unable to improve our capabilities substantially, any of these could cause a decline in sales, loss of market acceptance of our products or services and corresponding loss of market share, or profit margin compression. We have experienced instances in which customers have transferred all or certain portions of their business to competitors in response to more attractive pricing quotations than we have been willing to offer to retain such customers, and there can be no assurance that we will not lose business in the future in response to such competitive pricing or other inducements which may be offered by our competitors.

We depend on the continuing trend of OEMs to outsource.

 

A substantial factor in our past revenue growth was attributable to the transfer of manufacturing and supply-based management activities from our OEM customers. Future growth is partially dependent on new outsourcing opportunities. To the extent that these opportunities are not available, our future growth would be unfavorably impacted.

 

Our strategic relationships with major customers create risks.

 

In the past several years, we completed several strategic transactions with OEM customers. Under these arrangements, we generally acquired inventory, equipment and other assets from the OEM, and leased (or in some cases acquired) their manufacturing facilities, while simultaneously entering into multi-year supply agreements for the production of their products. There has been strong competition among EMS companies for these transactions, and this competition may continue to be a factor in customers’ selection of their EMS providers. These transactions contributed to a significant portion of our past revenue growth, as well as to a significant portion of our more recent restructuring charges and goodwill and intangible asset impairments. While we do not anticipate our acquisitions of OEM plants and equipment in the near future to return to the levels at which they occurred in the recent past, there may be occasions on which we determine it to be advantageous to complete acquisitions in selected geographic or industry markets. As part of such arrangements, we would typically enter into supply agreements with the divesting OEMs, but such agreements generally do not require any minimum volumes of purchases by the OEM and the actual volume of purchases may be less than anticipated. Arrangements which may be entered into with divesting OEMs typically would involve many risks, including the following:

 

 

As a result of these and other risks, we may be unable to achieve anticipated levels of profitability under such arrangements and they may not result in material revenues or contribute positively to our earnings. Additionally, other OEMs may not wish to obtain logistics or operations management services from us.

 

Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.

 

Our worldwide operations could be subject to natural disasters and other business disruptions, which could seriously harm our revenue and financial condition and increase our costs and expenses. We are predominantly self-insured for losses and interruptions caused by earthquakes, power shortages, telecommunications failures, water shortages, tsunamis, floods, typhoons, hurricanes, fires, extreme weather conditions and other natural or manmade disasters.

 

If we are unable to manage future acquisitions, and cost-effectively run our operations, our profitability could be adversely affected.

 

Our ability to manage and integrate future acquisitions will require successful integration of such acquisitions into our manufacturing and logistics infrastructure, and may require enhancements or upgrades of accounting and other internal management systems and the implementation of a variety of procedures and controls. We cannot

guarantee that significant problems in these areas will not occur. Any failure to enhance or expand these systems and implement such procedures and controls in an efficient manner and at a pace consistent with our business activities could harm our consolidated financial condition and results of operations. In addition, we may experience inefficiencies from the management of geographically dispersed facilities and incur substantial infrastructure and working capital costs. We incurred approximately $14.0 million of restructuring and impairment costs relating to continuing operations in fiscal 2006 and approximately $91.1 million during fiscal 2005. See also the Risk Factor entitled “If we incur more restructuring-related charges than currently anticipated, our consolidated financial condition and results of operations may suffer.”

 

If we have a material weakness in our internal controls over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our securities.

 

One or more material weaknesses in our internal controls over financial reporting could occur or be identified in the future. In addition, because of inherent limitations, our internal controls over financial reporting may not prevent or detect misstatements, and any projections of any evaluation of effectiveness of internal controls to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with our policies or procedures may deteriorate. If we fail to maintain the adequacy of our internal controls, including any failure or difficulty in implementing required new or improved controls, our business and results of operations could be harmed, we may not be able to provide reasonable assurance as to our financial results or meet our reporting obligations and there could be a material adverse effect on the price of our securities.

 

If our products are subject to warranty or liability claims, we may incur significant costs.

 

Our customers may experience defects in our designs or deficiencies with respect to our manufacturing services. We may be exposed to warranty or manufacturers’ liability claims as a result of these defects or deficiencies, and some claims may relate to customer product recalls. A claim for damages arising as a result of such defects or deficiencies could have a material adverse effect on our business, results of operations and financial condition. A claim for such damages, or a product recall conducted by one of our customers, also could have an adverse effect on our business reputation.

 

In addition, as we increase our engagements with customers in the medical device and automotive industries, we may have greater exposure to product and personal injury liability claims, as well as to liabilities relating to product recalls. Any claim, regardless of merit, may be time-consuming and expensive to resolve, and a successful claim could have a material adverse effect on our results of operations and financial condition.

 

We may not have sufficient insurance coverage for certain of the risks and liabilities we assume in connection with the products and services we provide to our customers.

 

We carry various forms of business and liability insurance that we believe are typical for companies in our industry. However, we may not have sufficient insurance coverage for certain risks and liabilities we assume in connection with the products and services we provide to our customers, such as potential warranty, product liability and product recall claims. Such liability claims may only be partially covered under our insurance policies. We continue to monitor the insurance marketplace to evaluate the need to obtain additional insurance coverage in the future. Costs associated with potential claims and liabilities for which we do not have sufficient insurance coverage could have a material adverse effect on our results of operations, financial condition and liquidity.

 

Our design and engineering services may result in additional exposure to product liability, intellectual property infringement and other claims.

 

We are offering more design services, primarily those relating to products that we manufacture for our customers, and we offer design services related to collaborative design manufacturing and turnkey solutions. Providing such services can expose us to different or greater potential liabilities than those we face when providing our regular manufacturing services. With the growth of our design services business, we have increased exposure to potential product liability claims resulting from injuries caused by defects in products we design, as well as

potential claims that products we design infringe third-party intellectual property rights. Such claims could subject us to significant liability for damages and, regardless of their merits, could be time-consuming and expensive to resolve. We also may have greater potential exposure from warranty claims, and from product recalls due to problems caused by product design. Costs associated with possible product liability claims, intellectual property infringement claims, and product recalls could have a material adverse effect on our results of operations.

 

Notwithstanding our divestiture of certain businesses in recent years, we remain subject to certain indemnification obligations for a period of time after completion of the divestitures.

 

The sale agreements for the businesses we divested in recent years contain indemnification provisions pursuant to which we may be required to indemnify the buyer of the divested business for liabilities, losses, or expenses arising out of breaches of covenants and certain breaches of representations and warranties relating to the condition of the business prior to and at the time of sale. While we believe, based upon the facts presently known to us, that we have made adequate provision for any such potential indemnification obligations, it is possible that other facts may become known in the future which may subject us to claims for additional liabilities or expenses beyond those presently anticipated and provided for. Should any such unexpected liabilities or expenses be of a material amount, our finances could be adversely affected.

 

We are exposed to fluctuations in foreign currency exchange rates and interest rate fluctuations.

 

We have currency exposure arising from both sales and purchases denominated in currencies other than the functional currency of our sites. Fluctuations in the rate of exchange between the currency of the exposure and the functional currency of our sites could seriously harm our business, operating results and consolidated financial condition.

 

As of August 31, 2006, we had outstanding foreign exchange forward contracts with a total notional amount of approximately $293.2 million related to continuing operations. The change in value of the foreign exchange forward contracts resulting from a hypothetical 10% change in foreign exchange rates would be offset by the remeasurement of the related balance sheet items, the result of which would not be significant.

 

The primary objective of our investment activities is to preserve principal, while at the same time maximize yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents in a variety of securities, including government and corporate obligations, certificates of deposit and money market funds. As of August 31, 2006, substantially our entire portfolio was scheduled to mature in less than three months. A hypothetical 10% change in interest rates would not have a material effect on the fair value of our investment portfolios.

 

Failure to comply with environmental regulations could harm our business.

 

As a company in the electronics manufacturing services industry, we are subject to a variety of environmental regulations, including those relating to the use, storage, discharge and disposal of hazardous chemicals used during our manufacturing process as well as air quality and water quality regulations, restrictions on water use, and storm water regulations. We are also required to comply with laws and regulations relating to occupational safety and health, product disposal and product content and labeling. Although we have never sustained any significant loss as a result of non-compliance with such regulations, any failure by us to comply with environmental laws and regulations could result in liabilities or the suspension of production. In addition, these laws and regulations could restrict our ability to expand our facilities or require us to acquire costly equipment or incur other significant costs to comply with regulations.

 

We own and lease some contaminated sites (for some of which we have been indemnified by third parties for required remediation), sites for which there is a risk of the presence of contamination, and sites with some levels of contamination for which we may be liable and which may or may not ultimately require any remediation. We have obtained environmental insurance to reduce potential environmental liability exposures posed by some of our operations and facilities. We believe, based on our current knowledge, that the cost of any groundwater or soil clean up that may be required at our facilities would not materially harm our business, consolidated financial condition and results of operations. Nevertheless, the process of remediating contamination in soil and groundwater at facilities is costly and cannot be estimated with high levels of confidence, and there can be no assurance that the

costs of such activities would not harm our business, consolidated financial condition and results of operations in the future.

 

In general, we are not directly responsible for compliance with laws like Waste Electrical and Electronic Equipment (WEEE) and Restrictions of Hazardous Substances (RoHS). However, some customers may require that we take responsibility for the non-compliance risk of some or all of the components we procure for the customer product. Solectron requires all of its suppliers to comply with all hazardous substance laws and regulations and employs inventory management processes to mitigate non-compliance risk. Failure to have the capability of delivering the products which comply with these present and future environmental laws and regulations could restrict our ability to expand facilities, or could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations, and could impair our relations with our customers. Moreover, to the extent we are found non-compliant with any environmental laws and regulations applicable to our activities, we may incur substantial fines and penalties.

 

Our ongoing implementation of new enterprise resource planning (ERP) software and systems may cause disruptions in our business operations.

 

The ongoing implementation of new ERP software and systems at various Solectron sites domestically and internationally is a technically intensive process, requiring extensive testing, modifications, customization and project coordination. We may experience disruptions in our business operations from time to time relating to these implementation efforts or as a result of complications with the software or systems, and such disruptions may have a material adverse effect on our business, consolidated financial condition and results of operations.

 

We may not be able to adequately protect or enforce our intellectual property rights and could become involved in intellectual property disputes.

 

In the past we have been and may from time to time continue to be notified of claims that we may be infringing patents, copyrights or other intellectual property rights owned by other parties. In the event of an infringement claim, we may be required to spend a significant amount of money to develop a non-infringing alternative, to obtain licenses, or to defend against the claim. We may not be successful in developing such an alternative or obtaining a license on reasonable terms, if at all. Any litigation, even where an infringement claim is without merit, could result in substantial costs and diversion of resources. Accordingly, the resolution or adjudication of intellectual property disputes could have a material adverse effect on our business, consolidated financial condition and results of operations.

 

Our ability to effectively compete may be affected by our ability to protect our proprietary information. We hold a number of patents, patent applications, and various trade secrets and license rights. These patents, trade secrets, and license rights may not provide meaningful protection for our proprietary manufacturing processes, equipment innovations and products, or we might find it necessary to initiate litigation proceedings to protect our intellectual property rights. Any such litigation could be lengthy and costly and could harm our consolidated financial condition.

 

Rating downgrades may make it more expensive for us to borrow money.

 

Our senior unsecured debt has been rated as “B+” with a positive outlook by Standard and Poors and as “B1” with stable outlook by Moody’s. These credit ratings are subject to change at the discretion of the rating agencies. If our credit ratings were downgraded, it would increase our cost of capital should we borrow under our revolving lines of credit, and it may make it more expensive for us to raise additional capital in the future. Such capital raising may be on terms that may not be acceptable to us or otherwise not available. Any future adverse rating agency actions with respect to our ratings could have an adverse effect on the market price of our securities, our ability to compete for new business, our cost of capital, and our ability to access capital markets.

 

Unanticipated changes in our tax rates or in our exposure to additional tax liabilities could affect our operating results and financial condition.

 

We are subject to income taxes both in the United States and various foreign jurisdictions. Our effective tax rates could be adversely affected by changes in tax laws and increases in the percentages of our earnings from

countries with higher tax rates, as well as other factors. If any of these changes were to occur, our income tax provision, operating results and financial condition could be adversely affected.

 

We have received an examination report from the Internal Revenue Service proposing a tax deficiency in certain of our tax returns, and the outcome may have a material adverse effect on our results of operations and cash flows.

 

The Internal Revenue Service (“IRS”) and other tax authorities regularly examine our income tax returns. In the quarter ended May 31, 2006, the IRS completed its field examination of the Company’s federal income tax returns for fiscal years 2001 and 2002 and issued a Revenue Agent’s Report (“RAR”). The RAR is not a final Statutory Notice of Deficiency, and we filed a protest during the quarter ended August 25, 2006 to protest certain of the proposed adjustments with the Appeals Office of the IRS. The most significant of the disputed adjustments relates to transfer pricing arrangements that the Company has with its foreign subsidiaries. We believe that the proposed IRS adjustments are inconsistent with applicable tax laws, and that the Company has meritorious defenses to the proposed adjustments.

 

In determining the adequacy of our provision for income taxes, we regularly assess the likelihood of adverse outcomes resulting from tax examinations, including the IRS RAR for the fiscal years 2001 and 2002. Based upon that assessment, Solectron may establish contingency reserves for income taxes in various jurisdictions. The estimate of appropriate tax reserves is based upon the amount of prior tax benefit that might be at risk upon audit and the reasonable estimate of the amount at risk. However, the ultimate outcome of the tax examination process is always uncertain, including the total amount payable or the timing of any such payments upon resolution of these issues. In addition, we cannot assure you that such amount will not be materially different than that which is reflected in our historical income tax provisions and accruals. Should the IRS or other tax authorities assess additional taxes as a result of a current or future examinations, we may be required to record charges to operations in future periods that could have a material impact on the results of operations, financial position or cash flows in the applicable period or periods recorded.

 

None.

 

The table below lists our facilities leased or owned as of August 31, 2006:

 

 

 

 

Solectron is from time to time involved in various litigation and legal matters arising in the normal course of its business operations. Management believes that the final resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, cash flows, or results of operations. By describing any particular matter, Solectron does not intend to imply that it or its legal advisors have concluded or believe that the outcome of any of those particular matters is or is not likely to have a material adverse impact upon Solectron’s consolidated financial position, cash flows or results of operations.

 

Solectron has settled the previously reported shareholder class action lawsuit entitled Abrams v. Solectron Corporation et al., Case No. C-03-0986 CRB, filed in the United States District Court for the Northern District of California, on terms not considered to be material to Solectron. Court approval of the settlement terms was obtained on March 3, 2006.

 

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

Executive Officers of Solectron

 

Our executive officers and their ages as of August 31, 2006 are as follows:

 

 

Mr. Cannon joined Solectron in January 2003 as president and CEO and as a director on the company’s board of directors and has more than 25 years of manufacturing and technology experience. Prior to joining Solectron, Mr. Cannon was president, CEO and a director of Maxtor Corporation, a leading global provider of hard-disk drives and storage systems. Previously, Mr. Cannon was with IBM’s Storage Systems Division, where he held several senior leadership positions, including vice president of the Personal Storage Systems Division, vice president of product design and vice president of worldwide manufacturing. Prior to IBM, Mr. Cannon worked at several companies in the disk-drive industry, including Control Data Corporation’s Imprimis Technology spin-off. Mr. Cannon began his career at The Boeing Company, where he held engineering and management positions in the Manufacturing Research and Development Group. Mr. Cannon studied mechanical engineering at Michigan State University and completed the Advanced Management Program at Harvard Business School.

 

Mr. Britt joined Solectron in 2000 with extensive experience in supply chain and sales management. As executive vice president, sales and account management, Mr. Britt leads Solectron’s worldwide sales organization in growing business globally, building customer relationships and overseeing the company’s account-related activities. Prior to this role, he was senior vice president of corporate accounts and, prior to that position, vice president of supply chain operations. Mr. Britt came to Solectron from Future Electronics Corporation, where he was the regional vice president for the company’s northern California division. Previously, Mr. Britt held management positions with Sterling Electronics and Passive Technology Sales, Inc. Mr. Britt studied international business at the University of London, and holds a bachelor’s degree in business administration from California State University, Chico.

 

Mr. DuChene joined Solectron in 2005 with more than 17 years of legal experience. As executive vice president, general counsel and secretary, Mr. DuChene is responsible for all Solectron legal, regulatory and governmental affairs. Prior to Solectron, from 1996 to March 2005, he served as an executive officer of Fisher Scientific International Inc., manufacturer and distributor of scientific research, healthcare and safety products, most recently as senior vice president, corporate development, chief legal officer and secretary. Prior to that, Mr. DuChene was senior vice president, general counsel and secretary of OfficeMax, Inc., a retailer. Previously, Mr. DuChene was a lawyer with the national law firm of Baker & Hostetler, in the firm’s Cleveland office. Mr. DuChene holds a bachelor’s degree in political science from the College of Wooster and a J.D. from the University of Michigan Law School.

 

Mr. London joined Solectron in 2002 with nearly 30 years of sales, marketing and engineering management experience in the electronics industry. As executive vice president of Solectron Global Services, Mr. London is

responsible for this business unit that offers repair, logistics, parts management, remarketing and field based services. Previously, Mr. London was executive vice president and president of Solectron’s Technology Solutions business unit. Mr. London came to Solectron from Safeguard Scientifics, Inc., a diversified information technology company that identifies, develops and operates emerging technologies, where he served as an executive officer and managing director, Technology Product companies. Previously, he was president and chief executive officer of Diva Communications, Inc., a wireless communications equipment manufacturer. Mr. London also held executive management positions in sales, service and operations in the United States and Asia during his eight years with Nortel Networks. He also held various management positions at Rockwell International Telecommunications, Electronic Systems Associates, Pacific Telephone and AT&T. Mr. London holds a master’s degree in business administration from Pepperdine University and a bachelor’s degree in physics from the University of California, Berkeley.

 

Mr. Neese joined Solectron in 2004 with more than 15 years of sales, account management and operational leadership experience in the electronic manufacturing services industry. As executive vice president of Operations, Mr. Neese is responsible for worldwide global manufacturing, materials management and new product introduction. Prior to this role, Mr. Neese was Solectron’s executive vice president of Program Management and Supply Chain Solutions. Mr. Neese came to Solectron from Sanmina-SCI, where he served as vice president of Worldwide Sales Operations. He was responsible for all customer-relationship activities, including sales, margins, quotations/proposals and customer retention. Prior to that position, Mr. Neese led Sanmina-SCI’s program management activities. Mr. Neese arrived at Sanmina-SCI by way of Jabil Circuit, Inc., where he served as an SMT line production manager and director of Business Development. Previously, Mr. Neese served in the U.S. Army as a battery commander and battalion supply and logistics officer. Mr. Neese holds a master’s degree in business administration from the University of Florida and a bachelor’s degree in quantitative business systems from the U.S. Military Academy at West Point.

 

Mr. O’Connor joined Solectron in 2002 and has more than 25 years of experience in human resources. As executive vice president, and chief administrative officer, he is responsible for Solectron’s corporate human resources program and infrastructure to support the needs of the corporation and its business units, corporate communications and corporate security. Before joining Solectron, Mr. O’Connor served as senior vice president, human resources for Axcelis Technologies. Prior to Axcelis, Mr. O’Connor served as vice president, global human resources for Iomega Corporation. Before Iomega, he held a variety of senior human resources roles for Dell Computer, Frito-Lay (a division of PepsiCo) and Sperry Flight Systems. Mr. O’Connor holds a degree in management with an emphasis in industrial relations from Arizona State University.

 

Mr. Purvis joined Solectron in 2003 and has more than 30 years of experience in engineering and technology management. As executive vice president and chief technical officer, Mr. Purvis is responsible for Solectron’s product design and engineering, Solectron’s Enclosures business and Solectron’s Quality function. Prior to Solectron, Mr. Purvis served as chief technology officer with John Deere, where he led the engineering, information technology and corporate quality functions for the agricultural and forestry equipment manufacturer. Previously, Mr. Purvis spent more than 16 years with Allied Signal/Honeywell in a variety of senior design and engineering roles in the aerospace and automotive industries, including vice president of engineering for Honeywell’s Aerospace Electronics Systems Business. Mr. Purvis also has experience with electronics in the industrial, medical and analytical industries through several management and technology related positions with Monsanto, Fermi National Accelerator Laboratory, Packard Instruments and Allstate Insurance Company. Mr. Purvis holds a bachelor’s degree in applied mathematics from the University of Illinois.

 

Mr. Tufano joined Solectron in January 2006 with more than 25 years of extensive financial and management experience. As chief financial officer, Mr. Tufano leads our finance and investor relations and information technology activities. Prior to Solectron, Mr. Tufano served in several executive leadership roles at Maxtor Corporation, including chief executive officer, chief operating officer and chief financial officer from 1996 to 2004. From 1979 to 1996, Mr. Tufano held a variety of management positions at International Business Machines Corporation (IBM). He served as manager of worldwide logistics for IBM’s storage systems division, manager of plans and controls for IBM’s desktop and mobile storage products business unit, and controller for IBM’s San Jose, California facility. Mr. Tufano also serves on the board of Teradyne, a leading supplier of automatic test equipment.

Mr. Tufano holds a bachelor’s degree in economics from St. John’s University and a master of business degree from Columbia University.

 

Mr. Hayes joined Solectron in 1999 with extensive financial and management experience in the technology and banking industries. As senior vice president, investor relations and treasurer, Mr. Hayes is responsible for financing and capital market activities, as well as corporate liquidity and risk management. He also manages Solectron’s interaction with investors, institutional shareholders, financial analysts and credit rating agencies. Prior to Solectron, Mr. Hayes held senior treasury positions with Dell Computer and AirTouch Communications, Inc. He also has more than 10 years of international finance and banking experience as a vice president with Bank of America, working out of that company’s San Francisco, London and New York locations. Mr. Hayes holds a master’s degree in international business from the University of South Carolina.

 

Mr. Ligan joined Solectron in 2000 with more than 20 years of extensive financial and management experience. As senior vice president and chief accounting officer, Mr. Ligan is responsible for corporate accounting; tax; external reporting; and the company’s financial shared services. Prior to this role, Mr. Ligan served as vice president, global taxation, managing Solectron’s global tax position. Mr. Ligan came to Solectron from Chiquita Brands International, where as senior vice president and chief financial officer he oversaw all corporate financial functions, as well as purchasing and IT. Before Chiquita, Mr. Ligan held a variety of financial and tax management positions with the Monsanto Company and its subsidiary G.D. Searle & Co., The Upjohn Company, Coopers & Lybrand, and Football News Co. He began his career in the corporate accounting department of Chrysler Corporation. Mr. Ligan holds a bachelor’s degree in business administration from the Walsh College of Accountancy & Business Administration, and a law degree from the Detroit College of Law. He also holds a master’s of law degree in taxation from DePaul University.

 

There is no family relationship among any of the executive officers.

 

Common Stock Information

 

The following table sets forth the quarterly high and low per share sales prices of our common stock for the fiscal periods reported, as quoted on the New York Stock Exchange under the symbol “SLR.”

 

 

We have not paid any cash dividends since our inception and do not intend to pay any cash dividends in the foreseeable future. Covenants contained in our debt financing agreements allow the payment of cash dividends, subject to certain conditions. As of October 31, 2006, there were 6,709 stockholders of record based on data obtained from our transfer agent.

Issuer Purchases of Equity Securities

 

On November 1, 2005, Solectron’s Board of Directors approved a stock repurchase program whereby the Company is authorized to repurchase up to $250 million of the Company’s common stock pursuant to a 10b5-1 trading plan. Solectron commenced this $250 million repurchase program at the end of the quarter ended February 28, 2006. During the fourth fiscal quarter of 2006, Solectron repurchased 7.9 million shares of its common stock at an average price of $3.20 per share for approximately $25.2 million.

 

The following table summarizes the company’s repurchases of its common stock during the quarter ended August 31, 2006 (in millions, except for per share price):

 

 

As of August 31, 2006, Solectron had committed to repurchase an additional 0.4 million shares for approximately $1.2 million, which settled subsequent to August 31, 2006.

 

The following selected historical financial information of Solectron has been derived from the historical consolidated financial statements and should be read in conjunction with the consolidated financial statements and the notes included therein. For further discussion of factors that could affect comparability of these consolidated financial statements, see the notes following the table.

 

Consolidated Statement of Operations Data (in millions, except per share data)

 

Consolidated Balance Sheet Data (in millions)*:

 

 

 

 

 

The following discussion should be read in conjunction with our consolidated financial statements and the notes related to those consolidated financial statements contained in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Form 10-K.

 

Overview

 

We provide a full range of global electronics manufacturing and supply-chain management services to the world’s leading technology, automotive, industrial and medical device firms.

 

Sales to a relatively small number of customers historically have made up a significant portion of our net sales and we expect that trend to continue in the future. Sales to our ten largest customers accounted for 61.4%, 61.6%, and 59.8%, for fiscal 2006, 2005, and 2004, respectively. Currently, our largest customer, Cisco Systems, accounted for 10% or more of our net sales for fiscal 2006, 2005 and 2004. Also, Nortel Networks accounted for 10% or more of our net sales for fiscal 2005.

Summary of Results

 

The following table sets forth, for the three year periods indicated, certain key operating results and other financial information (in millions):

 

 

Net sales for fiscal 2006 increased 1.1% to $10.6 billion compared to $10.4 billion for fiscal 2005. The increase in net sales in fiscal 2006 when compared to fiscal 2005 is primarily due to a $124.2 million or 5.5% increase in computing and storage end market revenues resulting from an increase in consumer demand for computer servers. In addition, primarily attributable to an increase in sales of semiconductor manufacturing equipment, industrial sales revenue increased by $299.1 million or 48.4% when compared to the corresponding period in fiscal 2005. Revenue from the networking market increased by $147.2 million or 5.6% during fiscal 2006 when compared to the corresponding period in fiscal 2005. Partially offsetting these revenue increases for the year was a decrease in the consumer end market of $399.2 million or 27.9% largely due to a drop in cellular handset sales. Net sales for fiscal 2005 decreased 10.3% to $10.4 billion compared to $11.6 billion for fiscal 2004.

 

Net sales for fiscal 2005 decreased 10.3% to $10.4 billion compared to $11.6 billion for fiscal 2004. The decrease was in most end-markets, with the exception of the networking and automotive end-markets, which increased 3.8% and 9.9% respectively. Specific decreases include a 36.2% decrease in sales of consumer products; a 9.8% decrease in sales of computing and storage; a 5.5% decrease in sales of communication products; and a 2.5% decrease in industrial products. When comparing fiscal 2005 to fiscal 2004, the consumer end-market decreased by $0.8 billion which was primarily driven by a significant drop in demand for 3G cellular handsets and set-top boxes. In addition, set-top box businesses were adversely impacted due to existing products reaching end-of-life and newer model programs not yet ramping sufficiently to replace the revenue decline. The computing end-market decreased by $0.3 billion, primarily as a result of the disengagement from certain low-margin programs. The communication market decreased by $0.1 billion primarily as a result of seasonality and product transfers

 

Our gross profit percentages were 5.2%, 5.5%, and 4.9% for fiscal 2006, 2005 and 2004, respectively. The decrease in gross profit percentage from 5.5% in fiscal 2005 to 5.2% in fiscal 2006 was primarily due to zero margin component sales, an increase in freight costs, compensation expense from the adoption of SFAS 123R and an increase in ramp costs resulting from the acquisition of new business. Offsetting these costs were gross profit improvements resulting from the execution of our Lean Six Sigma manufacturing initiative (“Lean Initiative”), and increased discipline in the implementation of our quote process. The Lean Initiative has continued to give us improved flexibility, quality, and operational effectiveness and efficiency. The Lean Initiative encompasses identifying value more effectively. In general, the Lean Initiative in our manufacturing environment seeks to provide customers with what they require by using human effort, equipment, time and space more efficiently.

 

Selling, general and administrative (SG&A) expense (including research and development costs) increased in fiscal 2006 when compared to fiscal 2005 and decreased when compared to fiscal 2004. SG&A expense was 4.1%, 4.0%, and 3.8% as a percentage of net sales for fiscal 2006, 2005, and 2004, respectively. In absolute dollars, SG&A has decreased as a result of our cost reduction initiatives, restructuring activities and divestures.

 

Interest income increased in fiscal 2006 due to higher interest rates.

 

We have made significant progress in reducing our interest expense during the year ended August 31, 2006 and August 31, 2005 as a result of redemptions and settlements of our debt. In fiscal 2006, we settled all of the $150.0 million aggregate principal amount outstanding of our 7.375% unsubordinated notes. In fiscal 2005, we completed the redemption of all of the $500 million aggregate principal amount outstanding of our 9.625% senior

notes. In fiscal 2004, we completed the early settlement of approximately 94% of our outstanding ACES and the cash settlement of $950.0 million of our outstanding LYONs^tm(. Our debt to capital ratio was 23% and 22% at the end of fiscal 2006 and fiscal 2005, respectively. The debt-to-capital ratio is calculated as total debt divided by total debt plus total shareholders’ equity. Our short-term and current portion of long-term debt at August 31, 2006 is $89.5 million and our remaining long-term debt is $619.4 million.

 

Key Performance Indicators

 

Management regularly reviews the following financial performance indicators to assess the Company’s operating results. The following table sets forth, for the quarterly periods indicated, certain of management’s key financial performance indicators.

 

 

 

Inventory turns is calculated as the ratio of cost of sales compared to the average inventory for the quarter. The degradation in inventory turns during fiscal 2006 was primarily the result of the acquisition of inventory related to new program wins. DSO is calculated as the ratio of average accounts receivable, net, for the quarter compared to daily net sales for the quarter. DPO is calculated as the ratio of average accounts payable during the quarter compared to daily cost of sales for the quarter. The C2C cycle is determined by taking the ratio of 360 days compared to inventory turns plus DSO minus DPO. In fiscal 2006, total C2C has remained largely flat, however, the component make-up has changed since the fourth quarter of fiscal 2005. During fiscal 2006, inventory turns and DPO have deteriorated while DSO has improved. Capital expenditures are primarily related to equipment purchases supporting increased demand in certain products, new programs and information technology projects.

 

Critical Accounting Policies and Estimates

 

Management is required to make judgments, assumptions and estimates that affect the amounts reported when we prepare consolidated financial statements and related disclosures in conformity with generally accepted accounting principles in the United States. Note 1, “Summary of Significant Accounting Policies,” to the consolidated financial statements in this Annual Report on Form 10-K describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. Estimates are used for, but not limited to, our accounting for revenue recognition, inventory valuation, allowance for doubtful accounts, goodwill, intangible assets, restructuring and related impairment costs, income taxes, loss contingencies and stock-based compensation. Actual results could differ from these estimates. The following critical accounting policies are

 

 

(     ^(tm) Trademark of Merrill Lynch & Co. Inc.

impacted significantly by judgments, assumptions and estimates used in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

Solectron principally generates revenues from the manufacture of products for customers, the repair of both in-warranty and out-of-warranty products, and the provision of supply chain services. The Company also derives revenues from sales of certain inventory, including raw materials, to customers who reschedule, amend or cancel purchase orders after we have procured inventory to fulfill their purchase orders. The Company recognizes manufacturing revenue, net of estimated product return costs, generally, upon shipment of goods to customers and in certain cases when the goods are received by its customer, title and risk of ownership have passed, the price to the buyer is fixed or determinable and recoverability is reasonably assured. Generally, there are no formal customer acceptance requirements related to manufacturing services. If such requirements or obligations exist, then the Company recognizes revenues at the time when such requirements are completed and the obligations are fulfilled. The Company recognizes service revenue when the services have been performed, and the related costs are expensed as incurred.

 

We record reductions to revenue for customer incentive programs in accordance with the provisions of Emerging Issues Task Force (EITF) Issue No. 01-09, “Accounting for Consideration Given from a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” Such incentive programs include premium payments and rebates. Premium payments are up-front payments to customers at program inception, made as a part of a competitive bidding arrangement, and sometimes in lieu of acquiring manufacturing assets and workforce from the customer. Premium payments are recognized either up-front or over time based on the terms of the customer agreement. In order to recognize a premium over time, the customer agreement must clearly state that we are entitled to a refund of the premium payment from the customer, either pro rata or otherwise, if certain production levels are not achieved. Where such contractual recovery provisions exist, we believe that a probable future economic benefit exists and, thus, establish an asset, which is amortized against revenue as product or service delivery occurs under the contract. When the contractual recovery provisions do not exist, we record the premium payment as an immediate up-front reduction of revenues. For those incentives that require the estimation of future sales, such as for rebates, we use historical experience and internal and customer data to estimate the sales incentive at the time revenue is recognized. In the event that the actual results of these items differ from the estimates, adjustments to the sales incentive accruals are recorded. To date, these adjustments have not been material.

 

From time-to-time, Solectron includes an extended warranty at the time of product shipment. The revenue associated with the extended warranty is deferred and recognized over the extended warranty period.

 

Certain customer arrangements require evaluation of the criteria outlined in EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal Versus Net as an Agent,” in determining whether it is appropriate to record the gross amount of sales and related costs or the net amount earned as commissions. Generally, when Solectron is primarily obligated in a transaction, is subject to general and physical inventory risk, has latitude in establishing prices, has discretion in selecting suppliers, changes the product or performs the service, is involved in the determination of product or service specifications, and has credit risk, or has several but not all of these indicators, revenue is recorded gross. If several of these indicators are not present, Solectron generally records the net amounts as commissions earned. For example, in a situation where a customer retains ownership of the materials utilized in their products, Solectron would generally only recognize revenue on a net basis.

 

Inventory Valuation

 

Our inventories are stated at the lower of weighted average cost or market. Our industry is characterized by rapid technological change, short-term customer commitments and rapid changes in demand, as well as other factors that may influence the recoverability of inventories. We make provisions for estimated excess and obsolete inventory based on our regular reviews of inventory quantities on hand and the latest forecasts of product demand and production requirements from our customers. Our provisions for excess and obsolete inventory are also impacted by our contractual arrangements with our customers including our ability or inability to re-sell such inventory to them. If actual market conditions or our customers’ product demands are less favorable than those

projected or if our customers are unwilling or unable to comply with any contractual arrangements related to excess and obsolete inventory, additional provisions may be required. If an additional 0.2% to 0.5% of our inventory were determined to be excess and obsolete at August 31, 2006, our fiscal 2006 gross profit and operating income from continuing operations before income taxes would have each decreased by $3.0 million to $7.6 million.

 

Allowance for Doubtful Accounts

 

Another area of judgment affecting reported revenue and net income is management’s estimate of receivables that will ultimately be collected. We evaluate the collectibility of our accounts receivable based on a combination of factors. This risk is mitigated by (i) sales to well-established companies, (ii) ongoing credit evaluation of our customers, and (iii) frequent contact with our customers, especially our most significant customers, which enables us to monitor current changes in business operations and to respond accordingly. When we are aware of circumstances that may impair a specific customer’s ability to meet its financial obligations to us, we record a specific allowance against amounts due to us and thereby reduce the net receivable to the amount we reasonably believe is likely to be collected. For all other customers, we recognize allowances for doubtful accounts based on the length of time the receivables are outstanding, industry and geographic concentrations, the current business environment and our historical experience. If the financial condition of our customers deteriorates or if economic conditions worsen, additional allowances may be required. Using this information, management reserves an amount that is believed to be uncollectible. Based on management’s analysis of uncollectible accounts, reserves totaling $14.5 million or 1.0% of the gross accounts receivable balance were established at August 31, 2006, compared with $22.3 million or 1.9% of the gross accounts receivable balance at August 31, 2005.

 

Goodwill

 

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we review the carrying amount of goodwill for impairment on an annual basis during the fourth quarter (as of June 1). Additionally, we perform an impairment assessment of goodwill whenever events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. Significant changes in circumstances can be both internal to our strategic and financial direction, as well as changes to the competitive and economic landscape. We have determined that there is a single reporting unit for the purpose of goodwill impairment tests under SFAS No. 142. For purposes of assessing the impairment of our goodwill, we estimate the value of the reporting unit using our market capitalization as the best evidence of fair value. This fair value is then compared to the carrying value of the reporting unit. If the fair value of the reporting unit is less than its carrying value, we then allocate the fair value of the unit to all the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit’s fair value was the purchase price to acquire the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of the goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The process of evaluating the potential impairment of goodwill is subjective and requires judgment at many points during the test including future revenue forecasts, discount rates and various reporting unit allocations.

 

Impairment of Long-Lived Assets

 

Solectron evaluates long-lived assets, such as property, plant and equipment and intangible assets obtained in acquisitions such as supply agreements, intellectual property, and contractual — non-contractual customer relationships for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). When conducting our impairment analysis, assets are grouped at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets or liabilities. Intangible assets subject to impairment testing whenever events or changes in circumstances indicate total $16.3 million as of August 31, 2006. We assess the fair value of the assets based on the undiscounted future cash flow the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When we identify an

impairment, we reduce the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach, or, when available and appropriate, to comparable market values. There is significant judgment involved in determining these cash flows.

 

Restructuring and Related Impairment Costs

 

Over the past few years, we have recorded restructuring and impairment costs as we rationalized our operations in light of customer demand declines and the economic downturn. These measures, which included reducing the workforce, consolidating facilities and changing the strategic focus of a number of sites, were largely intended to align our capacity and infrastructure to anticipated customer demand and transition our operations to lower cost regions. These restructuring measures were undertaken in accordance with restructuring plans that were reasonable, probable and unlikely of significant change at the time of plan establishment. These restructuring and impairment costs include employee severance and benefit costs, costs related to leased facilities abandoned and subleased, impairment of owned facilities no longer used by us which will be disposed, costs related to leased equipment that has been abandoned, and impairment of owned equipment that will be disposed. For owned facilities and equipment, the impairment loss recognized was based on the fair value less costs to sell, with fair value estimated based on existing market prices for similar assets.

 

Severance and benefit costs have been recorded in accordance with SFAS No. 112, “Employer’s Accounting for Postemployment Benefits,” as we concluded that we had a substantive severance plan based on past restructuring actions in many of the geographies in which we operate. These costs are recognized when Solectron management has committed to a formal restructuring plan and the severance costs are probable and estimable. We apply the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” relating to one-time termination benefits to both (1) severance activities in geographies where we do not have a substantive severance plan and (2) situations in which the severance benefits offered to employees within a given geography are in excess of those offered under prior restructuring plans. Severance costs accounted for under SFAS No. 146 are recognized when Solectron management having the appropriate authorization has committed to a restructuring plan and communicated those actions to employees. Our estimate of severance and benefit costs assumptions are subjective as they are based on estimates of employee attrition and assumptions about future business opportunities.

 

In accordance with SFAS No. 146, the estimated lease loss accrued for leased facilities abandoned and subleased after December 31, 2002 represents the fair value of the lease liability as measured by the present value of future lease payments subsequent to abandonment less the present value of any estimated sublease income. For those facilities abandoned and subleased before January 1, 2003, as part of restructuring activities under EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity”, the estimated lease loss represents payments subsequent to abandonment less any estimated sublease income. In order to estimate future sublease income, we work with real estate brokers to estimate the length of time until we can sublease a facility and the amount of rent we can expect to receive. Estimates of expected sublease income could change based on factors that affect our ability to sublease those facilities such as general economic conditions and the real estate market, among others.

 

Other exit costs include costs to consolidate facilities or close facilities and relocate employees. A liability for such costs is recorded at its fair value in the period in which the liability is incurred.

 

At each reporting date, we evaluate our accruals for exit costs and employee separation costs to ensure the accruals are still appropriate. In certain circumstances, accruals are no longer required because of efficiencies in carrying out the plans or because employees previously identified for separation resigned and did not receive severance or were redeployed due to circumstances not foreseen when the original plans were initiated. If necessary, we reverse accruals through the income statement line item entitled “restructuring and impairment costs”, where the original charges were recorded, when it is determined that they are no longer required.

 

Income Taxes

 

We currently have significant deferred tax assets in certain jurisdictions resulting from tax credit carry forwards, net operating losses and other deductible temporary differences, which will reduce taxable income in such jurisdictions in future periods. We have provided valuation allowances for future tax benefits resulting from U.S. and

certain foreign net operating loss carry forwards and for certain other U.S. and foreign deductible temporary differences where we believe future realizability is in doubt. SFAS No. 109 requires a valuation allowance be established when it is “more likely than not” that all or a portion of deferred tax assets will not be realized, and further provides that it is difficult to conclude that a valuation allowance is not needed when there is negative evidence in the form of cumulative losses in recent years. Therefore, cumulative losses weigh heavily in the overall assessment. In the third quarter of fiscal year 2003, we established a valuation allowance for most of our deferred tax assets. This was primarily due to cumulative losses from prior years and uncertainty regarding our ability to generate certain minimum levels of taxable income within the next three years. We have not yet established a sustained level of profitability since that time in those countries in which the deferred tax assets arose and thus expect to record a full valuation allowance on future tax benefits. Our ability to realize sustained profitability in those jurisdictions in the near term is uncertain as Solectron derives the majority of its revenue from low-cost locations. It is these low-cost locations where Solectron anticipates reporting taxable profits. Solectron will not be able to offset any tax expense associated with these taxable profits with the unrecognized deferred tax assets described above. As a result of our assessment, our total valuation allowance on deferred tax assets arising from continuing operations is approximately $1.6 billion at August 31, 2006.

 

We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide income tax provision and evaluating tax positions. There are many transactions and calculations where the ultimate tax determination is uncertain and we are regularly under audit by tax authorities. Accordingly, we have established contingency reserves for income taxes in various jurisdictions in accordance with SFAS No. 5 “Accounting for Contingencies”.

 

We believe that our accruals for tax liabilities are adequate for all open years, based on our assessment of many factors, including past experience and interpretations of tax law applied to the facts of each matter. Although we believe that our accruals for tax liabilities are reasonable, tax regulations are subject to interpretation and the tax controversy process is inherently uncertain; therefore, our assessments can involve both a series of complex judgments about future events and rely heavily on estimates and assumptions. To the extent that the probable tax outcome of these matters changes, such changes in estimates will impact the income tax provision in the period in which such determination is made.

 

In the quarter ended May 31, 2006, the IRS completed its field examination of the Company’s federal income tax returns for fiscal years 2001 and 2002 and issued a Revenue Agent’s Report (“RAR”). The RAR is not a final Statutory Notice of Deficiency, and we filed a protest during the quarter ended August 25, 2006 to protest certain of the proposed adjustments with the Appeals Office of the IRS. The most significant of the disputed adjustments relates to transfer pricing arrangements that the Company has with its foreign subsidiaries. We believe that the proposed IRS adjustments are inconsistent with applicable tax laws, and that the Company has meritorious defenses to the proposed adjustments.

 

Loss Contingencies

 

We are subject to the possibility of various loss contingencies arising in the ordinary course of business (for example, environmental and legal matters). We consider the likelihood of the loss occurring and our ability to reasonably estimate the amount of loss in determining the necessity for, and amount of, any loss contingencies. Estimated loss contingencies are accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate information available to us to determine whether any such accruals should be adjusted. Such revisions in the estimates of the potential loss contingencies could have a material impact on our consolidated results of operations and financial position.

 

Stock-Based Compensation

 

Beginning in fiscal 2006, we account for stock-based compensation in accordance with SFAS No. 123R (revised 2004), “Share-Based Payment” (“SFAS 123R”) as interpreted by SEC Staff Accounting Bulletin No. 107. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair

value of share-based awards at the grant date requires judgment, including estimating our stock price volatility, employee stock option exercise behaviors and employee option forfeiture rates.

 

Our expected volatility is based upon equal weightings of the historical volatility of Solectron’s stock and, for fiscal periods in which there is sufficient trading volume in options on Solectron’s stock, the implied volatility of traded options on Solectron stock having a life of more than 6 months.

 

The expected life of options is based on observed historical exercise patterns, which can vary over time.

 

As stock-based compensation expense recognized in the Consolidated Statement of Operations is based on awards ultimately expected to vest, the amount of expense has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience.

 

If factors change and we employ different assumptions in the application of SFAS 123R, the compensation expense that we record in future periods may differ significantly from what we have recorded in the current period.

 

Recent Accounting Pronouncements

 

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 48, “Accounting for Income Tax Uncertainties” (“FIN 48”). FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. The recently issued literature also provides guidance on the derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 also includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. FIN 48 is effective for fiscal years beginning after December 15, 2006. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption will be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. The Company is currently in the process of determining the impact, if any, of adopting the provisions of FIN 48 on its financial position, results of operations and cash flows.

 

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, (“SAB 108”). The interpretations in SAB 108 are being issued to address diversity in practice in quantifying financial statement misstatements and the potential under current practice for the build up of improper amounts on the balance sheet. SAB 108 is effective for the first interim period of the first fiscal year ending after November 15, 2006 and must be adopted by the fourth quarter of that fiscal year. Solectron has not yet completed its analysis, however, the Company estimates that the expected net reduction to opening retained earnings will be approximately $10.0 million as a result of adopting SAB 108. The Company is continuing to evaluate the impact of adopting SAB 108 and, as a result, the actual reduction to the opening retained earnings balance could be different than the $10.0 million estimate.

 

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 replaces the different definitions of fair value in the accounting literature with a single definition. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 is effective for fair-value measurements already required or permitted by other standards for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently in the process of determining the impact, if any, of adopting the provisions of SFAS 157 on its financial position, results of operations and cash flows.

Results of Operations for Fiscal Years 2006, 2005 and 2004

 

The following table summarizes certain items in the consolidated statements of operations as a percentage of net sales. The financial information and the discussion below should be read in conjunction with the accompanying consolidated financial statements and notes thereto. The discussion following the table is provided separately for continuing and discontinued operations. In fiscal 2004, certain operations we planned to divest qualified for discontinued operations classification. Accordingly, our consolidated statements of operations include these results in discontinued operations for all periods presented. Information related to the discontinued operations results is provided separately following the continuing operations discussion.

 

 

Net Sales — Continuing Operations

 

Net sales for fiscal 2006 increased 1.1% to $10.6 billion compared to $10.4 billion for fiscal 2005. The increase in net sales in fiscal 2006 when compared to fiscal 2005 is primarily due to a $124.2 million or 5.5% increase in computing and storage end market revenues resulting from an increase in consumer demand for computer servers. In addition, primarily attributable to an increase in sales of semiconductor manufacturing equipment and industrial sales, revenue increased by $299.1 million or 48.4% when compared to the corresponding period in fiscal 2005. Revenue from the networking market increased by $147.2 million or 5.6% during fiscal 2006 when compared to the corresponding period in fiscal 2005. Partially offsetting the revenue increase for the year was a decrease in the consumer end market of $399.2 million or 27.9% largely due to a drop in cellular handset sales.

 

Net sales for fiscal 2005 decreased 10.3% to $10.4 billion compared to $11.6 billion for fiscal 2004. The decrease was in most end-markets, with the exception of the networking and automotive end-markets, which increased 3.8% and 9.9% respectively. Specific decreases include a 36.2% decrease in sales of consumer products; a 9.8% decrease in sales of computing and storage; a 5.5% decrease in sales of communication products; and a 2.5% decrease in industrial products. When comparing fiscal 2005 to fiscal 2004, the consumer end-market decreased by $0.8 billion which was primarily driven by a significant drop in demand for 3G cellular handsets and set-top boxes. In addition, set-top box businesses were adversely impacted due to existing products reaching end-of-life and newer

model programs not yet ramping sufficiently to replace the revenue decline. The computing end-market decreased by $0.3 billion, primarily as a result of the disengagement from certain low-margin programs. The communication market decreased by $0.1 billion primarily as a result of seasonality and product transfers.

 

The following table depicts, for the periods indicated, revenue by market expressed as a percentage of net sales. The distribution of revenue across our markets has fluctuated, and will continue to fluctuate, as a result of numerous factors, including but not limited to: increased business from new and existing customers; fluctuations in customer demand; seasonality of our customers’ markets; and growth in market outsourcing.

 

 

International Sales

 

International locations contributed 69.0% of consolidated net sales in fiscal 2006, compared with 70.1% in fiscal 2005 and 72.3% in fiscal 2004.

 

The following table indicates geographic net sales that are attributable to the country in which the product is manufactured (in millions):

 

 

Major Customers

 

Net sales to major customers as a percentage of net sales were as follows:

 

 

 

 

Our top ten customers accounted for 61.4% of net sales in fiscal 2006, 61.6% of net sales in fiscal 2005 and 59.8% of net sales in fiscal 2004. We cannot guarantee that these or any other customers will not increase or

decrease as a percentage of our consolidated net sales either individually or as a group. Consequently, any material decrease in sales to these or other customers could materially harm our consolidated results of operations.

 

We believe our ability to grow depends on increasing sales to existing customers and on successfully attracting new customers. Customer contracts can be canceled and volume levels can be changed or delayed by our customers. The timely replacement of delayed, canceled or reduced orders with new business cannot be assured. In addition, we cannot assume that any of our current customers will continue to utilize our services. Consequently, our consolidated results of operations may be materially adversely affected.

 

Cisco Systems launched its Lean initiative as part of its ongoing effort to improve accuracy of demand forecasting and planning in its supply chain. Cisco Systems is in the midst of a phased implementation of the Cisco Systems Lean initiative amongst its manufacturing partners, with the Solectron transition currently scheduled to begin during fiscal 2007. In the initial stages of this implementation, Solectron expects inventory to increase by approximately $200 million.

 

Gross Profit — Continuing Operations

 

Gross profit varies from period to period and is affected by a number of factors, including product mix, production efficiencies, component costs and delivery linearity, product life cycles, unit volumes, expansion and consolidation of manufacturing facilities, utilization of manufacturing capacity, pricing, competition, and unanticipated inventory charges. Over time, gross profit may continue to fluctuate.

 

Our gross profit percentages were 5.2%, 5.5%, and 4.9% for fiscal 2006, 2005 and 2004, respectively. The decrease in gross profit percentage from 5.5% in fiscal 2005 to 5.2% in fiscal 2006 was primarily due to zero margin component sales, an increase in freight costs, compensation expense from the adoption of SFAS 123R and an increase in ramp costs resulting from the acquisition of new business. Offsetting these costs were gross profit improvements resulting from the execution of our Lean Initiative, and increased discipline in the implementation of our quote process. The Lean Initiative has continued to give us improved flexibility, quality, and operational effectiveness and efficiency. The Lean Initiative encompasses identifying value more effectively. In general, the Lean Initiative in our manufacturing environment seeks to provide customers with what they require by using human effort, equipment, time and space more efficiently. We continue to drive a number of initiatives to improve our gross profit: (1) improving flexibility, quality, and operational effectiveness and efficiency; (2) improving capacity utilization; (3) ensuring contractual relationships reflect the value provided by our operations; (4) a disciplined pricing model; (5) engaging with our customers in collaborative design; and (6) profitability-based sales force compensation.

 

Fiscal 2005 gross profit improved to 5.5% compared to 4.9% for fiscal 2004. The improvement in gross profit was primarily the result of the execution of our Lean Initiative and increased discipline in the implementation of our quote process.

 

Selling, General and Administrative (SG&A) Expenses — Continuing Operations

 

SG&A expenses increased $20.5 million, or 5.0%, for fiscal 2006 when compared to fiscal 2005. SG&A expenses decreased $33.9 million, or 7.6%, for fiscal 2005 compared to fiscal 2004. As a percentage of net sales, SG&A expenses increased to 4.1% in fiscal 2006 from 4.0% in fiscal 2005, and increased from 3.8% in fiscal 2004.

 

The increase in SG&A expenses in fiscal 2006 over fiscal 2005 was attributable to approximately $9.6 million in new SG&A expenses due to the adoption of SFAS 123R, plus approximately $14.1 million arising from additional headcount in the sales and account management and program management areas, and $5.2 million in non-restructuring related severance expenses. These increases were partially offset by lower R&D spending of $5.8 million, and reduced insurance expenses of $2.2 million. When comparing fiscal 2005 to fiscal 2004, the overall dollar decrease in SG&A expense was due to headcount and SG&A expense reduction resulting from the full realization of our cost reduction initiatives, our restructuring initiatives that began in fiscal year 2003 and reductions in bad debt expense, offset by costs for Sarbanes-Oxley compliance.

Restructuring and Impairment Costs — Continuing Operations

 

In recent years, we have initiated a series of restructuring measures, including reducing our workforce and consolidating facilities, that were intended to align our capacity and infrastructure to anticipated customer demand and transition our operations to lower cost regions. This has enhanced our ability to provide cost-effective manufacturing service offerings, which enables us to retain and expand our existing relationships with customers and attract new business.

 

We have recognized restructuring and impairment costs of $14.0 million, $91.1 million and $177.9 million during fiscal 2006, 2005 and 2004, respectively.

 

The $14.0 million of restructuring and impairment charges for fiscal year 2006 consists of $12.9 million of fixed asset impairment charges, $1.9 million of impairment charges related to intangible assets, and $10.0 million of facility and other exit costs. These impairment charges were offset by a $10.8 million reduction to the severance provision from earlier restructuring activities due to new business opportunities resulting in changes to planned severance actions, differences between actual and estimated payment obligations and employee turnover.

 

The $91.1 million of restructuring and impairment charges for fiscal year 2005 is comprised of $55.2 million of restructuring charges, principally arising from the Fiscal Year 2005 Restructuring Plan to consolidate facilities, reduce the workforce in Europe and North America, and impair certain long-lived assets, and $35.9 million of non-cash charges in connection with the sale of a facility in Japan.

 

The $177.9 million of restructuring and impairment charges for fiscal year 2004 includes $130.4 million of restructuring charges and a $47.5 million impairment of an intangible asset arising from our disengagement from certain product lines.

 

Fiscal Year 2007 Restructuring Plan

 

On October 2, 2006, the Solectron Board of Directors approved the Fiscal Year 2007 Restructuring Plan to optimize our global footprint and reduce our cost structure. We anticipate that total charges related to this restructuring plan will be in the range of $50 million to $60 million. The restructuring plan consists of the following measures:

 

 

Total estimated charges consist of (i) $32 million to $39 million related to severance costs, (ii) $10 million to $13 million related to leased facility liabilities and transfer and other exit costs and (iii) an estimated non-cash charge of $8 million related to disposition of facilities and equipment, of which $3.1 million was impaired and recorded at the end of fiscal year 2006. The restructuring plan is expected to be completed within the next twelve months.

 

Currently, Solectron estimates that the Fiscal Year 2007 restructuring plan will realize a savings of approximately $35 million to $40 million annually once fully implemented due to reductions in workforce, facility, lease and depreciation expenses.

 

Fiscal Year 2005 Restructuring Plan

 

During fiscal year 2005, in response to a decline in revenues from fiscal year 2004 levels, we reviewed our cost structure and geographic footprint and determined that cost savings could be realized by moving certain activities from high-cost facilities in Europe and North America to facilities in low cost geographies. During fiscal year 2006, the Company lowered its total anticipated restructuring costs for the 2005 restructuring plan from $80-$95 million to $55-$65 million. The original anticipated costs were based on the occurrence of certain future events. Due to non-

occurrence of some events and changes in business conditions, the Company lowered its total anticipated costs. However, for the restructuring items that were executed, the Company expects cost savings to be in line with the original estimates which were noted below. This restructuring plan as amended will result in restructuring charges of approximately $55 million to $65 million, and includes the following measures:

 

 

Through August 31, 2006, we recorded approximately $57.8 million of restructuring and impairment expense, primarily consisting of severance costs, related to the plan. As of August 31, 2006, we have reduced our workforce by 2,400 personnel in connection with this plan and expect to reduce headcount by an additional 100 personnel prior to the completion of this plan. The remaining accrual balance of $7.1 million is largely related to severance payouts for the additional 100 personnel, of which $5.5 million is expected to be paid by December 31, 2006. This plan is substantially complete as of the end of fiscal 2006.

 

Currently, Solectron estimates that the restructuring plan initiated during fiscal year 2005 is expected to realize a savings of approximately $30 million annually due to reductions in workforce, facility, lease and depreciation expenses. We expect a substantial amount of these savings are and will be used to offset the impact on gross margin by market forces as we consolidate facilities and shift manufacturing and repair services from high cost countries to lower costs countries. These savings predominantly relate to Cost of Sales.

 

Fiscal Year 2004 Restructuring Plan and Legacy Restructuring Plans

 

The Fiscal Year 2004 Restructuring Plan and Legacy Restructuring Plans are substantially complete as of August 31, 2006. However, we expect to incur nominal restructuring charges in the future that will consist of both cash and non-cash charges as we continue to revise previous estimates and sell the restructured long-lived assets. Revisions to estimates, if any, would primarily be due to changes in assumptions used for the facility lease loss accrual. The remaining accrual balances of $2.1 million for the Fiscal Year 2004 Restructuring Plan and $21.1 million for the Legacy Restructuring Plans are primarily related to accruals for facility lease obligations, which are currently leased through 2014.

 

Cash payments scheduled in the next 12 months across the Fiscal Year 2005, Fiscal Year 2004 and Legacy restructuring plans, which have already been accrued for, are expected to be $22.9 million.

 

We continue to evaluate our operations and we may propose selected future restructuring actions as a result of changes in market conditions and footprint alignment with our customers’ production needs.

 

See Note 16, “Restructuring,” to the consolidated financial statements for further discussion of our restructuring activities.

 

We have impaired certain intangible assets. During fiscal year 2006, Solectron recorded a $1.9 million net impairment charge in connection with the termination of a customer relationship for which an intangible asset had previously been established. This net amount consisted of a $2.4 million impairment charge offset by a $0.5 million gain on the sale of equipment to this former customer. As a result of impairment tests performed during fiscal year 2004, we recorded approximately $47.5 million in non-cash impairment charges. For fiscal 2004, the intangible impairment charges were the result of our disengagement from certain businesses.

Interest Income — Continuing Operations

 

Interest income increased $8.2 million to $47.0 million for fiscal 2006 from $38.8 million in fiscal 2005. Interest income increased $23.7 million to $38.8 million in fiscal 2005 from $15.1 million in fiscal 2004. These increases were due to higher average interest rates.

 

Interest Expense — Continuing Operations

 

Interest expense decreased $28.0 million to $28.5 million for fiscal 2006 from $56.5 million in fiscal 2005, and interest expense was $145.3 million in fiscal 2004. The decrease in interest expense during fiscal 2006 was primarily due to the early redemption of our $500 million 9.625% Senior Notes on May 20, 2005. The decrease in interest expense during fiscal 2005 was primarily due to the retirement of approximately $1.6 billion aggregate principal amount of our LYONs^tm and the settlement of approximately 94% of our ACES debentures during fiscal 2004.

 

Other Expense — Net — Continuing Operations

 

Other expense — net for fiscal 2006 was $1.7 million, compared to $45.5 million in fiscal 2005 and $80.6 million in fiscal 2004. In fiscal 2006, other expense-net consisted primarily of foreign currency gains and losses and other miscellaneous income and expense items. In fiscal 2005, other expense — net consisted primarily of a $52.3 million loss related to the early retirement of our 9.625% senior notes. In fiscal 2004, other expense — net consisted primarily of a loss resulting from the early settlement of approximately 94% of our ACES of $77.7 million and a $15.2 million loss resulting from the sale of our minority interest in ECS Holdings Limited.

 

The following tables provide the details of our redemption of our 9.625% senior notes, the early settlement of our 7.25% ACES debentures, the retirement of our 2.75% LYONs^tm due 2020 and the retirement of our 3.25% LYONs^tm due 2020 in each period presented in the accompanying consolidated financial statements (in millions):

 

 

 

See “Basis of Presentation” and “Recent Accounting Pronouncements,” of Note 1, “Summary of Significant Accounting Policies,” to the consolidated financial statements, for further discussion of other (expense) income — net.

 

Income Taxes — Continuing Operations

 

Our income tax benefit was $1.3 million in fiscal 2006. We recorded an income tax expense of $15.7 million in fiscal 2005, and an income tax benefit of $3.3 million in fiscal 2004. The income tax provision for fiscal 2006 included the recognition of benefits of $21.4 million associated with refunds of taxes paid by two foreign subsidiaries on reinvested earnings.

 

Our effective tax rate for fiscal 2006, 2005, and 2004 was (1.1%), 301.9%, and 1.2%, respectively.

 

The effective income tax rate is largely a function of the balance between income and losses from international and domestic operations. Our international operations, taken as a whole, have been subject to tax at a lower rate than operations in the United States, primarily due to tax holidays granted to certain of our overseas sites in Malaysia and Singapore and from benefits resulting from taxes paid on earnings by reinvesting the earnings of two of our international operations. The Malaysian tax holiday is effective through January 2012, and the Singapore tax holiday is effective through March 2011. Both tax holidays are subject to certain conditions, including maintaining levels of research and development expenditures, incremental fixed asset expenditures, or qualifying headcount. It is anticipated that the annual effective tax rate for the foreign subsidiaries will be favorably impacted in future periods as the Company intends to continue to apply for refunds of taxes paid on the reinvested earnings of the foreign subsidiaries.

 

Certain of our offshore operations are reporting taxable profits, mostly arising in low-cost locations. Accordingly, we are recognizing some tax expense related to those operations. We will not be able to offset this tax expense with unrecognized deferred tax assets described above, because, for the most part, those assets did not arise in the jurisdictions where we are realizing taxable profits.

 

In addition, Solectron has established contingency reserves for income taxes in various jurisdictions. The estimate of appropriate tax reserves is based upon the probable amount of prior tax benefit that is at risk upon audit and upon the reasonable estimate of the amount at risk. Solectron periodically reassesses the amount of such reserves and adjusts reserve balances as necessary.

 

In the quarter ended May 31, 2006, the IRS completed its field examination of the Company’s federal income tax returns for fiscal years 2001 and 2002 and issued a Revenue Agent’s Report (“RAR”). The RAR is not a final Statutory Notice of Deficiency, and the Company filed a protest during the quarter ended August 25, 2006 to protest certain of the proposed adjustments with the Appeals Office of the IRS. Although the outcome of the Appeals process is always uncertain, the Company believes that adequate amounts of tax and interest have been provided for any adjustments that are expected to result for these years.

 

Quarterly Results (Unaudited)

 

See Note 23, “Quarterly Consolidated Financial Data (Unaudited)” to the consolidated financial statements which sets forth the unaudited quarterly financial information for the 2006 and 2005 fiscal years. In the opinion of management, this information has been presented on the same basis as the audited consolidated financial statements appearing elsewhere, and all necessary adjustments (consisting of normal recurring adjustments) have been included in the amounts stated below to present fairly the unaudited quarterly results when read in conjunction with the audited consolidated financial statements and related notes thereto. The operating results for any quarter are not necessarily indicative of results for any future period.

Liquidity and Capital Resources

 

Cash, cash equivalents, and short-term investments decreased to approximately $1.2 billion at August 31, 2006 from approximately $1.7 billion at August 31, 2005. The table below, for the periods indicated, provides selected consolidated cash flow information (in millions):

 

 

Net cash used in operating activities of continuing operations was $151.1 million during the fiscal year ended August 31, 2006. This change was generated by a $407.4 million increase in inventories and a $246.3 million increase in accounts receivable. This was partially offset by net income of $133.2 million, non-cash depreciation and amortization charges of $173.5 million, and a $244.2 million increase in accounts payable. The inventory increase was attributable to new program ramps, certain program launch delays and the creation of buffer stock to accommodate both program transfers between sites and the go-live date of a new ERP system at one of our facilities. Net cash used in operating activities of discontinued operations was $8.2 million during the fiscal year ended August 31, 2006 and was primarily attributable to changes in operating assets and liabilities of discontinued operations.

 

Net cash used in investing activities of continuing operations of $186.8 million during the fiscal year ended August 31, 2006 primarily consisted of $196.5 million in capital expenditures offset by cash provided from other activities including proceeds from sale of property and equipment. Net cash provided by investing activities of discontinued operations was $17.1 million during the fiscal year ended August 31, 2006 and was due to proceeds from the sale of MicroTechnology and sales of facilities.

 

Net cash used in financing activities of continuing operations of $222.8 million during the fiscal year ended August 31, 2006 primarily consisted of $230.9 million of share repurchases and $150.0 million of payments made to redeem the 7.375% Senior Notes, partially offset by $147.4 million in net proceeds from the issuance of our 8% senior subordinated notes due 2016. Net cash used in financing activities of discontinued operations was $8.9 million for fiscal 2006.

 

As of August 25, 2006, we had available a $500 million secured revolving credit facility (the “Existing Facility”) that expires on August 20, 2007. The facility amended and restated a previous $250 million secured credit facility. Our Existing Facility is guaranteed by certain of our domestic subsidiaries and secured by the pledge of domestic accounts receivable, inventory and equipment, the pledge of equity interests in certain of our subsidiaries and notes evidencing inter-company debt. Borrowings under the Existing Facility bear interest, at our option, at the London Inter-bank Offered Rate (LIBOR) plus a margin of 2.25% based on our current senior secured debt ratings, or the higher of the Federal Funds Rate plus 1/2 of 1% or Bank of America N.A.’s publicly announced prime rate. As of August 25, 2006, there were no borrowings outstanding under this Existing Facility. We are subject to compliance

with certain financial covenants set forth in these facilities including, but not limited to, capital expenditures, cash interest coverage ratio and leverage ratio. We were in compliance with all applicable covenants as of August 31, 2006.

 

Subsequent to year end, Solectron entered into a $350 million Credit Agreement (“the Credit Agreement”) that amends and replaces the Existing Facility. The Credit Agreement provides for a revolving, multicurrency, secured-credit facility, which may be used to borrow revolving loans or issue standby letters of credit, subject to a $100 million letter of credit sub-limit. The Company may request an increase in the credit facility of up to an additional $150 million, to provide for an aggregate commitment of up to $500 million. There are currently no revolving loans outstanding and approximately $2.3 million in letters of credit outstanding under the Credit Agreement. The revolving loans under the Credit Agreement bear interest, at the Company’s option, at either (i) the base rate, which is defined as a fluctuating rate per annum equal to the greater of (A) Bank of America N.A.’s prime rate, or (B) the average rate on overnight federal funds plus one-half of one percent, or (ii) a rate equal to (A) the London Inter-bank Offered Rate (LIBOR) plus (B) an applicable margin of ranging from 1.0% to 2.0% based on Solectron’s non-credit-enhanced senior unsecured long-term debt ratings. The Credit Agreement matures on August 28, 2009 and may be prepaid at any time without penalty or premium at the option of the Company.

 

The obligations under the Credit Agreement are guaranteed by the Company’s existing and future material domestic subsidiaries, and such obligations, including the guarantees, are secured by: (i) the Company’s and its domestic subsidiaries’ accounts receivable, equipment and inventory, (ii) a pledge of the capital stock of the Company’s material domestic subsidiaries, (iii) a pledge of 65% of the capital stock of the Company’s material first-tier foreign subsidiaries, and (iv) a pledge of certain inter-company indebtedness among the Company and certain of its subsidiaries. In the event that the Company’s non-credit-enhanced senior unsecured long-term debt achieves a rating of BB/Ba3 (stable/stable) or BB-/Ba2 (stable/stable) or higher from Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc., respectively, the liens on the collateral described in clause (i) above will be released. Solectron is subject to compliance with certain financial covenants set forth in this facility including, but not limited to, capital expenditures, cash interest coverage ratio and leverage ratio. Solectron was in compliance with all applicable covenants as of August 31, 2006.

 

In addition, we had no committed foreign lines of credit and $13.3 million in uncommitted foreign lines of credit and other bank facilities as of August 31, 2006. A committed line of credit obligates a lender to loan us amounts under the credit facility as long as we adhere to the terms of the credit agreement. An uncommitted line of credit is extended to us at the sole discretion of a lender. The interest rates range from the bank’s prime lending rate to the bank’s prime rate plus 1.0%. As of August 31, 2006, we had no borrowings under uncommitted foreign lines of credit and $2.4 million of guaranteed amounts under uncommitted foreign lines of credit.

 

$64.3 million aggregate principal amount of our 7.97% ACES debentures is due November 15, 2006.

 

Holders of our 2.75% LYONs^tm due 2020 have the option to require us to repurchase their notes on May 8, 2010 at a price of $761.00 per $1,000 principal amount of each note. Solectron repurchased $1.0 million LYONs^tm for approximately $0.6 million in cash during fiscal 2006.

 

Holders of our 3.25% LYONs^tm due 2020 have the option to require us to repurchase their notes on November 20, 2010 in an amount of $724.42 per $1,000 principal amount of each note. Solectron repurchased $3.3 million LYONS^tm for approximately $2.0 million in cash during fiscal 2006.

 

We have synthetic lease agreements relating to three manufacturing sites for continuing operations. The synthetic leases have expiration dates in September 2007. At the end of the lease terms, we have an option, subject to certain conditions, to purchase or to cause a third party to purchase the facilities subject to the synthetic leases for the “Termination Value,” which approximates the lessor’s original cost for each facility, or we may market the property to a third party at a different price. We are entitled to any proceeds from a sale of the properties to third parties in excess of the Termination Value and liable to the lessor for any shortfall not to exceed 85% of the Termination Value. We have provided loans to the lessor equaling approximately 85% of the Termination Value for each synthetic lease. These loans are repayable solely from the sale of the properties to third parties in the future, are subordinated to the amounts payable to the lessor at the end of the synthetic leases, and may be credited against the

Termination Value payable if we purchase the properties. The approximate aggregate Termination Values and loan amounts were $87.7 million and $74.5 million, respectively, as of August 31, 2006.

 

In addition, cash of $13.2 million, an amount equal to the difference between the aggregate Termination Values and the loan amounts, is pledged as collateral. Each synthetic lease agreement contains various affirmative covenants. A default under a lease, including violation of these covenants, may accelerate the termination date of the arrangement. We were in compliance with all applicable covenants as of August 31, 2006. Monthly lease payments are generally based on the Termination Value and 30-day LIBOR index (5.33% as of August 31, 2006) plus an interest-rate margin, which may vary depending upon our Moody’s Investors’ Services and Standard and Poor’s ratings, and are allocated between the lessor and us based on the proportion of the loan amount to the Termination Value for each synthetic lease.

 

We account for these synthetic lease arrangements as operating leases in accordance with SFAS No. 13, “Accounting for Leases,” as amended. Our loans to the lessor and cash collateral are included in other assets and restricted cash and cash equivalents, respectively, in the consolidated balance sheets.

 

We believe that our current cash, cash equivalents, short-term investments, lines of credit and cash anticipated to be generated from continuing operations will satisfy our expected working capital, capital expenditures, debt service, restructuring and investment requirements through at least the next 12 months.

 

On November 1, 2006, we exercised our purchase option granted under the leases and terminated the synthetic lease agreements. The purchase price was the Termination Value. We have elected to set-off our loans against the purchase price and paid the remaining $13.2 million in cash.

 

Debt, Other Contractual Obligations, and Off Balance Sheet Arrangements

 

The following is a summary of certain contractual obligations and commitments as of August 31, 2006:

 

 

 

 

Other long-term liabilities of $36.3 million as of August 31, 2006 disclosed on the financial statements includes deferred tax liabilities related to timing differences and non-U.S. pension liabilities, which due to their nature are not included in the table above.

 

Our off-balance sheet arrangements consist of our synthetic and operating leases, our foreign exchange contracts (described in the “We are exposed to fluctuations in foreign currency exchange rates and interest rate fluctuations” Risk Factor), and certain indemnification provisions related to our seven divestitures (described in the “Discontinued Operations” portion below).

Stock Repurchase Program

 

On November 1, 2005, Solectron’s Board of Directors approved a stock repurchase program whereby the Company is authorized to repurchase up to $250 million of the Company’s common stock pursuant to a 10b5-1 trading plan. Solectron commenced this $250 million repurchase program at the end of the quarter ended February 28, 2006. Under this program during fiscal year 2006, Solectron repurchased 14.8 million shares of its common stock at an average price of $3.49 for approximately $51.6 million. As of August 31, 2006, Solectron had committed to repurchase an additional 0.4 million shares for approximately $1.2 million, which settled subsequent to August 31, 2006.

 

The purchase price for the shares of our common stock repurchased was reflected as a reduction to shareholders’ equity. In accordance with Accounting Principles Board Opinion No. 6, “Status of Accounting Research Bulletins,” we have allocated the purchase price of the repurchased shares as a reduction to common stock and additional paid-in capital.

 

Discontinued Operations

 

During fiscal 2004, as a result of a full review of our portfolio of businesses, we committed to a plan to divest a number of business operations that are no longer part of our strategic plan for the future. In accordance with SFAS No. 144, we have reported the results of operations and financial position of these businesses in discontinued operations within the consolidated statements of operations and balance sheets for all periods presented. The companies that we have divested and that are included in discontinued operations are: Dy 4 Systems Inc., Kavlico Corporation, Solectron’s MicroTechnology division, SMART Modular Technologies Inc., Stream International Inc., our 63% interest in US Robotics Corporation, and Force Computers, Inc.

 

The collective results from all discontinued operations for all periods presented were as follows (in millions):

 

 

Fiscal 2006

 

During fiscal 2006, Solectron recorded a $4.4 million gain on sale of assets of discontinued operations having no remaining book value and an $11.2 million gain associated with the favorable resolution of certain contingencies.

 

Fiscal 2005

 

Net sales, gross profit, operating (income) expenses — net, interest income — net, other income (expense) — net, and income tax expense from discontinued operations decreased for fiscal year 2005 as compared to fiscal year 2004 due to the fact that the final discontinued operation was sold in the first quarter of fiscal 2005. Furthermore, we recorded $10.1 million pre-tax gain from the sale of the discontinued operation recorded in operating (income) expense — net, in the first quarter of fiscal 2005. As a result of the disposition, we transferred approximately

$28.3 million from accumulated foreign currency translation gains included in accumulated other comprehensive losses within Stockholders Equity and recognized that amount as part of the pre-tax gain.

 

Fiscal 2004

 

During fiscal year 2004, Solectron recorded an aggregate pre-tax gain from the sale of six discontinued operations of $190.6 million in operating (income) expenses — net, and recorded $123.8 million in operating (income) expenses — net in restructuring and impairment costs (including goodwill).

 

The sale agreements for all the divestitures contain certain indemnification provisions pursuant to which Solectron may be required to indemnify the buyer of the divested business for liabilities, losses, or expenses arising out of breaches of covenants and certain breaches of representations and warranties relating to the condition of the business prior to and at the time of sale. In aggregate, Solectron is contingently liable for up to $94.8 million for a period of 12 to 24 months subsequent to the completion of the sale. As of August 31, 2006, most of these indemnification provisions have expired, and there were no significant liabilities recorded under these indemnification obligations. Additionally, Solectron may be required to indemnify a buyer for environmental remediation costs for a period up to 10 years and not to exceed $13 million. Solectron maintains an insurance policy to cover environmental remediation liabilities in excess of reserves previously established upon the acquisition of these properties. Solectron did not record any environmental charges upon disposition of these properties.

 

See Management’s Discussion and Analysis of Financial Condition and Results of Operations for factors related to fluctuations in the exchange rates of foreign currency and fluctuations in interest rates under “Risk Factors — We are exposed to fluctuations in foreign currency exchange rates and interest rate fluctuations.”

 

The information required by Item 8 of Form 10-K is presented here in the following order:

 

SOLECTRON CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS