Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Vishay Intertechnology, Inc. is an international manufacturer and supplier of discrete semiconductors and passive electronic components, including power MOSFETs, power conversion and motor control integrated circuits, transistors, diodes, optoelectronic components, resistors, capacitors, inductors, strain gages, load cells, force measurement sensors, displacement sensors, and photoelastic sensors. Semiconductors and passive electronic components manufactured by Vishay are used in virtually all types of electronic products, including those in the industrial, computer, automotive, consumer electronic products, telecommunications, military/aerospace, and medical industries.
Vishay operates in two segments, Semiconductors and Passive Components. Semiconductors segment products include transistors, diodes, rectifiers, certain types of integrated circuits, and optoelectronic products. Passive Components segment products include resistors, capacitors, and inductors. We include in the Passive Components segment our Measurements Group, which manufactures and markets strain gages, load cells, transducers, instruments, and weighing systems whose core components are resistors that are sensitive to various types of mechanical stress. While the passive components business had historically predominated at Vishay, following several acquisitions of semiconductor businesses, revenues from our Semiconductors and Passive Components segments were essentially split evenly from 2003 through the first quarter of 2007. On April 1, 2007, Vishay acquired the Power Control Systems (“PCS”) business of International Rectifier Corporation, which has been included in the Semiconductors segment. Going forward, revenues from our Semiconductors segment are expected to represent slightly more than half of our total revenues.
Net revenues for the fiscal quarter ended September 27, 2008 were $739.1 million, compared to $729.6 million for the fiscal quarter ended September 29, 2007.
Vishay reported a loss from continuing operations in the third quarter of 2008 of $312.9 million, or $1.68 per share. The loss includes noncash goodwill and indefinite-lived intangible asset impairment charges, totaling $357.9 million ($328.8 million, net of tax). The amount of the impairment charge is based on a preliminary analysis and may be adjusted in the fourth quarter.
The third quarter 2008 results also include a pretax charge for restructuring and severance costs of $6.8 million, a loss on early extinguishment of debt of $13.6 million, and $4.0 million of costs associated with Vishay’s terminated tender offer for all outstanding shares of International Rectifier. On an after tax basis, these items and the impairment charges had a negative $1.86 per share effect on earnings (loss) from continuing operations.
Income from continuing operations for the fiscal quarter ended September 29, 2007 was $37.1 million, or $0.20 per diluted share. Income from continuing operations for the fiscal quarter ended September 29, 2007 was impacted by pretax charges for restructuring and severance costs of $9.9 million. Additionally, reported income tax expense is net of benefits totaling $0.9 million for changes in uncertain tax positions and a change in enacted tax rates. These items, net, had a negative $0.05 per share effect on income from continuing operations.
Net revenues for the nine fiscal months ended September 27, 2008 were $2,246.8 million, compared to $2,103.7 million for the nine fiscal months ended September 29, 2007. The loss from continuing operations for the nine fiscal months ended September 27, 2008 was $1,037.0 million or $5.56 per share, compared to income from continuing operations of $129.1 million or $0.67 per diluted share for the nine fiscal months ended September 29, 2007.
The loss from continuing operations for the nine fiscal months ended September 27, 2008 was impacted by pretax charges for goodwill and indefinite-lived asset impairments of $1,157.9 million, restructuring and severance costs of $34.0 million, related asset write-downs of $4.2 million, a loss on early extinguishment of debt of $13.6 million, $4.0 million of costs associated with Vishay’s terminated tender offer for all outstanding shares of International Rectifier, and $9.9 million of tax expense associated with the repatriation of cash from certain non-U.S. subsidiaries. Including the tax effects of the pretax charges, these items had a negative $6.15 per share effect on earnings (loss) from continuing operations.
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Income from continuing operations for the nine fiscal months ended September 29, 2007 was impacted by pretax charges for restructuring and severance costs of $13.2 million and related asset write-downs of $2.7 million. These items and their tax-related consequences, plus additional tax expense for changes in uncertain tax positions net of benefits for a change in enacted tax rates totaling $2.5 million, had a negative $0.09 per share effect on income from continuing operations.
On April 7, 2008, Vishay sold the automotive modules and subsystems business unit (“ASBU”) acquired on April 1, 2007 as part of the acquisition of the PCS business of International Rectifier. The operations of ASBU have been classified as discontinued operations. Including the loss from discontinued operations, the net loss for the fiscal quarter and nine fiscal months ended September 27, 2008 was $312.9 million and $1,079.1 million, respectively, compared to net earnings of $35.2 million and $125.9 million, respectively, for the comparable prior year periods.
During the third quarter of 2008, the electronics industry abruptly experienced the impact of the present macro economic turbulences. Despite results that were below our expectations, we continued to generate strong cash flows. We remain confident for the long-term prospects of our businesses, although we expect further deterioration of market conditions in the short-term.
Financial Metrics
We utilize several financial measures and metrics to evaluate the performance and assess the future direction of our business. These key financial measures and metrics include net revenues, gross profit margin, end-of-period backlog, and the book-to-bill ratio. We also monitor changes in inventory turnover and average selling prices (“ASP”).
Gross profit margin is computed as gross profit as a percentage of sales. Gross profit is generally net revenues less costs of products sold, but also deducts certain other period costs, particularly losses on purchase commitments and inventory write-downs. Losses on purchase commitments and inventory write-downs have the impact of reducing gross profit margin in the period of the charge, but result in improved gross profit margins in subsequent periods by reducing costs of products sold as inventory is used. Gross profit margin is clearly a function of net revenues, but also reflects our ability to contain costs.
End-of-period backlog is one indicator of future sales. We include in our backlog only open orders that have been released by the customer for shipment in the next twelve months. If demand falls below customers’ forecasts, or if customers do not control their inventory effectively, they may cancel or reschedule the shipments that are included in our backlog, in many instances without the payment of any penalty. Therefore, the backlog is not necessarily indicative of the results to be expected for future periods.
Another important indicator of demand in our industry is the book-to-bill ratio, which is the ratio of the amount of product ordered during a period as compared with the product that we ship during that period. A book-to-bill ratio that is greater than one indicates that our backlog is building and that we are likely to see increasing revenues in future periods. Conversely, a book-to-bill ratio that is less than one is an indicator of declining demand and may foretell declining sales.
We focus on our inventory turnover as a measure of how well we are managing our inventory. We define inventory turnover for a financial reporting period as our costs of products sold for the four quarters ending on the last day of the reporting period divided by our average inventory (computed using each quarter-end balance) for this same period. The inventory balance used for computation of this ratio includes tantalum inventories in excess of one year supply, which are classified as other assets in the consolidated balance sheet. See Note 14 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007. A higher level of inventory turnover reflects more efficient use of our capital.
Pricing in our industry can be volatile. We analyze trends and changes in average selling prices to evaluate likely future pricing. The erosion of average selling prices of established products is typical of the industry. However, we attempt to offset this deterioration with on-going cost reduction activities and new product introductions, as newer products typically yield larger gross margins.
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The quarter-to-quarter trends in these financial metrics can also be an important indicator of the likely direction of our business. The following table shows net revenues, gross profit margin, end-of-period backlog, book-to-bill ratio, inventory turnover, and changes in ASP for our business as a whole during the five quarters beginning with the third quarter of 2007 through the third quarter of 2008(dollars in thousands):
| 3rd Quarter | | 4th Quarter | | 1st Quarter | | 2nd Quarter | | 3rd Quarter |
| 2007 | | 2007 | | 2008 | | 2008 | | 2008 |
| Net revenues | $ | 729,616 | | $ | 729,597 | | $ | 733,313 | | $ | 774,364 | | $ | 739,092 |
| | | | | | | | | | | | | | | |
| Gross profit margin | | 24.0% | | | 22.9% | | | 23.5% | | | 23.2% | | | 21.6% |
| | | | | | | | | | | | | | | |
| End-of-period backlog | $ | 678,300 | | $ | 646,700 | | $ | 696,700 | | $ | 695,900 | | $ | 619,000 |
| | | | | | | | | | | | | | | |
| Book-to-bill ratio | | 0.98 | | | 0.96 | | | 1.04 | | | 1.00 | | | 0.92 |
| | | | | | | | | | | | | | | |
| Inventory turnover | | 3.62 | | | 3.76 | | | 3.74 | | | 3.89 | | | 3.85 |
| | | | | | | | | | | | | | | |
| Change in ASP vs. prior quarter | | -1.3% | | | -1.2% | | | -0.4% | | | -0.9% | | | -1.4% |
See “Financial Metrics by Segment” below for net revenues, book-to-bill ratio, and gross profit margin broken out by segment.
Revenues for the third quarter of 2008 were below our expectations. During the quarter, we experienced a substantial slow down in our order-rate, which has continued into fourth quarter. Gross profit margin decreased, principally due to lower volume and decreases in ASPs, particularly in our Semiconductors segment businesses. The book-to-bill ratio decreased to 0.92 from 1.00 in the second quarter of 2008. Orders were particularly weak for Semiconductor segment products from Asian distributors. For the third quarter of 2008, the book-to-bill ratios for distribution customers and original equipment manufacturers (“OEM”) were 0.88 and 0.95, respectively, versus ratios of 1.01 and 1.00, respectively, during the second quarter of 2008. We remain confident for the long-term prospects of the electronics industry, but it is difficult in the current environment to make precise short term projections. We expect revenues between $640 million and $670 million for the fourth quarter of 2008, at flat gross margins. The expected revenues have been negatively impacted by the strengthening of the U.S. dollar compared to other currencies, principally the Euro.
We have continued to see relatively modest pricing pressure in 2008, continuing the trend experienced in 2006 and 2007, although we have experienced accelerating price declines for our Semiconductors segment products, and expect increasing pricing pressure for the remainder of the year.
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Financial Metrics by Segment
The following table shows net revenues, book-to-bill ratio, and gross profit margin broken out by segment for the five quarters beginning with the third quarter of 2007 through the third quarter of 2008(dollars in thousands):
| 3rd Quarter | | 4th Quarter | | 1st Quarter | | 2nd Quarter | | 3rd Quarter |
| 2007 | | 2007 | | 2008 | | 2008 | | 2008 |
| Semiconductors | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Net revenues | $ | 400,967 | | $ | 386,013 | | $ | 387,780 | | $ | 407,443 | | $ | 392,934 |
| | | | | | | | | | | | | | | |
| Book-to-bill ratio | | 0.95 | | | 0.94 | | | 1.03 | | | 1.01 | | | 0.85 |
| | | | | | | | | | | | | | | |
| Gross profit margin | | 23.3% | | | 22.5% | | | 22.9% | | | 22.5% | | | 21.8% |
| | | | | | | | | | | | | | | |
| Passive Components | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Net revenues | $ | 328,649 | | $ | 343,584 | | $ | 345,533 | | $ | 366,921 | | $ | 346,158 |
| | | | | | | | | | | | | | | |
| Book-to-bill ratio | | 1.02 | | | 0.99 | | | 1.05 | | | 0.99 | | | 0.98 |
| | | | | | | | | | | | | | | |
| Gross profit margin | | 24.9% | | | 23.3% | | | 24.3% | | | 24.1% | | | 21.4% |
Acquisition and Divestiture Activity
As part of our growth strategy, we seek to expand through the acquisition of other manufacturers of electronic components that have established positions in major markets, reputations for product quality and reliability, and product lines with which we have substantial marketing and technical expertise. This includes exploring opportunities to acquire smaller targets to gain market share, effectively penetrate different geographic markets, enhance new product development, round out our product lines, or grow our high margin niche market businesses. Also as part of this growth strategy, we seek to explore opportunities with privately held developers of electronic components, whether through acquisition, investment in non-controlling interests, or strategic alliances.
During the third quarter of 2008, Vishay made three acquisitions. On June 30, 2008, Vishay acquired its partner’s 51% interest in a transducer manufacturing joint venture in India for approximately $9.6 million. On July 23, 2008, Vishay acquired Powertron GmbH, a manufacturer of specialty precision resistors, for approximately $14.3 million, including the repayment of certain debt of Powertron. On September 15, 2008, Vishay acquired the wet tantalum capacitor business of KEMET Corporation for $35.2 million and other consideration in the form of a three-year term loan of $15 million. Terms of the secured loan of $15 million to KEMET from Vishay include a three-year non-amortizing maturity, an interest rate of LIBOR plus four percent, and security consisting of accounts receivable.
As further described in Note 13 to our consolidated condensed financial statements, during the third quarter, Vishay made an unsolicited offer to acquire all outstanding shares of International Rectifier. This tender offer was terminated on October 13, 2008. Vishay incurred $4 million of costs associated with the International Rectifier tender offer, which are presented as a separate line item in the consolidated condensed statements of operations.
In April 2007, Vishay acquired the PCS business of International Rectifier. On April 7, 2008, Vishay sold the automotive modules and subsystems business unit (“ASBU”) it had acquired as part of the acquisition of the PCS business. During the first quarter of 2008, we recorded an impairment charge of $32.3 million to reduce the carrying value of the net assets of ASBU to the selling price.
Vishay has notified International Rectifier of damage claims concerning forecasts provided to Vishay regarding ASBU in advance of the PCS business acquisition that Vishay believes International Rectifier knew to be unsupportable. Vishay has also notified International Rectifier of certain other claims that it has regarding the sale of the PCS business to Vishay. International Rectifier has stated that it does not believe that Vishay’s claims have merit and that it intends to vigorously defend its position.
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Cost Management
We place a strong emphasis on reducing our costs. Since 2001, we have been implementing aggressive cost reduction programs to enhance our competitiveness, particularly in light of the erosion of average selling prices of established products that is typical of the industry.
One way we have reduced costs is by moving production to the extent possible from high-labor-cost markets, such as the United States and Western Europe, to lower-labor-cost markets, such as the Czech Republic, Israel, India, Malaysia, Mexico, the People’s Republic of China, and the Philippines. The percentage of our total headcount in lower-labor-cost countries is a measure of the extent to which we are successful in implementing this program. This percentage was 75.6% at the end of the third quarter of 2008, compared to 74.0% at the end of 2007, 74.2% at the end of 2006, and 57% when this program began in 2001. Our target is to have between 75% and 80% of our headcount in lower-labor-cost countries.
These production transfers and other long-term cost cutting measures require us to initially incur significant severance and other exit costs and to record losses on excess buildings and equipment. We anticipate that we will realize the benefits of our restructuring through lower labor costs and other operating expenses in future periods. Since 2001, we recorded over $225 million of restructuring and severance costs and recorded related asset write-downs of over $80 million in order to reduce our cost structure going forward. We have realized, and expect to continue to realize, annual net cost savings associated with these restructuring activities.
Restructuring and severance costs, as presented on the consolidated condensed statement of operations, are separate from plant closure, employee termination and similar integration costs we incur in connection with our acquisition activities. These plant closure and employee termination costs subsequent to acquisitions are also integral to our cost reduction program. These amounts, which were not significant in recent years, are included in the costs of our acquisitions and do not affect earnings or losses on our statement of operations.
We evaluate potential restructuring projects based on an expected payback period. The payback period represents the number of years of annual cost savings necessary to recover the initial cash outlay for severance and other exit costs. In general, a restructuring project must have a payback of less than 3 years to be considered beneficial. On average, our restructuring projects have a payback of between 1 and 1.5 years.
During 2005 and the first quarter of 2006, we completed a broad-based fixed cost reduction program. In April 2005, we began evaluating additional restructuring initiatives to improve the results of underperforming divisions. Annual pretax savings resulting from restructuring projects initiated under these programs were expected to be approximately $50 million, of which approximately 70% of the savings would reduce costs of products sold, and approximately 30% of the savings would result in reduced selling, general, and administrative costs. Our actual costs savings from these programs in 2007 were approximately $40 million. Of this $40 million of annualized savings, approximately $20 million began to be realized in 2006, and $20 million began to be realized in 2007. We expect to realize an additional $10 million of savings from these programs in 2008. The expected and actual savings quantified above are net of additional costs incurred after production was transferred to lower-labor-cost regions.
We expect these restructuring programs to result in higher profitability through better gross margins and lower selling, general, and administrative expenses. However, these programs to improve our profitability also involve certain risks which could materially impact our future operating results, as further detailed in Item 1A, “Risk Factors,” included in our Annual Report on Form 10-K for the year ended December 31, 2007.
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In light of the current uncertain market conditions, we expanded our restructuring programs in 2008 to further reduce costs. Most of the costs related to our anticipated 2008 restructuring projects were recorded in the first quarter of 2008. These projects include the transfer of production of resistor products from Brazil to India and Czech Republic and the transfer of certain processes in Belgium and the United States to third party subcontractors. We also announced our intention to transfer production from the Netherlands and the United States to Israel later in 2008. We expect to continue to incur restructuring expenses to reduce our fixed costs, particularly in light of the current economic environment. We expect the restructuring projects anticipated for 2008 (including those projects initiated in the nine fiscal months ended September 27, 2008) will generate approximately $25 million of annual cost savings, of which approximately 60% of the savings would reduce costs of products sold, and approximately 40% of the savings would result in reduced selling, general, and administrative costs. We began to realize some of these savings in the third quarter of 2008.
While streamlining and reducing fixed overhead, we are exercising caution so that we will not negatively impact our customer service or our ability to further develop products and processes. Our cost management plans also include expansion of certain critical capacities, which we hope will reduce average materials and processing costs.
Foreign Currency Translation
We are exposed to foreign currency exchange rate risks, particularly due to transactions in currencies other than the functional currencies of certain subsidiaries. While we have in the past used forward exchange contracts to hedge a portion of our projected cash flows from these exposures, we generally have not done so in recent periods.
Statement of Financial Accounting Standards (“SFAS”) No. 52 requires that entities identify the “functional currency” of each of their subsidiaries and measure all elements of the financial statements in that functional currency. A subsidary’s functional currency is the currency of the primary economic environment in which it operates. In cases where a subsidiary is relatively self-contained within a particular country, the local currency is generally deemed to be the functional currency. However, a foreign subsidiary that is a direct and integral component or extension of the parent company’s operations generally would have the parent company’s currency as its functional currency. Vishay has both situations among its subsidiaries.
Foreign Subsidiaries which use the Local Currency as the Functional Currency
We finance our operations in Europe and certain locations in Asia in local currencies, and accordingly, these subsidiaries utilize the local currency as their functional currency. For those subsidiaries where the local currency is the functional currency, assets and liabilities in the consolidated balance sheets have been translated at the rate of exchange as of the balance sheet date. Translation adjustments do not impact the results of operations and are reported as a separate component of stockholders’ equity. With the general weakening of the U.S. dollar over the past year, this translation of these subsidiaries’ financial statements into U.S. dollars has resulted in a significant increase in the translation adjustment recorded in accumulated other comprehensive income on our balance sheet. As the U.S. dollar modestly strengthened in the third quarter, we saw a moderate decrease in the translation adjustment recorded in accumulated other comprehensive income on our balance sheet. See Note 7 to our consolidated condensed financial statements.
For those subsidiaries where the local currency is the functional currency, revenues and expenses are translated at the average exchange rate for the year. While the translation of revenues and expenses into U.S. dollars does not directly impact the statement of operations, the translation effectively increases or decreases the U.S. dollar equivalent of revenues generated and expenses incurred in those foreign currencies. As a result of the general weakening of the U.S. dollar versus several foreign currencies, the translation of foreign currency revenues and expenses into U.S. dollars has significantly increased reported revenues and expenses during the nine fiscal months ended September 27, 2008. Expected general strengthening of the U.S. dollar during the fourth quarter of 2008, as experienced in October, is expected to reduce the U.S. dollar equivalent of revenues generated and expenses incurred in foreign currencies, particularly the Euro.
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Foreign Subsidiaries which use the U.S. Dollar as the Functional Currency
Our operations in Israel and most significant locations in Asia are largely financed in U.S. dollars, and accordingly, these subsidiaries utilize the U.S. dollar as their functional currency. For those foreign subsidiaries where the U.S. dollar is the functional currency, all foreign currency financial statement amounts are remeasured into U.S. dollars. Exchange gains and losses arising from remeasurement of foreign currency-denominated monetary assets and liabilities are included in the results of operations. While these subsidiaries transact most business in U.S. dollars, they may have significant costs, particularly payroll-related, which are incurred in the local currency. The cost of products sold and selling, general, and administrative expense for the nine fiscal months ended September 27, 2008 have been significantly increased by local currency transactions of subsidiaries which use the U.S. dollar as their functional currency, particularly our subsidiaries in Israel.
Critical Accounting Policies and Estimates
We supplement our discussion of critical accounting policies and estimates, which appears in Item 7 of our Annual Report on Form 10-K, as follows.
Goodwill
Goodwill represents the excess of the cost of businesses acquired over the fair value of the related net assets at the date of acquisition. Goodwill is not amortized but rather tested for impairment at least annually. We perform our annual impairment test as of the first day of the fiscal fourth quarter. These impairment tests must be performed more frequently if there are triggering events.
SFAS No. 142,Goodwill and Other Intangible Assets,prescribes a two-step method for determining goodwill impairment. In the first step, we determine the fair value of the reporting unit using a comparable companies market multiple approach. The comparable companies utilized in our evaluation are generally the members of our peer group included in the presentation of our stock performance graph in Item 5 of our Annual Report on Form 10-K. We also utilized other valuation techniques, including a discounted cash flow analysis, to evaluate the reasonableness of the fair value determined using the market multiple approach.
If the net book value of the reporting unit exceeds the fair value, we would then perform the second step of the impairment test, which requires allocation of the reporting unit’s fair value to all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. An impairment charge will be recognized only when the implied fair value of a reporting unit’s goodwill is less than its carrying amount.
In light of a sustained decline in market capitalization for Vishay and its peer group companies, and other factors, Vishay determined that an interim impairment test was necessary as of the end of the second and third fiscal quarters of 2008.
Passive Components segment goodwill is allocated to two reporting units for SFAS No. 142 evaluation purposes, namely Other Passives and Measurements Group. The Semiconductors segment represents a single reporting unit for SFAS No. 142 evaluation purposes.
After completing step one of the impairment test as of June 28, 2008, we determined that the estimated fair value of our Semiconductors and Other Passives reporting units was less than the net book value of those reporting units, requiring the completion of the second step of the impairment test. The estimated fair value of the Measurements Group reporting unit was greater than the net book value of that unit, and accordingly, no second step was required for the Measurement Group reporting unit.
To measure the amount of the impairment, SFAS No. 142 prescribes that we determine the implied fair value of goodwill in the same manner as if we had acquired those business units. Specifically, we must allocate the fair value of the reporting unit to all of the assets of that unit, including any unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill. The impairment loss is measured as the difference between the book value of the goodwill and the implied fair value of the goodwill computed in step two.
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Upon completion of a preliminary step two analysis, we recorded our best estimate of the impairment loss as of June 28, 2008, which was refined during the third quarter of 2008.
Given the further deterioration of market conditions, an additional impairment test was performed as of September 27, 2008. After completing step one of the impairment test as of September 27, 2008, we determined that the estimated fair value of our Other Passives reporting unit was less than the net book value of this reporting unit. This required the completion of the second step of the impairment test. The estimated fair value of the Semiconductors and Measurements Group reporting units was greater than the net book value of the respective reporting units as of September 27, 2008, and accordingly, no second step was required for the Semiconductors and Measurement Group reporting units at September 27, 2008.
As a result of these impairment tests, we recorded goodwill impairment charges aggregating $1,130.9 million.
The third quarter impairment loss is based on a preliminary step two analysis prepared as of September 27, 2008, which is subject to completion in the fourth quarter of 2008. The completion of this analysis may result in the recognition of an additional impairment charge in the fourth quarter of 2008.
As a result of the analysis described above, the goodwill associated with our Other Passives and Semiconductors reporting units was recorded at fair value. In accordance with FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, we have not applied SFAS No. 157 to the determination of the fair value of these assets (see Note 14 to our consolidated condensed financial statements included in Part I, Item 1). However, the provisions of SFAS No. 157 were applied to the determination of the fair value of financial assets and financial liabilities that were part of the SFAS No. 142 step two analysis.
The determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within those reporting units requires the Company to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which we compete; the discount rate; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization, and capital expenditures. The allocation requires several analyses to determine fair value of assets and liabilities including, among others, completed technology, tradenames, in-process research and development, customer relationships, and certain property and equipment (valued at replacement costs).
Due to the inherent uncertainty involved in making these estimates, actual financial results could differ from those estimates. In addition, changes in assumptions concerning future financial results or other underlying assumptions would have a significant impact on either the fair value of the reporting unit or the amount of the goodwill impairment charge.
The goodwill impairment charge is noncash in nature and does not affect Vishay’s liquidity, cash flows from operating activities, or debt covenants, and will not have a material impact on future operations.
Long-Lived Assets and Indefinite-Lived Intangible Assets
We assess the impairment of our long-lived assets, other than goodwill and tradenames, including property and equipment, long-term prepaid assets, and identifiable intangible assets subject to amortization, whenever events or changes in circumstances indicate the carrying value may not be recoverable. Factors we consider important, which could trigger an impairment review, include significant changes in the manner of our use of the asset, changes in historical or projected operating performance, and significant negative economic trends. The carrying value of a long-lived asset is considered impaired when the total projected undiscounted cash flows from such asset are separately identifiable and are less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset, primarily determined using discounted future cash flows.
Indefinite-lived intangible assets (which for Vishay are comprised entirely of tradenames) are not amortized, but similar to goodwill, are tested for impairment at least annually. These tests are performed more frequently if there are triggering events. The fair value of the tradenames is measured as the discounted cash flow savings realized from owning such tradenames and not having to pay a royalty for their use.
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As a result of the decision to close our facility in Brazil, we completed a long-lived asset impairment analysis during the first quarter of 2008 and determined that various fixed assets and definite-lived intangible assets were impaired. We recorded fixed asset write-downs of $3.4 million and intangible asset write-downs of $0.8 million.
Prior to completing the interim assessment of goodwill for impairment during the second quarter of 2008, we performed a recoverability test of certain long-lived assets in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, and certain indefinite-lived intangible assets in accordance with SFAS No. 142. As a result of those assessments, we recorded indefinite-lived intangible asset impairment charges totaling $27 million during the third quarter of 2008.
The evaluation of the recoverability of long-lived assets, and the determination of their fair value, requires us to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the identification of the asset group at the lowest level of independent cash flows and the principal asset of the group; the discount rate; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization, and capital expenditures.
The evaluation of the fair value of indefinite-lived trademarks also requires us to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the assumed market-royalty rate; the discount rate; terminal growth rates; and forecasts of revenue.
Due to the inherent uncertainty involved in making these estimates, actual results could differ from those estimates. In addition, changes in underlying assumptions would have a significant impact on the conclusion that an asset group’s carrying value is recoverable, that an indefinite-lived asset is not impaired, or the determination of any impairment charge if it was determined that the asset values were indeed impaired.
Results of Operations
Statement of operations captions as a percentage of net revenues and the effective tax rates were as follows:
| Fiscal quarter ended | | Nine fiscal months ended |
| Sept. 27, 2008 | | Sept. 29, 2007 | | Sept. 27, 2008 | | Sept. 29, 2007 |
| Cost of products sold | 78.4% | | 76.0% | | 77.2% | | 74.9% |
| Gross profit | 21.6% | | 24.0% | | 22.8% | | 25.1% |
| Selling, general & administrative expenses | 15.3% | | 15.2% | | 15.7% | | 15.7% |
| Operating income (loss) | -43.6% | | 7.4% | | -46.3% | | 8.7% |
| Income (loss) from continuing operations | | | | | | | |
| before taxes and minority interest | -45.2% | | 6.7% | | -47.2% | | 8.2% |
| Income (loss) from continuing operations | -42.3% | | 5.1% | | -46.2% | | 6.1% |
| Net earnings (loss) | -42.3% | | 4.8% | | -48.0% | | 6.0% |
| ________ | | | | | | | |
| Effective tax rate | 6.3% | | 23.6% | | 2.4% | | 24.7% |
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Net Revenues
Net revenues were as follows (dollars in thousands):
| Fiscal quarter ended | | Nine fiscal months ended |
| Sept. 27, 2008 | | Sept. 29, 2007 | | Sept. 27, 2008 | | Sept. 29, 2007 |
| Net revenues | $ | 739,092 | | $ | 729,616 | | $ | 2,246,769 | | $ | 2,103,669 |
| Change versus comparable prior year period | $ | 9,476 | | | | | $ | 143,100 | | | |
| Percentage change versus | | | | | | | | | | | |
| comparable prior year period | | 1.3% | | | | | | 6.8% | | | |
Changes in net revenues were attributable to the following:
| vs. Prior Year | | vs. Prior |
| Quarter | | Year-to-Date |
| Change attributable to: | | | |
| Increase in volume | 1.6% | | 2.5% |
| Decrease in average selling prices | -3.4% | | -3.1% |
| Foreign currency effects | 3.1% | | 4.3% |
| Acquisitions | 0.2% | | 3.3% |
| Other | -0.2% | | -0.2% |
| Net change | 1.3% | | 6.8% |
During the third quarter of 2008, we have experienced a substantial slow down in our order rate. While sales volume is higher for both the third quarter and fiscal nine months ended September 27, 2008, this is in part due to sales from our backlog. The markets for our products, which had been relatively healthy through most of 2008, began to be impacted by the economic downturn in September of 2008. The automotive industry seems most heavily impacted, and sales of products for end-uses in the computer, mobile phone, and consumer industries were below seasonal expectations. Sales of products for end-uses in the industrial and military/aerospace industries continued to be stable. The overall increase in net revenues for the nine fiscal months ended September 27, 2008 was principally driven by acquisitions and foreign currency effects. The weakening U.S. dollar effectively increased the amount reported for revenues during the third quarter and nine fiscal months ended September 27, 2008 versus the comparable prior year periods.
We deduct, from the sales that we record to distributors, allowances for future credits that we expect to provide for returns, scrapped product, and price adjustments under various programs made available to the distributors. We make deductions corresponding to particular sales in the period in which the sales are made, although the corresponding credits may not be issued until future periods. We estimate the deductions based on sales levels to distributors, inventory levels at the distributors, current and projected market trends and conditions, recent and historical activity under the relevant programs, changes in program policies, and open requests for credits. We recorded deductions from gross sales under our distributor incentive programs of $60 million and $61 million for the nine fiscal months ended September 27, 2008 and September 29, 2007, respectively, or 2.6% and 2.8% of gross sales, respectively. Actual credits issued under the programs during the nine fiscal months ended September 27, 2008 and September 29, 2007, were $57 million and $58 million, respectively. Increases and decreases in these incentives are largely attributable to the then-current business climate.
As a result of a concentrated effort to defend our intellectual property and generate additional licensing income, we began receiving royalties in the fourth quarter of 2004. We continue to seek to expand our royalty streams. Royalty revenues, included in net revenues on the consolidated condensed statements of operations, were approximately $3.1 million and $5.8 million for the nine fiscal months ended September 27, 2008 and September 29, 2007, respectively.
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Gross Profit and Margins
Gross profit margins for the fiscal quarter and nine fiscal months ended September 27, 2008 were 21.6% and 22.8%, respectively, versus 24.0% and 25.1%, respectively, for the comparable prior year periods. These decreases in gross profit margin reflect lower average selling prices, negative foreign currency effects, generally higher precious metals and raw materials costs, and a less favorable product mix. When compared to the nine fiscal months ended September 29, 2007, gross profit margin for the nine fiscal months ended September 27, 2008 was also negatively impacted by the acquisition of the PCS business, which has lower gross profit margins than legacy Vishay products.
Segments
Analysis of revenues and gross profit margins for our Semiconductors and Passive Components segments is provided below.
Semiconductors
Net revenues of the Semiconductors segment were as follows (dollars in thousands):
| Fiscal quarter ended | | Nine fiscal months ended |
| Sept. 27, 2008 | | Sept. 29, 2007 | | Sept. 27, 2008 | | Sept. 29, 2007 |
| Net revenues | $ | 392,934 | | | $ | 400,967 | | $ | 1,188,157 | | $ | 1,103,587 |
| Change versus comparable prior year period | $ | (8,033 | ) | | | | | $ | 84,570 | | | |
| Percentage change versus | | | | | | | | | | | | |
| comparable prior year period | | -2.0% | | | | | | | 7.7% | | | |
Changes in Semiconductors segment net revenues were attributable to the following:
| vs. Prior Year | | vs. Prior |
| Quarter | | Year-to-Date |
| Change attributable to: | | | |
| Increase in volume | 1.2% | | 4.5% |
| Decrease in average selling prices | -5.3% | | -4.9% |
| Foreign currency effects | 2.3% | | 3.2% |
| Acquisitions | 0.0% | | 5.4% |
| Other | -0.2% | | -0.5% |
| Net change | -2.0% | | 7.7% |
Gross profit as a percentage of net revenues for the Semiconductors segment was as follows:
| Fiscal quarter ended | | Nine fiscal months ended |
| Sept. 27, 2008 | | Sept. 29, 2007 | | Sept. 27, 2008 | | Sept. 29, 2007 |
| Gross margin percentage | 21.8% | | 23.3% | | 22.4% | | 24.2% |
The decrease in gross margin percentages for the third quarter and nine fiscal months ended September 27, 2008 versus the comparable prior year periods reflects accelerated average selling price decline and generally higher precious metals and raw materials costs. When compared to the nine fiscal months ended September 29, 2007, gross profit margin for the nine fiscal months ended September 27, 2008 was also negatively impacted by the acquisition of the PCS business, which has lower gross profit margins than legacy Vishay products.
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Passive Components
Net revenues of the Passive Components segment were as follows (dollars in thousands):
| | Fiscal quarter ended | | Nine fiscal months ended |
| | Sept. 27, 2008 | | Sept. 29, 2007 | | Sept. 27, 2008 | | Sept. 29, 2007 |
| Net revenues | $ | 346,158 | | $ | 328,649 | | $ | 1,058,612 | | $ | 1,000,082 |
| Change versus comparable prior year period | $ | 17,509 | | | | | $ | 58,530 | | | |
| Percentage change versus | | | | | | | | | | | |
| comparable prior year period | | 5.3% | | | | | | 5.9% | | | |
Changes in Passive Components segment net revenues were attributable to the following:
| | vs. Prior Year | | vs. Prior |
| | Quarter | | Year-to-Date |
| Change attributable to: | | | |
| Increase (decrease) in volume | 2.0% | | 0.5% |
| Decrease in average selling prices | -1.2% | | -1.2% |
| Foreign currency effects | 4.0% | | 5.5% |
| Acquisitions | 0.5% | | 1.0% |
| Other | 0.0% | | 0.1% |
| Net change | 5.3% | | 5.9% |
Gross profit as a percentage of net revenues for the Passive Components segment was as follows:
| | Fiscal quarter ended | | Nine fiscal months ended |
| | Sept. 27, 2008 | | Sept. 29, 2007 | | Sept. 27, 2008 | | Sept. 29, 2007 |
| Gross margin percentage | 21.4% | | 24.9% | | 23.2% | | 26.1% |
The decrease in gross margin percentage for the third quarter and nine fiscal months ended September 27, 2008 versus the comparable prior year period largely reflects negative foreign currency effects, principally from changes in the Israeli shekel, Chinese renminbi, and Czech koruna, which more than offset cost reduction initiatives.
Selling, General, and Administrative Expenses
Selling, general, and administrative (“SG&A”) expenses in 2008 have increased versus 2007 largely due to increased sales. SG&A expenses for the third quarter and nine fiscal months ended September 27, 2008 were 15.3% and 15.7%, respectively, of net revenues, versus 15.2% and 15.7% for the comparable prior year periods. Amortization of intangible assets, included in SG&A expenses, was $5.2 million and $14.9 million for the quarter and nine fiscal months ended September 27, 2008, respectively, versus $4.3 million and $12.1 million, respectively, for the comparable prior year periods. This increase in amortization expense is principally due to the acquisition of the PCS business, and to a lesser extent, PM Group. The nine fiscal months ended September 27, 2008 also includes higher legal costs attributable to a patent infringement case. A weaker U.S. dollar and increases in salaries and wages versus the prior year also contributed to the increased level of SG&A costs. Also, SG&A expense for the quarter and nine fiscal months ended September 27, 2008 are net of gains on sales of assets totaling $2.5 million and $3.2 million, respectively, compared to a gain (loss) on sales of assets of $(0.6) million and $0.7 million for the comparable prior year periods.
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Restructuring and Severance Costs and Related Asset Write-Downs
Our restructuring programs have been on-going since 2001. Our restructuring activities have been designed to reduce both fixed and variable costs. These activities include the closing of facilities and the termination of employees. Because costs are recorded based upon estimates, actual expenditures for the restructuring activities may differ from the initially recorded costs. If the initial estimates are too low or too high, we could be required either to record additional expenses in future periods or to reverse previously recorded expenses. We anticipate that we will realize the benefits of our restructuring through lower labor costs and other operating expenses in future periods. We continued our restructuring activities during the nine fiscal months ended September 27, 2008, recording restructuring and severance costs of $34.0 million, and related asset write-downs of $4.2 million. We expect to continue to incur restructuring expenses to reduce our fixed costs, particularly in light of the current economic environment, as further explained in “Cost Management” above, in Note 4 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007, and in Note 4 to our consolidated condensed financial statements included in Part I of this document.
Other Income (Expense)
Interest expense for the fiscal quarter and nine fiscal months ended September 27, 2008 decreased by $2.6 million and $4.5 million versus the comparable prior year periods. These decreases are primarily due to the repayment of the convertible subordinated notes on August 1, 2008 and lower interest rates on our variable rate debt.
The following tables analyze the components of the line “Other” on the consolidated condensed statement of operations(in thousands):
| | | Fiscal quarter ended | | | | |
| | | Sept. 27, 2008 | | Sept. 29, 2007 | | Change |
| Foreign exchange (loss) gain | | $ | 4,131 | | | $ | (2,546 | ) | | $ | 6,677 | |
| Interest income | | | 2,426 | | | | 3,887 | | | | (1,461 | ) |
| Dividend income | | | - | | | | 148 | | | | (148 | ) |
| Other | | | 296 | | | | 790 | | | | (494 | ) |
| | | $ | 6,853 | | | $ | 2,279 | | | $ | 4,574 | |
| |
| | | Nine fiscal months ended | | | | |
| | | Sept. 27, 2008 | | Sept. 29, 2007 | | Change |
| Foreign exchange loss | | $ | (2,456 | ) | | $ | (2,790 | ) | | $ | 334 | |
| Interest income | | | 10,642 | | | | 14,230 | | | | (3,588 | ) |
| Dividend income | | | 92 | | | | 368 | | | | (276 | ) |
| Incentive from Chinese government | | | 800 | | | | - | | | | 800 | |
| Other | | | 2,250 | | | | 384 | | | | 1,866 | |
| | | $ | 11,328 | | | $ | 12,192 | | | $ | (864 | ) |
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Income Taxes
The effective tax rate, based on income from continuing operations before income taxes and minority interest, for the quarter and nine fiscal months ended September 27, 2008 was 6.3% and 2.4%, respectively, compared to 23.6% and 24.7%, respectively, for the comparable prior year periods.
The relatively low effective tax rates for the quarter and nine fiscal months ended September 27, 2008 are principally attributable to the goodwill and indefinite-lived intangible asset impairment charges recorded in the second and third quarters. The vast majority of our goodwill is not deductible for income tax purposes. We recognized tax benefits of $29.1 million and $59.1 million during the third quarter and nine fiscal months ended September 27, 2008, respectively, associated with the goodwill and indefinite-lived intangible asset impairment charges.
In connection with the repurchase of the convertible subordinated notes on August 1, 2008, we repatriated approximately $250 million of cash from non-U.S. subsidiaries. This repatriation of cash resulted in net tax expense of approximately $9.9 million, recorded in the third quarter of 2008, after the utilization of net operating losses and tax credits.
We operate in an international environment with significant operations in various locations outside the United States. Accordingly, the consolidated income tax rate is a composite rate reflecting our earnings and the applicable tax rates in the various locations where we operate. Part of our strategy is to achieve cost savings through the transfer and expansion of manufacturing operations to countries where we can take advantage of lower labor costs and available tax and other government-sponsored incentives. Accordingly, our effective tax rate is generally less than the U.S. statutory tax rate. Changes in the effective tax rate are largely attributable to changes in the mix of pretax income among our various taxing jurisdictions.
The effective tax rates reflect the fact that we could not recognize for accounting purposes the tax benefit of losses incurred in certain jurisdictions, although these losses are available to offset future taxable income. Under applicable accounting principles, we may not recognize deferred tax assets for loss carryforwards in jurisdictions where there is a recent history of cumulative losses, where there is no taxable income in the carryback period, where there is insufficient evidence of future earnings to overcome the loss history and where there is no other positive evidence, such as the likely reversal of taxable temporary differences, that would result in the utilization of loss carryforwards for tax purposes.
During the nine fiscal months ended September 27, 2008, the liabilities for unrecognized tax benefits decreased by a net $7.6 million, due principally to the settlement of tax audits (approximately $14.7 million), partially offset by increases for tax positions taken during the period (approximately $5.4 million) and foreign currency effects (approximately $1.9 million).
Income tax expense for the nine fiscal months ended September 29, 2007, includes additional tax expense of approximately $3.3 million for changes in uncertain tax positions related to tax positions taken in prior years. Income tax expense for the third quarter and nine fiscal months ended September 29, 2007 reflects a benefit of $0.8 million, representing the effects of adjusting deferred income taxes for a tax rate decrease enacted in Germany.
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Financial Condition, Liquidity, and Capital Resources
As more fully described in Note 6 to the consolidated condensed financial statements in Item 1, on August 1, 2008, Vishay repurchased substantially all of the convertible subordinated notes due 2023 for an aggregate purchase price of $498.1 million. The purchase price was paid in cash and funded from approximately $250 million of cash on-hand, $125 million of borrowings under the revolving credit facility, and $125 million from the term loan commitment.
The following table summarizes the components of net debt at September 27, 2008 and December 31, 2007(in thousands):
| | Sept. 27, | | December 31, |
| | 2008 | | 2007 |
| Convertible subordinated notes, due 2023 | $ | 1,870 | | $ | 500,000 |
| Exchangeable unsecured notes, due 2102 | | 105,000 | | | 105,000 |
| Credit facility - revolving debt | | 125,000 | | | - |
| Credit facility - term loan | | 125,000 | | | - |
| Other debt | | 2,156 | | | 3,583 |
| Total debt | | 359,026 | | | 608,583 |
| |
| Cash | | 312,021 | | | 537,295 |
| | | | | | |
| Net debt | $ | 47,005 | | $ | 71,288 |
Measurements such as “net debt” do not have a uniform definition and are not recognized in accordance with generally accepted accounting principles (“GAAP”). Such measures should not be viewed as an alternative to GAAP measures of performance or liquidity. However, management believes that an analysis of net debt assists investors in understanding aspects of our cash and debt management. This measure, as calculated by Vishay, may not be comparable to similarly titled measures used by other companies.
The early extinguishment of the notes will have a negligible impact on future net interest expense, as both interest expense and interest income will decrease.
We repatriated approximately $250 million of cash from our foreign subsidiaries in order to meet the obligation to repurchase the convertible subordinated notes due 2023 pursuant to the option of the holders on August 1, 2008. Substantially all of the September 27, 2008 cash and cash equivalents balance was held by our non-U.S. subsidiaries. Although we utilized cash and profits generated by our foreign subsidiaries to fund the repurchase transaction, at the present time, we expect the remaining cash and profits generated by foreign subsidiaries will continue to be reinvested indefinitely.
Our financial condition as of September 27, 2008 continued to be strong, with a current ratio (current assets to current liabilities) of 2.6 to 1, as compared to 2.9 to 1 as of December 31, 2007. The change in this ratio is principally due to a decrease in cash subsequent to the repurchase of the convertible subordinated notes on August 1, 2008 and increases in current maturities of debt due to the financing of a portion of that repurchase using the term loan described in Note 6 to our consolidated condensed financial statements. Our ratio of total debt to stockholders’ equity was 0.16 to 1 at September 27, 2008, as compared to 0.18 to 1 as of December 31, 2007. The change in this ratio reflects both the reduction of debt subsequent to the repurchase of the convertible subordinated notes and also the reduction of equity resulting from to the noncash goodwill and indefinite-lived intangible asset impairment charges recorded during the second and third quarters of 2008.
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Cash flows provided by continuing operating activities were $191.2 million for the nine fiscal months ended September 27, 2008, as compared to cash flows provided by operations of $210.4 million for the comparable prior year period. This decrease is principally due to less favorable operating results (adjusted for noncash expenses and charges), partially offset by smaller changes in net working capital during the nine fiscal months ended September 27, 2008 versus the comparable prior year period.
Cash used by discontinued operating activities of $10.4 million for the nine fiscal months ended September 27, 2008 primarily reflects receivables collected by Vishay and remitted to the purchaser of the ASBU business pursuant to the transaction agreement. Cash provided by discontinued investing activities reflects the proceeds of sale of the ASBU business, net of capital spending for information technology systems.
Cash paid for property and equipment for the nine fiscal months ended September 27, 2008 was $99.1 million, as compared to $107.8 million for the fiscal quarter ended September 29, 2007. Our total capital expenditures are projected to be between $150 million and $160 million for the full year 2008, principally to expand capacity in the Semiconductors businesses.
Cash paid for acquisitions for the nine fiscal months ended September 27, 2008 totaled $73.9 million for the acquisitions of our partner’s 51% interest in a transducer manufacturing joint venture, Powertron GmbH, and the KEMET wet tantalum business. This amount also includes a $15 million loan extended to KEMET as part of the wet tantalum business acquisition. Cash paid for acquisitions for the nine fiscal months ended September 29, 2007 was $331.8 million, representing the acquisitions of the PCS business and PM Group, net of cash acquired. Proceeds from sale of businesses of $18.7 million include approximately $16.1 million from the sale of PM Group’s electrical contracting business.
We maintain a credit facility, which provides a revolving commitment of up to $250 million through April 20, 2012. As more fully described in Note 6 to the consolidated condensed financial statements, we entered into an amendment to this credit facility to also provide a term loan commitment up to $125 million. This term loan commitment was drawn in July 2008 to fund a portion of the repurchase of the convertible subordinated notes and remains outstanding at September 27, 2008. We also utilized $125 million of our revolving credit facility to fund a portion of the repurchase of the convertible subordinated notes, which also remains outstanding at September 27, 2008. At December 31, 2007, there were no amounts outstanding under the credit facility.
Interest on the credit facility is payable at prime or other variable interest rate options. We are required to pay facility commitment fees. The credit facility also restricts us from paying cash dividends and requires us to comply with other covenants, including the maintenance of specific financial ratios. We were in compliance with all covenants at September 27, 2008.
Borrowings under the credit facility are secured by pledges of stock in certain significant subsidiaries and certain guarantees by significant subsidiaries. The subsidiaries would be required to perform under the guarantees in the event that Vishay failed to make principal or interest payments under the credit facility. Certain of our subsidiaries are permitted to borrow under the credit facility. Any borrowings by these subsidiaries under the credit facility are guaranteed by Vishay.
As described above, we have utilized the credit facility, including the new term loan commitment, to repurchase the convertible subordinated notes in August 2008. The timing and location of scheduled payments have also required us to draw on our revolving credit facilities from time to time over the past year. While the timing and location of scheduled payments for certain liabilities will require us to draw additional amounts on our credit facility from time to time, for the next twelve months, management expects that cash on-hand and cash flows from operations will be sufficient to meet our normal operating requirements, to meet our obligations under restructuring and acquisition integration programs, and to fund our research and development and capital expenditure plans. Acquisition activity may require additional borrowing under our credit facility or may otherwise require us to incur additional debt.
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Economic Outlook and Impact on Operations and Future Financial Results
A worldwide financial crisis became more pronounced and intensified significantly in September and October 2008. This has resulted in significant volatility in capital and commodities markets, decreased access to credit markets, and produced recessionary pressures through most of the world’s economies.
We believe that Vishay has adequate financial resources to weather a short-term recession, and we remain confident for the long-term prospects for the electronics industry. However, the factors driving the current economic crisis are different than in previous recessions, and as a result, there is limited historical experience available to guide our business strategy.
The worldwide financial crisis will have direct and indirect impacts on our business operations and the amounts reported in our consolidated financial statements. Many of these impacts are related to inherent risks of our business, as more fully described in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the year ended December 31, 2007. Specifically, these impacts could include, but are not limited to, the following:
Orders, Revenues, and Margins
A decline in product demand on a global basis could result in order cancellations and deferrals, lower total revenues, and lower average selling prices. Our customers may cancel orders if business is weak and their inventories are excessive. The prospect of a slowdown in demand or recessionary trends in the global economy makes it more difficult for us to predict our future sales and manage our operations.
Declines in demand are driven by market conditions in the end-use markets for our products. Changes in the demand mix, needed technologies, and these end-use markets may adversely affect our ability to match our products, inventory, and capacity to meet customer demand. This may result in a material increase in excess or obsolete inventory and excess capacity, which will reduce gross margins.
Prices of Raw Materials
The prices of certain raw materials used in our products, particularly precious metals, are highly volatile. For example, palladium, a metal used to produce certain capacitors, has fluctuated in a range from $168 to $588 per troy ounce during 2008. From time-to-time, we enter into purchase commitments to acquire these materials at fixed prices. For periods when the prices of these materials are declining, we may be required to record losses on adverse purchase commitments or write down our inventory carrying costs for these raw materials, because we record our inventory at the lower of cost or market. Depending on the extent of the difference between market price and our carrying cost or committed purchase price, this write-down could have a material adverse effect on our net earnings. For periods when the prices of these materials are increasing, we may be unable to pass on the increased cost to our customers, which would result in decreased margins for the products in which these materials are used.
Collectibility of Accounts Receivable
Due to Vishay’s large number of customers and their dispersion across many countries and industries, we have limited exposure to concentrations of credit risk. However, further deterioration of economic conditions could result in customers defaulting on payment or delaying payment, which could have a material impact on our cash flows and results of operations.
Acquisitions
As part of our growth strategy, we seek to expand through acquisition of other manufacturers of electronic components that have established positions in major markets, reputations for product quality and reliability, and product lines with which we have substantial marketing and technical expertise. Our ability to identify suitable acquisition targets and to successfully negotiate their acquisition may be limited. Furthermore, our ability to finance the acquisition of suitable targets may be limited, particularly in light of the current credit crisis.
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Access to Capital Markets
We presently have a revolving credit facility with approximately $125 million of unused borrowing capacity. We also have other committed and uncommitted lines of credit available on a short-term basis in various countries around the world. In light of the current environment, credit markets are functioning differently than in the past, with key interest rate spreads increasing substantially, and banks tightening lending standards. If Vishay were to require additional capital, either to sustain normal operations or to pursue a strategic acquisition, we may be unable to obtain financing on terms which we consider acceptable, if at all.
Interest Rates
We are exposed to changes in interest rates as a result of our borrowing activities and our cash balances. Our credit facility and our exchangeable notes due 2102 bear interest at variable rates based on LIBOR. LIBOR has increased from approximately 2.8% at the end of June 2008 to 4.1% at the end of September 2008, and has fluctuated between 3.3% and 4.6% during October 2008. A significant increase in LIBOR would significantly increase our interest expense. A general increase in interest rates would be largely offset by an increase in interest income earned on our cash balances. However, their can be no assurance that the interest rate earned on cash balances will move in tandem with the interest rate paid on our variable-rate debt.
Impairment of Goodwill and Long-Lived Assets
During 2008, we have recorded material impairment charges to reduce the carrying value of our goodwill, certain intangible assets, and certain property and equipment. These impairments are generally measured based on expected future cash flows. A material decline in market conditions could require us to assess whether or not our assets are further impaired, and may require additional, material impairment charges.
Capital Expenditures
To preserve cash, we might defer capital expenditures. This could limit our new product introductions or our ability to meet customer demands. When the economy rebounds, we may experience intense demand for our products. During such future periods, we may not have adequate manufacturing capacity, or we may have difficulty expanding our manufacturing capacity, to satisfy future demand.
Pension and Other Postretirement Benefits
Accounting for defined benefit pension and other postretirement plans involves numerous assumptions and estimates. The expected long-term rate of return on plan assets (for funded plans) and the discount rate at which obligations could effectively be settled are two critical assumptions in measuring the cost and benefit obligations of our pension and other postretirement benefit plans.
The expected return on plan assets is incorporated into the computation of pension expense. The difference between this expected return and the actual return on plan assets is deferred. The net deferral of past asset losses (gains) affects the calculated value of plan assets and, ultimately, future pension expense (income).
Events in financial markets have led to declines in the fair value of investment securities held by our pension plans. In addition, negative investment returns could ultimately affect the funded status of the plans, requiring additional cash contributions.
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Restructuring
Due to the recessionary pressures, we may be required to restructure our operations to reduce our cost structure and to remain competitive. In such restructuring programs, we seek to eliminate redundant facilities and staff positions and move operations, where possible, to jurisdictions with lower labor costs. During this process, we may experience under-utilization of certain plants in high-labor-cost regions and capacity constraints in plants located in low-labor-cost regions. This under-utilization may result initially in production inefficiencies and higher costs. These costs include those associated with compensation in connection with work force reductions and increased depreciation costs in connection with the initiation or expansion of production in lower-labor-cost regions. In addition, as we implement transfers of certain of our operations we may experience strikes or other types of labor unrest as a result of lay-offs or termination of our employees in high-labor-cost countries.
Income Taxes
We have recorded deferred tax assets representing future tax benefits, but may not be able to generate sufficient income to realize these future tax benefits in certain jurisdictions. A sustained decline in economic conditions could affect the ultimate realizability of these deferred tax assets.
Foreign Currency
Foreign currency exchange rates have fluctuated significantly over the past year. We are exposed to foreign currency exchange rate risks, particularly due to transactions in currencies other than the functional currencies of certain subsidiaries. See also “Foreign Currency Translation” above for additional discussion and analysis of the effects of foreign currency.
Contractual Commitments
Our Annual Report on Form 10-K includes a table of contractual commitments as of December 31, 2007. Material changes to these commitments which occurred in 2008 are described below.
Tower Purchase Commitments
We maintain long-term foundry agreements with subcontractors to ensure access to external front-end capacity for our semiconductor products. Our Siliconix division entered into an agreement in 2004 with Tower Semiconductor (the “2004 agreement”), pursuant to which we were required to place orders valued at approximately $200 million for the purchase of semiconductor wafers to be manufactured in Tower’s Fab 1 facility over a seven to ten year period. During 2007, Siliconix was committed to purchase approximately $22 million of semiconductor wafers, but did not meet its commitments due to changing market demand for products manufactured using wafers supplied by Tower. At December 31, 2007, the remaining future purchase commitments under the 2004 agreement were approximately $160 million.
In March 2008, Siliconix and Tower entered into an amended and restated foundry agreement (the “2008 agreement”). Pursuant to the 2008 agreement, Tower will continue to manufacture wafers covered by the 2004 agreement, but at lower quantities and at lower prices, through 2009. Tower will also begin manufacturing wafers for other product lines acquired as part of the PCS acquisition through 2012, pending a scheduled technology transfer. Siliconix must pay for any short-fall in the reduced minimum order quantities specified under the 2008 agreement through the payment of penalties equal to unavoidable fixed costs.
Management estimates its minimum purchase commitments under the 2008 agreement as follows(in thousands):
| 2008 | $ | 20,400 |
| 2009 | | 14,700 |
| 2010 | | 8,400 |
| 2011 | | 8,800 |
| 2012 | | 8,800 |
Siliconix has granted Tower an option to produce additional wafers under this agreement, as needed by Siliconix, and accordingly, actual purchases from Tower may be greater than the commitments disclosed above.
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These purchase commitments are for the manufacture of proprietary products using Siliconix-owned technology licensed to Tower by Siliconix, and accordingly, management can only estimate the “market price” of the wafers which are the subject of the 2008 agreement. Management believes that these commitments are at prices that are not in excess of current market prices.
Long-term Debt and Interest Payments on Long-term Debt
On August 1, 2008, Vishay repurchased substantially all of the convertible subordinated notes due 2023 for an aggregate purchase price of $498.1 million. The purchase price was paid in cash and funded from $250 million of cash on-hand, $125 million of borrowings under the revolving credit facility, and $125 million from the term loan commitment.
Based on the debt outstanding at September 27, 2008, future maturities of long-term debt and related interest payments are estimated as follows(in thousands):
| | Debt | | Interest |
| Remainder of 2008 | $ | 419 | | 4,872 |
| 2009 | | 25,345 | | 18,253 |
| 2010 | | 25,047 | | 17,433 |
| 2011 | | 75,000 | | 16,614 |
| 2012 | | 125,000 | | 8,918 |
| Thereafter | | 108,215 | | 383,706 |
Commitments for interest payments on long-term debt are based on the stated maturity dates of each agreement, one of which bears a maturity date of 2102. Various factors could have a material effect on the amount of future interest payments. These factors include the facts that $105 million of our debt is exchangeable for common stock (although the exchange ratio is based on a stock price which is substantially higher than the current market price), and that the variable-rate debt included in the table above are based on the rate prevailing at September 27, 2008. Commitments for interest payments on long-term debt also include commitment fess under our revolving credit facility, which expires in April 2012.
Recent Accounting Pronouncements
As more fully described in Note 14 to our consolidated condensed financial statements, several new accounting pronouncements became effective in 2008 or will become effective in future periods.
The adoption of SFAS No. 141-R,Business Combinations, effective January 1, 2009, will change the manner in which Vishay accounts for acquisitions. While this new standard will impact all companies, certain aspects of the new standard will have a particular impact on Vishay.
A primary tenet of our business strategy is the expansion within the electronic components industry through the acquisition of other manufacturers of electronic components that have established positions in major markets, reputations for product quality and reliability, and product lines with which we have substantial marketing and technical expertise. Our acquisition strategy relies upon reducing selling, general, and administrative expenses through the integration or elimination of redundant sales offices and administrative functions at acquired companies, and achieving significant production cost savings through the transfer and expansion of manufacturing operations to countries where we can benefit from lower labor costs and available tax and other government-sponsored incentives.
Under present accounting standards, plant closure and employee termination costs that we incur in connection with our acquisition activities are included in the costs of our acquisitions and do not affect earnings or losses on our statement of operations. SFAS No. 141-R will require such costs to be recorded as expenses in our statement of operations, as such expenses are incurred.
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The adoption of FSP APB 14-1,Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (including partial cash settlement) on January 1, 2009 will require retroactive restatement of interest expense for the years ended December 31, 2007 and 2008. For Vishay, this would represent imputed interest expense related to the convertible subordinated notes due 2023, which were substantially all repurchased in August 2008. The impact of FSP APB 14-1 on the remaining outstanding convertible notes is expected to be immaterial to future periods. Vishay will report an increase in interest expense associated with these notes for the full year of 2007 and the first three quarters of 2008. We are presently evaluating the quantitative impact of adoption of the FSP.
Except as described above, the adoption of the new standards described in Note 14 to our consolidated condensed financial statements is not expected to have a material effect on our financial position, results of operations, or liquidity.
Safe Harbor Statement
From time to time, information provided by us, including but not limited to statements in this report, or other statements made by or on our behalf, may contain “forward-looking” information within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve a number of risks, uncertainties, and contingencies, many of which are beyond our control, which may cause actual results, performance, or achievements to differ materially from those anticipated.
Such statements are based on current expectations only, and are subject to certain risks, uncertainties, and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. Among the factors that could cause actual results to materially differ include: general business and economic conditions, particularly in the markets that we serve; difficulties in integrating acquired companies, the inability to realize anticipated synergies and expansion possibilities, and other unanticipated conditions adversely affecting the operation of these companies; difficulties in new product development;changes in competition and technology in the markets that we serve and the mix of our products required to address these changes; an inability to attract and retain highly qualified personnel, particularly in respect of our acquired businesses; changes in foreign currency exchange rates; difficulties in implementing our cost reduction strategies such as labor unrest or legal challenges to our lay-off or termination plans, underutilization of production facilities in lower-labor-cost countries, operation of redundant facilities due to difficulties in transferring production to lower-labor-cost countries;and other factors affecting our operations, markets, products, services, and prices that are set forth in our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission (the “SEC”). We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
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Item 3.Quantitative and Qualitative Disclosures About Market Risk
We are exposed to changes in interest rates as a result of our borrowing activities and our cash balances.
We had no interest rate exposure to our convertible subordinated notes, as the interest payable on these notes was fixed. On August 1, 2008, we repurchased substantially all of the convertible subordinated notes for an aggregate purchase price of $498.1 million. We utilized approximately $250 million of cash on-hand, $125 million borrowed under the revolving credit commitment under our credit facility, and $125 million from a new term loan under the credit facility to fund the purchase price.
We are exposed to changes in interest rates on our credit facility. At December 31, 2007, there were no amounts outstanding under the credit facility. At September 27, 2008, we had $125 million outstanding under the revolving credit facility and $125 million outstanding under the term loan facility, due to the repurchase of the convertible subordinated notes. Cash utilized under the revolving credit facility for the repurchase of the convertible subordinated notes bears interest at LIBOR plus 1.00%, and cash utilized under the term loan commitment for the repurchase of the convertible subordinated notes bears interest at LIBOR plus 2.50%.
At September 27, 2008 and December 31, 2007, we had cash totaling $312.0 million and $537.3 million, respectively. Our cash balance was reduced by approximately $250 million by the repurchase of the convertible subordinated notes in August 2008.
We are also exposed to interest rate changes with respect to our variable rate exchangeable notes, which bear interest at LIBOR, reset quarterly. The aggregate principal amount of the exchangeable notes is $105 million.
Based on the debt and cash positions at September 27, 2008, we would expect a 50 basis point increase or decrease in interest rates to increase or decrease our annualized net earnings by approximately $0.6 million.
See Note 6 to our consolidated financial statements, included in our annual report on Form 10-K, and Note 6 to our consolidated condensed financial statements included in Item 1 of this quarterly report on Form 10-Q for additional information about our long-term debt.
See “Economic Outlook and Impact on Operations and Future Financial Results” included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional discussion of market risks.
Except as described above, there have been no material changes in the market risks previously disclosed in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on February 27, 2008.
Item 4.Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are: (1) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms; and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1.Legal Proceedings
Not applicable.
Item 1A.Risk Factors
See “Economic Outlook and Impact on Operations and Future Financial Results” included in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional discussion and analysis of market risks, which is hereby incorporated by reference.
Except as incorporated by reference above, there have been no material changes from the risk factors previously disclosed in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on February 27, 2008.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3.Defaults Upon Senior Securities
Not applicable.
Item 4.Submission of Matters to a Vote of Security Holders
None.
Item 5.Other Information
Not applicable.
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Item 6. Exhibits
| 2.1 | | Asset Purchase Agreement dated as of September 15, 2008, by and between KEMET Electronics Corporation (a wholly-owned subsidiary of KEMET Corporation) and Siliconix Technology C.V. (a wholly-owned subsidiary of Vishay Intertechnology, Inc.). |
| |
| 10.1 | | Loan Agreement dated as of September 15, 2008, between KEMET Electronics Corporation and Vishay Intertechnology, Inc. |
| |
| 10.2 | | Pledge and Security Agreement dated as of September 15, 2008 made by KEMET Electronics Corporation in favor of Vishay Intertechnology, Inc. |
| | | |
| 31.1 | | Certification pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Dr. Gerald Paul, Chief Executive Officer. |
| | | |
| 31.2 | | Certification pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Dr. Lior E. Yahalomi, Chief Financial Officer. |
| | | |
| 32.1 | | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Dr. Gerald Paul, Chief Executive Officer. |
| |
| 32.2 | | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Dr. Lior E. Yahalomi, Chief Financial Officer. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| VISHAY INTERTECHNOLOGY, INC. |
| |
| |
| /s/ Lior E. Yahalomi | |
| Dr. Lior E. Yahalomi |
| Executive Vice President and Chief Financial Officer |
| (as a duly authorized officer and principal financial officer) |
| |
| |
| /s/ Lori Lipcaman | |
| Lori Lipcaman |
| Executive Vice President and Chief Accounting Officer |
| (as a duly authorized officer and principal accounting officer) |
Date: November 4, 2008
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