1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTER ENDED JULY 1, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO ________
COMMISSION FILE NUMBER: 0-11674
LSI LOGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-2712976
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
1551 MCCARTHY BOULEVARD
MILPITAS, CALIFORNIA 95035
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 433-8000
(REGISTRANT'S TELEPHONE NUMBER)
-----------------------
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 [X] NO [ ]
As of August 8, 2001, there were 365,957,004 of the registrant's Common
Stock, $.01 par value, outstanding.
2
LSI LOGIC CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2001
INDEX
PAGE
NO.
------
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets -- June 30, 2001 and
December 31, 2000 3
Consolidated Statements of Operations -- Three and Six
Months Ended June 30, 2001 and 2000 4
Consolidated Statements of Cash Flows -- Six Month
Periods Ended June 30, 2001 and 2000 5
Notes to Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations 19
Item 3 Quantitative and Qualitative Disclosures About Market Risk 30
PART II. OTHER INFORMATION
Item 1 Legal Proceedings 31
Item 4 Submission of Matters to a Vote of Security Holders 31
Item 5 Other Information 32
Item 6 Exhibits and Reports on Form 8-K 32
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PART I
ITEM 1. FINANCIAL STATEMENTS
LSI LOGIC CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
(In thousands, except per-share amounts) 2001 2000
----------- -----------
ASSETS
Cash and cash equivalents $ 317,909 $ 235,895
Short-term investments 823,796 897,347
Accounts receivable, less allowances of $13,266 and $8,297 301,220 522,729
Inventories 355,680 290,375
Deferred tax assets 54,654 54,552
Prepaid expenses and other current assets 187,033 71,342
----------- -----------
Total current assets 2,040,292 2,072,240
Property and equipment, net 1,133,926 1,278,683
Goodwill and other intangibles 1,232,184 580,861
Other assets 318,696 265,703
----------- -----------
Total assets $ 4,725,098 $ 4,197,487
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 183,682 $ 268,215
Accrued salaries, wages and benefits 81,101 87,738
Other accrued liabilities 267,930 181,199
Income tax payable 38,114 88,752
Current portion of long-term obligations 433 1,030
----------- -----------
Total current liabilities 571,260 626,934
----------- -----------
Deferred tax liabilities 130,616 130,616
Other long-term obligations 967,359 936,058
----------- -----------
Total long-term obligations and deferred tax liabilities 1,097,975 1,066,674
----------- -----------
Commitments and contingencies (Note 11)
Minority interest in subsidiaries 5,743 5,742
----------- -----------
Stockholders' equity:
Preferred shares; $.01 par value; 2,000 shares authorized -- --
Common stock; $.01 par value; 1,300,000 shares authorized;
365,250 and 321,523 shares outstanding 3,653 3,215
Additional paid-in capital 2,852,410 1,931,564
Deferred stock compensation (163,211) (163,045)
Retained earnings 328,423 672,152
Accumulated other comprehensive income 28,845 54,251
----------- -----------
Total stockholders' equity 3,050,120 2,498,137
----------- -----------
Total liabilities and stockholders' equity $ 4,725,098 $ 4,197,487
=========== ===========
See notes to unaudited consolidated financial statements.
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LSI LOGIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
(In thousands, except per share amounts) 2001 2000 2001 2000
----------- ----------- ----------- -----------
Revenues $ 465,219 $ 644,328 $ 982,418 $ 1,259,514
----------- ----------- ----------- -----------
Costs and expenses:
Cost of revenues 284,759 367,978 595,904 722,378
Additional excess inventory charges 108,026 -- 108,026 11,100
Research and development 127,412 86,801 246,179 167,030
Selling, general and administrative 77,480 75,079 156,451 145,319
Acquired in-process research and 77,500 16,333 77,500 16,333
development
Restructuring of operations and
other non-recurring charges, net 59,839 -- 59,839 2,781
Amortization of non-cash deferred
stock compensation(*) 27,840 -- 49,107 --
Amortization of intangibles 43,469 13,820 70,558 25,656
----------- ----------- ----------- -----------
Total costs and expenses 806,325 560,011 1,363,564 1,090,597
----------- ----------- ----------- -----------
(Loss)/income from operations (341,106) 84,317 (381,146) 168,917
Interest expense (9,864) (10,323) (19,804) (21,216)
Interest income and other, net 3,742 11,507 12,721 18,636
Gain on sale of equity securities -- 15,314 5,302 49,486
----------- ----------- ----------- -----------
(Loss)/income before income taxes (347,228) 100,815 (382,927) 215,823
(Benefit)/provision for income taxes (34,747) 30,239 (39,198) 59,004
----------- ----------- ----------- -----------
Net (loss)/income $ (312,481) $ 70,576 $ (343,729) $ 156,819
=========== =========== =========== ===========
(Loss)/earnings per share:
Basic $ (0.91) $ 0.23 $ (1.03) $ 0.51
=========== =========== =========== ===========
Dilutive $ (0.91) $ 0.21 $ (1.03) $ 0.46
=========== =========== =========== ===========
Shares used in computing per share amounts:
Basic 344,873 308,275 332,728 305,464
=========== =========== =========== ===========
Dilutive 344,873 353,120 332,728 351,155
=========== =========== =========== ===========
(*) Amortization of non-cash deferred stock compensation, if not shown
separately, of $685, $19,625 and $7,530 would have been included in cost of
revenues, research and development and selling, general and administrative
expenses respectively for the three months ended June 30, 2001. Amortization of
non-cash deferred stock compensation, if not shown separately, of $848, $36,707
and $11,552 would have been included in cost of revenues, research and
development and selling, general and administrative expenses, respectively for
the six months ended June 30, 2001.
See notes to unaudited consolidated financial statements.
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5
LSI LOGIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended
June 30,
---------------------------
(In thousands) 2001 2000
---------- ----------
Operating activities:
Net (loss)/income $ (343,729) $ 156,819
Adjustments:
Depreciation and amortization 243,614 187,798
Amortization of non-cash deferred stock compensation 49,107 --
Acquired in-process research and development 77,500 14,745
Non-cash restructuring charges, net 59,517 2,781
Gain on sale of equity securities (5,302) (49,486)
Changes in working capital components, net of assets
acquired and liabilities assumed in business combinations:
Accounts receivable, net 237,013 (126,135)
Inventories, net (54,763) (43,037)
Prepaid expenses and other assets (48,477) (51,678)
Accounts payable (91,166) (13,237)
Accrued and other liabilities (19,349) 53,075
---------- ----------
Net cash provided by operating activities 103,965 131,645
---------- ----------
Investing activities:
Purchase of debt and equity securities available-for-sale (923,378) (684,199)
Maturities and sales of debt and equity securities 941,687 485,534
available-for-sale
Purchase of equity securities (10,819) (6,035)
Proceeds from sale of stock investments 7,926 45,741
Purchases of property and equipment, net of retirements (125,635) (83,537)
Acquisition of companies, net of cash acquired 43,979 (37,565)
---------- ----------
Net cash used in investing activities (66,240) (280,061)
---------- ----------
Financing activities:
Proceeds from borrowings -- 500,000
Repayment of debt obligations (869) (375,786)
Debt issuance costs -- (15,300)
Issuance of common stock, net 44,367 90,166
---------- ----------
Net cash provided by financing activities 43,498 199,080
---------- ----------
Effect of exchange rate changes on cash and cash equivalents 791 (6,130)
---------- ----------
Increase in cash and cash equivalents 82,014 44,534
---------- ----------
Cash and cash equivalents at beginning of period 235,895 250,603
---------- ----------
Cash and cash equivalents at end of period $ 317,909 $ 295,137
---------- ----------
See notes to unaudited consolidated financial statements.
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LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BASIS OF PRESENTATION
In the opinion of LSI Logic Corporation (the "Company" or "LSI"), the
accompanying unaudited consolidated financial statements contain all adjustments
(consisting only of normal recurring adjustments, except for additional excess
inventory charges, acquired in-process research and development and
restructuring and other non-recurring charges as discussed in Notes 2 and 3),
necessary to present fairly the financial information included therein. While
the Company believes that the disclosures are adequate to make the information
not misleading, it is suggested that these financial statements be read in
conjunction with the audited consolidated financial statements and accompanying
notes included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
For financial reporting purposes, the Company reports on a 13 or 14 week
quarter with a year ending December 31. For presentation purposes, the
consolidated financial statements refer to the quarter's calendar month end for
convenience. The results of operations for the quarter ended June 30, 2001 are
not necessarily indicative of the results to be expected for the full year.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from these estimates.
NOTE 2 -- ACQUISITIONS
ACQUISITION OF C-CUBE. On March 26, 2001, the Company signed a definitive
merger agreement ("Merger Agreement") to acquire C-Cube Microsystems Inc.
("C-Cube"). In accordance with the Merger Agreement, the Company commenced an
exchange offer whereby it offered 0.79 of a share of common stock for each
outstanding share of C-Cube common stock. Under the terms of the Merger
Agreement, the exchange offer was followed by a merger in which the Company
acquired, at the same exchange ratio, the remaining shares of C-Cube common
stock not previously acquired in the exchange offer. Upon completion of the
merger, the Company assumed all options and warrants to purchase shares of
C-Cube common stock and converted them into options and warrants to purchase
shares of the Company's common stock. The merger was subject to customary
closing conditions, including the tender for exchange of at least a majority of
C-Cube's outstanding shares of common stock (including for purposes of the
calculation of the majority of shares, certain outstanding options and warrants
to purchase C-Cube shares.) The acquisition was effective May 11, 2001.
The Company issued approximately 40.2 million shares of its common stock,
10.6 million options and 0.8 million warrants in exchange for the outstanding
ordinary shares, options and warrants of C-Cube, respectively. The acquisition
is intended to enhance and accelerate the Company's digital video product
offerings in the Semiconductor segment.
The acquisition was accounted for as a purchase. Accordingly, the results of
operations of C-Cube and estimated fair value of assets acquired and liabilities
assumed were included in the Company's consolidated financial statements as of
May 11, 2001 through the end of the period.
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The components of purchase price are as follows (in thousands):
Fair value of common shares issued $ 752,557
Fair value of options assumed 116,174
Fair value of warrants assumed 8,121
Direct acquisition costs 16,856
----------
Total purchase price $ 893,708
==========
The fair value of common shares issued was determined using a price of
approximately $18.73, which represents the average closing stock price for the
period of two days before and after the announcement of the merger. The fair
value of the options and warrants assumed was determined using the Black-Scholes
method. The portion of the intrinsic value of unvested options of C-Cube
relating to the vesting period following consummation of the transaction has
been allocated to deferred stock compensation. The Company calculated the
intrinsic value of the unvested options using the closing price of its common
stock on the date of consummation of the merger. Deferred stock compensation is
included as a component of stockholders' equity and will be amortized over the
remaining vesting period of the options. Direct acquisition costs consist of
investment banking, legal and accounting fees.
The total purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed based on independent appraisals and
management estimates as follows (in thousands):
Tangible net assets acquired $ 64,315
Acquired in-process research and development 77,500
Current technology 74,000
Trademarks 20,500
Assembled workforce 36,000
Excess of purchase price over net assets acquired 572,120
----------
Total purchase price excluding deferred stock compensation 844,435
Deferred stock compensation 49,273
----------
Total purchase price $ 893,708
==========
In-process research and development. In connection with the purchase of
C-Cube, the Company recorded a $77.5 million charge to in-process research and
development. The amount was determined by identifying research projects for
which technological feasibility had not been established and no alternative
future uses existed. As of the acquisition date, there were various projects
that met the above criteria. The primary projects identified consisted of
digital video disc ("DVD"), recordable digital video ("DVD-R"), Consumer
Set-Top Box and Cable Modem.
The value of the projects identified to be in progress was determined by
estimating the future cash flows from the projects once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value. The net cash flows from the
identified projects were based on estimates of revenues, cost of revenues,
research and development costs, selling general and administrative costs and
applicable income taxes for the projects. The percentage of completion for the
projects was determined based on research and development expenses incurred as
of May 11, 2001 for the projects as a percentage of total research and
development expenses to bring the projects to technological feasibility. The
discount rate used was 27.5% for these projects. The development of these
projects started in early 1999. As of May 11, 2001, the Company estimated the
projects were approximately 84%, 62%, 61% and 69% complete for DVD, DVD-R,
Consumer Set-Top Box and Cable Modem, respectively.
Development of the technology remains a substantial risk to the Company due
to factors including the remaining effort to achieve technological feasibility,
rapidly changing customer markets and competitive threats from other companies.
Additionally, the value of other intangible assets acquired may become impaired.
Useful life of intangible assets. The amount allocated to current
technology, trademarks, assembled workforce and excess of purchase price over
net assets acquired is being amortized over their estimated weighted average
useful life of six years using the straight-line method.
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8
Pro forma results. The following pro forma summary is provided for
illustrative purposes only and is not necessarily indicative of the consolidated
results of operations for future periods or that actually would have been
realized had the Company and C-Cube been a consolidated entity during the
periods presented. The summary combines the results of operations as if C-Cube
had been acquired as of the beginning of the periods presented.
The summary includes the impact of certain adjustments such as amortization
of intangibles and non-cash deferred stock compensation. Additionally, the
in-process research and development charge of $77.5 million discussed above has
been excluded from the periods presented as it arose from the acquisition of
C-Cube. The restructuring and other non-recurring charges of $60 million were
included in the pro forma calculation as the charges did not relate to the
acquisition of C-Cube (See Note 3 of the Notes.)
SIX MONTHS ENDED JUNE 30,
2001 2000
------------ ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT
PER-SHARE AMOUNTS)
-------------------------------
Revenues ..................... $ 1,000,275 $ 1,381,559
Net (loss)/ income ........... $ (324,665) $ 79,064
Basic EPS .................... $ (0.90) $ 0.23
Diluted EPS .................. $ (0.90) $ 0.21
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued FASB
Statements Nos. 141 and 142 (SFAS 141 and SFAS 142), "Business Combinations" and
"Goodwill and Other Intangible Assets." SFAS 141 replaces APB 16 and eliminates
pooling-of-interests accounting prospectively. It also provides guidance on
purchase accounting related to the recognition of intangible assets and
accounting for negative goodwill. SFAS 142 changes the accounting for goodwill
from an amortization method to an impairment-only approach. Under SFAS 142,
goodwill will be tested annually and whenever events or circumstances occur
indicating that goodwill might be impaired. SFAS 141 and SFAS 142 are effective
for all business combinations completed after June 30, 2001. Upon adoption of
SFAS 142, amortization of goodwill recorded for business combinations
consummated prior to July 1, 2001 will cease, and intangible assets acquired
prior to July 1, 2001 that do not meet the criteria for recognition under SFAS
141 will be reclassified to goodwill. Companies are required to adopt SFAS 142
for fiscal years beginning after December 15, 2001, but early adoption is
permitted. The Company will adopt SFAS 142 on January 1, 2002, the beginning of
fiscal 2002. In connection with the adoption of SFAS 142, the Company will be
required to perform a transitional goodwill impairment assessment. The Company
has not yet determined the impact these standards will have on its results of
operations and financial position.
NOTE 3 -- RESTRUCTURING AND OTHER NON-RECURRING ITEMS
The Company recorded approximately $60 million in restructuring and other
non-recurring charges during the three months ended June 30, 2001. Total
restructuring charges were $52 million and other non-recurring charges were
approximately $8 million for the three months ending June 30, 2001.
Restructuring:
In April of 2001, the Company announced the closure of the Company's
Colorado Springs fabrication facility ("the facility") in August of 2001. In May
of 2001, the Company entered into a definitive agreement to sell the facility to
X-FAB Semiconductor Foundries AG ("X-Fab"), a German corporation. As part of the
agreement, the Company agreed to purchase a minimum amount of production wafers
and die from the facility for a period of 18 months following the close of the
transaction. During the quarter ended June 30, 2001, the Company recorded an
impairment charge of $71 million relating to the facility of which approximately
$35 million was recorded in cost of sales and $36 million was recorded in
restructuring charges. The restructuring charges consisted of fixed asset
8
9
write-downs due to impairment, losses on an operating lease for equipment,
severance for approximately 413 employees and other exit costs. On August 1,
2001, the Company announced the termination of the agreement to sell the
facility because X-Fab was unable to secure the required funding to close the
transaction. The facility is currently scheduled to close in October of 2001.
The Company is continuing its efforts to dispose of the facility and estimates
that its reserves as of June 30, 2001 are adequate to cover losses associated
with the disposal of the facility. The Company reclassified approximately $96
million from property, plant and equipment to other current assets to reflect
the intention to dispose of the facility within the next twelve months.
The Company recorded approximately $16 million in additional restructuring
charges primarily associated with the write-down of fixed assets in the U.S.,
Japan and Hong Kong that will be disposed of and severance charges for
approximately 243 employees in the U.S., Europe and Asia Pacific.
The fair value of assets determined to be impaired was the result of
independent appraisals and the use of management estimates. Given that current
market conditions for the sale of older fabrication facilities and related
equipment may continue to deteriorate, there can be no assurance that the
company will realize its current net book value for the assets. The Company will
reassess the realizability of the carrying value of these assets at the end of
each quarter until the assets are sold or otherwise disposed of and additional
adjustments may be necessary.
The following table sets forth the Company's restructuring reserves as of
June 30, 2001:
(In thousands) Restructuring Balance
Expense June 30,
June 30, 2001 Utilized 2001
------------- ---------- ----------
Write-down of excess assets(a) $ 22,920 $ (21,513) $ 1,407
Lease terminations and maintenance contracts 14,253 14,253
Other exit costs 7,742 7,742
Payments to employees for severance(b) 6,848 (2,764) 4,084
---------- ---------- ----------
Total $ 51,763 $ (24,277) $ 27,486
========== ========== ==========
(a) Amounts utilized in 2001 reflect a write-down of fixed assets in the U.S.,
Japan and Hong Kong due to impairment. The amounts were accounted for as a
reduction of the assets and did not result in a liability. The $1.4 million
balance as of June 30, 2001 relates to machinery and equipment
decommissioning costs in the U.S.
(b) Amounts utilized represent cash payments related to the severance of 230
employees during the second quarter of 2001.
Other non-recurring:
The Company recorded approximately $8 million in other non-recurring
charges associated with the write-down of intangible assets due to impairment.
The majority of the intangible assets were originally acquired in the purchase
of a division of Neomagic in the second quarter of 2000.
On February 22, 2000, the Company entered into an agreement with a third
party to outsource certain testing services performed by the Company at its
Fremont, California facility. The agreement provided for the sale and transfer
of certain test equipment and related peripherals for total proceeds of
approximately $10.7 million. The Company recorded a loss of approximately $2.2
million associated with the agreement. In March 2000, the Company recorded
approximately $1.1 million of non-cash compensation-related expenses resulting
from a separation agreement entered into during the quarter with a former
employee and a $0.5 million benefit from the reversal of reserves established in
the second quarter of 1999 for merger related expenses in connection with the
merger with SEEQ Technology, Inc. ("SEEQ").
9
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In the second quarter of 1999, the Company and Silterra Malaysia Sdn. Bhd.
(formerly known as Wafer Technology (Malaysia) Sdn. Bhd.) ("Silterra") entered
into a technology transfer agreement under which the Company grants licenses to
Silterra with respect to certain of the Company's wafer fabrication technologies
and provides associated manufacturing training and related services. In
exchange, the Company receives cash and equity consideration valued at $120
million over three years for which transfers and obligations of the Company are
scheduled to occur. The Company transferred technology to Silterra valued at $6
million for each of the three month periods ended June 30, 2001 and 2000 and $12
million for each of the six month periods ended June 30, 2001 and 2000. The
amount was recorded as an offset to the Company's R&D expenses. In addition, the
Company provided engineering training with a value of $1 million for each of the
three month periods ended June 30, 2001 and 2000, and $2 million for each of the
six month periods ended June 30, 2001 and 2000. The amount was recorded as an
offset to cost of revenues.
NOTE 5 -- INVESTMENTS
As of June 30, 2001 and December 31, 2000, the Company held $132 million
and $89 million of debt securities, respectively, that were included in cash and
cash equivalents and $824 million and $897 million of debt and equity
securities, respectively, that were classified as short-term investments on the
Company's consolidated balance sheet. Debt securities consisted primarily of
U.S. and foreign corporate debt securities, commercial paper, auction rate
preferred stock, overnight deposits, certificates of deposit and U.S. government
and municipal agency securities. Unrealized holding gains and losses of
held-to-maturity securities and available-for-sale debt securities were not
significant and accordingly the amortized cost of these securities approximated
fair market value at June 30, 2001 and December 31, 2000. Contract maturities of
these securities were within one year as of June 30, 2001. Realized gains and
losses for held-to-maturity securities and available-for-sale debt securities
were not significant for the three month periods ended June 30, 2001 and 2000.
As of June 30, 2001 and December 31, 2000, the Company had marketable
equity securities with an aggregate carrying value of $50 million and $66
million, respectively, of which all securities were classified as other
long-term assets at June 30, 2001 and $60 million were classified as short-term
investments on the Company's consolidated balance sheet at December 31, 2000.
The remaining balance was included in other long-term assets. As of June 30,
2001, an unrealized gain of $25 million, net of the related tax effect of $13
million, related to these equity securities was included in accumulated other
comprehensive income. As of December 31, 2000, an unrealized gain of $31
million, net of the related tax effect of $17 million, on these equity
securities was included in accumulated other comprehensive income. During the
three month period ended June 30, 2001, the Company did not sell any equity
securities. During the six month period ended June 30, 2001, the Company sold
equity securities for approximately $8 million in the open market, realizing a
pre-tax gain of approximately $5 million. During the three and six month periods
ended June 30, 2000, the Company sold equity securities for approximately $16
million and $46 million, respectively, in the open market, realizing a pre-tax
gain of approximately $15 million and $42 million, respectively. In addition,
the Company realized a pre-tax loss of approximately $7 million associated with
a marketable equity investment in a certain technology company during the three
months ended June 30, 2001. The
10
11
decline in value of the investment was considered by management to be other than
temporary. The Company realized a pre-tax gain of approximately $7 million
associated with equity securities of a certain technology company that was
acquired by another technology company during the six month period ended June
30, 2000. The Company does not anticipate selling any marketable equity
securities in the second half of 2001.
NOTE 6 -- DERIVATIVE FINANCIAL INSTRUMENTS
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
by SFAS No. 137 and 138 as of January 1, 2001. SFAS No. 133 requires that an
entity recognizes all derivatives as either assets or liabilities in the
statement of financial position and measures those instruments at fair value. It
further provides criteria for derivative instruments to be designated as fair
value, cash flow and foreign currency hedges and establishes respective
accounting standards for reporting changes in the fair value of the instruments.
All of the Company's derivative instruments are recorded at their fair value in
other current assets or other accrued liabilities. The transition adjustment
upon adoption of SFAS No. 133 was not material.
On the date a derivative contract is entered into, the Company designates
its derivative as either a hedge of the fair value of a recognized asset or
liability ("fair-value" hedge), as a hedge of the variability of cash flows to
be received ("cash-flow" hedge), or as a foreign-currency hedge. Changes in the
fair value of a derivative that is highly effective, and is designated and
qualifies as a fair-value hedge, along with the loss or gain on the hedged asset
or liability that is attributable to the hedged risk (including losses or gains
on firm commitments), are recorded in current period earnings. Changes in the
fair value of a derivative that is highly effective, and is designated and
qualifies as a cash-flow hedge, are recorded in other comprehensive income,
until earnings are affected by the variability of the cash flows. Changes in the
fair value of derivatives that are highly effective as, and are designated and
qualify as a foreign-currency hedge, are recorded in either current period
earnings or other comprehensive income, depending on whether the hedge
transaction is a fair-value hedge (e.g., a hedge of a firm commitment that is to
be settled in a foreign currency) or a cash-flow hedge (e.g., a
foreign-currency-denominated forecasted transaction). As of June 30, 2001, the
Company had certain foreign currency fair-value and cash-flow hedges
outstanding. The Company's derivative instruments at December 31, 2000 were
designated as foreign currency fair-value hedges.
The Company formally documents all relationships between hedging instruments
and hedged items, as well as its risk management objective and strategy for
undertaking various hedge transactions. This process includes linking all
derivatives that are designated as fair-value, cash-flow or foreign-currency
hedges to specific assets and liabilities on the balance sheet or to specific
firm commitments or forecasted transactions. The Company also assesses, both at
the hedge's inception and on an ongoing basis, whether the derivatives that are
used in hedging transactions are highly effective in offsetting changes in fair
values or cash flows of the hedged items. If it were determined that a
derivative is not highly effective as a hedge or that it has ceased to be a
highly effective hedge, the Company would discontinue hedge accounting
prospectively, as discussed below.
The Company would discontinue hedge accounting prospectively when (1) it is
determined that the derivative is no longer effective in offsetting changes in
the fair value or cash flows of a hedged item (including firm commitments or
forecasted transactions); (2) the derivative expires or is sold, terminated or
exercised; (3) the derivative is no longer designated as a hedge instrument,
because it is unlikely that a forecasted transaction will occur; (4) the hedged
firm commitment no longer meets the definition of a firm commitment; or (5)
management determines that designation of the derivative as a hedge instrument
is no longer appropriate.
When hedge accounting is discontinued because it is determined that the
derivative no longer qualifies as an effective fair-value hedge, the derivative
will continue to be carried on the balance sheet at its fair value, and the
hedged asset or liability will no longer be adjusted for changes in fair value.
When hedge accounting is discontinued because the hedged item no longer meets
the definition of a firm commitment, the derivative will continue to be carried
on the balance sheet at its fair value, and any asset or liability that was
recorded pursuant to recognition of the firm commitment will be removed from
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12
the balance sheet and recognized as a gain or loss in current-period earnings.
When hedge accounting is discontinued because it is probable that a forecasted
transaction will not occur, the derivative will continue to be carried on the
balance sheet at its fair value, and gains and losses that were accumulated in
other comprehensive income will be recognized immediately in earnings. In all
other situations in which hedge accounting is discontinued, the derivative will
be carried as its fair value on the balance sheet, with changes in its fair
value recognized in current period earnings.
The Company has foreign subsidiaries that operate and sell the Company's
products in various global markets. As a result, the Company is exposed to
changes in foreign currency exchange rates and interest rates. The Company
utilizes various hedge instruments, primarily forward contracts and currency
option contracts, to manage its exposure associated with firm intercompany and
third-party transactions and net asset and liability positions denominated in
non-functional currencies. The Company does not hold derivative financial
instruments for speculative or trading purposes.
Forward contracts
Forward contracts are used to hedge certain cash flows denominated in
non-functional currencies. These contracts expire within one to seven month
periods and are designated as foreign currency fair-value hedges in accordance
with SFAS No. 133. Changes in the fair value of forward contracts due to changes
in time value are excluded from the assessment of effectiveness and are
recognized in other income and expense. For the three and six months ended June
30, 2001, the change in time value of the forward contracts was not significant.
The Company did not record any gains or losses due to hedge ineffectiveness for
the three and six month periods ended June 30, 2001.
Forward exchange contracts are also used to hedge certain foreign currency
denominated assets or liabilities. These derivatives do not qualify for SFAS No.
133 hedge accounting treatment. Accordingly, changes in the fair value of these
hedges are recorded immediately in earnings to offset the changes in fair value
of the assets or liabilities being hedged. The related gains and losses included
in other income and expense was not significant.
Option contracts
As of June 30, 2001, the Company held purchased currency option contracts
that were designated as foreign currency cash-flow hedges of third-party yen
revenue exposures. There were no option contracts outstanding as of December 31,
2000. Changes in the fair value of currency option contracts due to changes in
time value are excluded from the assessment of effectiveness and are recognized
in other income and expense. For the three and six months ended June 30, 2001,
the change in option time value was $1.7 million and $3.3 million, respectively.
The contracts expire over a six month period. For the three and six months ended
June 30, 2001, an amount of $1.3 million was reclassified to revenue. Unrealized
gains of $4.9 million were included in accumulated other comprehensive income
and will be reclassified to revenue over the next six month period as the
forecasted transactions occur. The Company did not record any gains or losses
due to hedge ineffectiveness for the three and six month periods ended June 30,
2001.
NOTE 7 -- BALANCE SHEET DETAIL
June 30, December 31,
(In thousands) 2001 2000
---------- ----------
Inventories:
Raw materials $ 41,060 $ 36,133
Work-in-process 103,311 129,394
Finished goods 211,309 124,848
---------- ----------
$ 355,680 $ 290,375
========== ==========
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During the second quarter of 2001, the Company wrote-down certain
inventory. This additional excess inventory charge was due to a sudden and
significant decrease in forecasted revenue and was calculated in accordance with
the Company's policy, which is primarily based on inventory levels in excess of
12-month demand for each specific product and the use of management judgment.
NOTE 8 --DEBT
June 30, December 31,
(In thousands) 2001 2000
------------ ------------
2000 Convertible Subordinated Notes $ 500,000 $ 500,000
1999 Convertible Subordinated Notes 344,935 345,000
Capital lease obligations 1,472 2,341
------------ ------------
846,407 847,341
Current portion of long-term debt, capital lease obligations
and short-term borrowings (433) (1,030)
------------ ------------
Long-term debt and capital lease obligations $ 845,974 $ 846,311
============ ============
On March 14, 2001, the Second Amended and Restated Credit Agreement was
amended to reduce the total revolving commitment by $165 million from $240
million to $75 million. On the effective date of this reduction, the revolving
commitment of each lender was reduced accordingly.
On February 18, 2000, the Company issued $500 million of 4% Convertible
Subordinated Notes (the "2000 Convertible Notes") due in 2005. The 2000
Convertible Notes are subordinated to all existing and future senior debt, are
convertible, at the option of the holder, at any time into shares of the
Company's common stock at a conversion price of $70.2845 per share and are
redeemable at the Company's option, in whole or in part, at any time on or after
February 20, 2003. Each holder of the 2000 Convertible Notes has the right to
cause the Company to repurchase all of such holder's convertible notes at 100%
of their principal amount plus accrued interest upon the occurrence of certain
events and in certain circumstances. Interest is payable semiannually. The
Company paid approximately $15.3 million for debt issuance costs related to the
2000 Convertible Notes. The debt issuance costs are being amortized using the
interest method. The net proceeds from the 2000 Convertible Notes were used to
repay bank debt outstanding with a balance of approximately $380 million as of
December 31, 1999.
NOTE 9 --RECONCILIATION OF BASIC AND DILUTED (LOSS)/ EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic and
diluted per share amount computations as required by SFAS No. 128 "Earnings Per
Share" ("EPS") is as follows:
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Three Months Ended June 30,
--------------------------------------------------------------------------------
2001 2000
-------------------------------------- ------------------------------------
Per-Share Per-Share
(In thousands except per share amounts) Loss* Shares+ Amount Income* Shares+ Amount
-------- -------- -------- -------- -------- ---------
Basic EPS:
Net (loss)/ income available to
Common stockholders $(312,481) 344,873 $ (0.91) $ 70,576 308,275 $ 0.23
-------- --------
Effect of dilutive securities:
Stock options -- -- -- -- 22,837 --
4 1/4% Convertible
Subordinated Notes -- -- -- 2,750 22,008 --
Diluted EPS:
Net (loss)/ income available to
Common stockholders $(312,481) 344,873 $ (0.91) $ 73,326 353,120 $ 0.21
-------- --------
* Numerator
+ Denominator
Options to purchase approximately 71,395,129 shares were outstanding at
June 30, 2001 and were excluded from the computation of diluted shares because
of their antidilutive effect on earnings per share for the three months ended
June 30, 2001. The exercise price of these options ranged from $0.01 to $72.25
at June 30, 2001. Options to purchase approximately 393,836 shares were
outstanding as of June 30, 2000, but were excluded from the computation of
diluted shares for the three months ended June 30, 2000 because the exercise
price of these options was greater than the average market price of common
shares for the three month period then ended. The exercise price of these
options ranged from $58.50 to $72.25 at June 30, 2000.
For the three months ended June 30, 2001, common equivalent shares of
22,003,317 and interest expense of $2.7 million, net of taxes, associated with
the 1999 Convertible Notes were excluded from the calculation of diluted shares
because of their antidilutive effect on earnings per share. Common equivalent
shares of 7,113,944 and interest expense of $3.7 million, net of taxes,
associated with the 2000 Convertible Notes were also excluded from the
calculation of diluted shares because of their antidilutive effect on earnings
per share. For the three months ended June 30, 2000, common equivalent shares of
7,113,944 and interest expense of $3.8 million, net of taxes, associated with
the 2000 Convertible Notes were excluded from the calculation of diluted shares
because of their antidilutive effect on earnings per share.
Six Months Ended June 30,
--------------------------------------------------------------------------------
2001 2000
-------------------------------------- ------------------------------------
Per-Share Per-Share
(In thousands except per share amounts) Loss* Shares+ Amount Income* Shares+ Amount
-------- -------- -------- -------- -------- ---------
Basic EPS:
Net (loss)/ income available to
Common stockholders $(343,729) 332,728 $ (1.03) $156,819 305,464 $ 0.51
-------- --------
Effect of dilutive securities:
Stock options -- -- -- -- 23,683 --
4 1/4% Convertible
Subordinated Notes -- -- -- 5,498 22,008 --
Diluted EPS:
Net (loss)/ income available to
Common stockholders $(343,729) 332,728 $ (1.03) $162,317 351,155 $ 0.46
-------- --------
* Numerator
+ Denominator
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15
Options to purchase approximately 71,395,129 shares were outstanding at
June 30, 2001 and were excluded from the computation of diluted shares because
of their antidilutive effect on earnings per share for the six months ended June
30, 2001. The exercise price of these options ranged from $0.01 to $72.25 at
June 30, 2001. Options to purchase approximately 208,764 shares were outstanding
as of June 30, 2000, but were excluded from the computation of diluted shares
for the six months ended June 30, 2000 because the exercise price of these
options was greater than the average market price of common shares for the six
month period then ended. The exercise price of these options ranged from $58.50
to $72.25 at June 30, 2000.
For the six months ended June 30, 2001, common equivalent shares of
22,003,317 and interest expense of $5.5 million, net of taxes, associated with
the 1999 Convertible Notes were excluded from the calculation of diluted shares
because of their antidilutive effect on earnings per share. Common equivalent
shares of 7,113,944 and interest expense of $7.5 million, net of taxes,
associated with the 2000 Convertible Notes were also excluded from the
calculation of diluted shares because of their antidilutive effect on earnings
per share. For the six months ended June 30, 2000, common equivalent shares of
5,258,169 and interest expense of $5.5 million, net of taxes, associated with
the 2000 Convertible Notes were excluded from the calculation of diluted shares
because of their antidilutive effect on earnings per share.
NOTE 10 -- COMPREHENSIVE (LOSS)/ INCOME
Comprehensive (loss)/ income is defined as a change in equity of a company
during a period from transactions and other events and circumstances, excluding
transactions resulting from investments by owners and distributions to owners.
The primary difference between net (loss)/ income and comprehensive (loss)/
income for the Company arises from foreign currency translation adjustments,
unrealized gains and losses on derivative instruments designated as and
qualifying as cash-flow hedges and unrealized gains and losses on
available-for-sale securities, net of applicable taxes. Comprehensive (loss)/
income, net of taxes for the current reporting period and comparable period in
the prior year is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
(In thousands) 2001 2000 2001 2000
--------- --------- --------- ---------
Net (loss)/ income $(312,481) $ 70,576 $(343,729) $ 156,819
Change in unrealized gain on derivative
instruments designated as and
qualifying as cash-flow hedges 726 -- 4,926 --
Change in unrealized gain on available for
sale securities 14,362 (10,050) (6,801) 12,454
Change in foreign currency translation
adjustments (3,396) (2,165) (23,531) (9,444)
========= ========= ========= =========
Comprehensive (loss)/ income $(300,789) $ 58,361 $(369,135) $ 159,829
========= ========= ========= =========
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NOTE 11 --SEGMENT REPORTING
The Company operates in two reportable segments: the Semiconductor segment
and the Storage Area Network ("SAN") Systems segment. In the Semiconductor
segment, the Company designs, develops, manufactures and markets integrated
circuits, including application-specific integrated circuits,
application-specific standard products and related products and services.
Semiconductor design and service revenues include engineering design services,
licensing of our advanced design tools software, and technology transfer and
support services. The Company's customers use these services in the design of
increasingly advanced integrated circuits characterized by higher levels of
functionality and performance. The proportion of revenues from ASIC design and
related services compared to semiconductor product sales varies among customers
depending upon their specific requirements. In the SAN Systems segment, the
Company designs, manufactures, markets and supports high performance data
storage management and storage systems solutions and a complete line of
Redundant Array of Independent Disk systems, subsystems and related software.
The following is a summary of operations by segment for the three and six
months ended June 30, 2001 and 2000:
Three months ended Six months ended
June 30, June 30,
--------------------------- ---------------------------
(In thousands) 2001 2000 2001 2000
---------- ---------- ---------- ----------
REVENUES:
Semiconductor $ 413,870 $ 547,285 $ 868,859 $1,077,672
SAN Systems 51,349 97,043 113,559 181,842
---------- ---------- ---------- ----------
Total $ 465,219 $ 644,328 $ 982,418 $1,259,514
========== ========== ========== ==========
(LOSS)/INCOME FROM OPERATIONS:
Semiconductor $ (319,984) $ 76,435 $ (351,140) $ 149,436
SAN Systems (21,122) 7,882 (30,006) 19,481
---------- ---------- ---------- ----------
Total $ (341,106) $ 84,317 $ (381,146) $ 168,917
========== ========== ========== ==========
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Intersegment revenues for the periods presented above were not significant.
Restructuring of operations and other non-recurring items were included in the
both segments for the applicable periods.
One customer represented 19% and 13% of the Company's total consolidated
revenues for each of the three month periods ended June 30, 2001 and 2000,
respectively. In the Semiconductor segment, one customer represented 21% and 11%
of total Semiconductor revenues for the three month periods ended June 30, 2001
and 2000, respectively. In the SAN Systems segment, there were three customers
with revenues representing 21%, 17% and 14% and two customers with revenues
representing 11% of total SAN Systems revenues, respectively for the three month
period ended June 30, 2001. For the three month period ended June 30, 2000,
there were four customers with revenues representing 28%, 20%, 17% and 14% of
total SAN Systems revenues, respectively.
One customer represented 17% and 13% of the Company's total consolidated
revenues for each of the six month periods ended June 30, 2001 and 2000,
respectively. In the Semiconductor segment, one customer represented 20% and 10%
of total Semiconductor revenues for the six month periods ended June 30, 2001
and 2000, respectively. In the SAN Systems segment, there were four customers
with revenues representing 20%, 19%, 16% and 12% of total SAN Systems revenues,
respectively for the six month period ended June 30, 2001. For the six month
period ended June 30, 2000, there were four customers with revenues representing
25%, 20%, 16% and 15% of total SAN Systems revenues, respectively.
The following is a summary of total assets by segment as of June 30, 2001
and December 31, 2000:
June 30, December 31,
(In thousands) 2001 2000
---------- ----------
TOTAL ASSETS:
Semiconductor $4,391,858 $3,851,849
SAN Systems 333,240 345,638
---------- ----------
Total $4,725,098 $4,197,487
========== ==========
Revenues from domestic operations were $256 million, representing 55% of
consolidated revenues, for the second quarter of 2001 compared to $404 million,
representing 63% of consolidated revenues, for the same period of 2000.
Revenues from domestic operations were $539 million, representing 55% of
consolidated revenues, for the first half of 2001 compared to $765 million,
representing 61% of consolidated revenues, for the same period of 2000.
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NOTE 12 --COMMITMENTS AND CONTINGENCIES
In April 2001, the Company entered into a master lease and security
agreement with a group of companies ("Lessor") for up to $230 million for
certain wafer fabrication equipment. Each lease supplement pursuant to the
transaction will have a lease term of five years with two consecutive renewal
options at the Lessor's option. The Company may, at the end of any lease term,
return, or purchase at a stated amount all the equipment. Upon return of the
equipment, the Company must pay the Lessor a termination value. In April 2001,
the Company has drawn down $60 million as the first supplement pursuant to the
agreement. Subsequently, the Company drew down $33 million in May 2001 as the
second supplement. Minimum rental payments under this operating lease, excluding
option periods, are $24.2 million in 2002, $22.6 million in 2003, $20.9 million
in 2004 and $19.3 million in 2005. Under this lease, the Company is required to
maintain compliance with certain financial covenants.
In March 2000, the Company entered into a master lease and security
agreement with a group of companies ("Lessor") for up to $250 million for
certain wafer fabrication equipment. Each lease supplement pursuant to the
transaction will have a lease term of three years with two consecutive renewal
options. The Company may, at the end of any lease term, return, or purchase at a
stated amount all the equipment. Upon return of the equipment, the Company must
pay the Lessor a termination value. Through June 30, 2001, the Company has drawn
down a total of $250 million under five lease supplements pursuant to the
agreement. Minimum rental payments under these operating leases, including
option periods, are $53.5 million in 2002, $47.9 million in 2003, $40.6 million
in 2004, $23.8 million in 2005 and $0.6 million in 2006. Under this lease, the
Company is required to maintain compliance with certain financial covenants.
NOTE 13 --LEGAL MATTERS
Reference is made to Item 3, Legal Proceedings, of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000 for a discussion
of certain pending legal proceedings. In addition, the Company is a party to
other litigation matters and claims that are normal in the course of its
operations. The information provided at such reference regarding those matters
remains substantially unchanged except as set forth herein.
Regarding the pending litigation initiated by the Lemelson Medical,
Education & Research Foundation, Limited Partnership against certain electronics
industry companies, including LSI, that was described in the Company's prior
reports, the court has completed its review of motion papers filed in connection
with Cypress Semiconductor's and plaintiff's cross-motions for summary judgment
with respect to the 4,390,586 patent and granted a motion for oral arguments to
be held in mid-December. These activities are ongoing and, as of yet, no trial
date has been set. In addition, the Company is a party to other litigation
matters and claims which are normal in the course of its operations. The Company
continues to believe that the final outcome of such matters will not have a
material adverse effect on the Company's consolidated financial position or
results of operations. No assurance can be given, however, that these matters
will be resolved without the Company becoming obligated to make payments or to
pay other costs to the opposing parties, with the potential for having an
adverse effect on the Company's financial position or its results of operations.
The information in Item 3 pertaining to the proceedings that are pending in
the Court of Queen's Bench of Alberta, Judicial District of Calgary (the
"Court") between the Company, its Canadian subsidiary ("LSI Canada) and certain
former shareholders of LSI Canada is updated as follows. Following a hearing
held in March 2001, the Court dismissed the motion of the former shareholders
that challenged the propriety of the fair value proceedings initiated by LSI
Canada and the jurisdiction of the Court to adjudicate the matter. In addition,
the Court ruled that the portions of the application of the former shareholders
to initiate a claim based upon allegations that actions of LSI Logic Corporation
and certain named (former) directors and a (former) officer of LSI Canada were
oppressive of the rights of minority shareholders in LSI Canada are struck and
the balance are stayed. The Court also directed the litigants to recommence
preparation for trial in the fair value proceeding and advised the litigants of
the Court's intention to schedule a date for trial of that matter as soon as
practicable. While we cannot give any assurances regarding the resolution of
these matters, we believe that the final outcome will not have a material
adverse effect on our consolidated results of operations or financial condition.
No assurance can be given, however, that these matters will be resolved without
the Company becoming obligated to make payments or to pay other costs to the
opposing parties, with the potential for having an adverse effect on the
Company's financial position or its results of operations.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
We believe that our future operating results will continue to be subject to
quarterly variations based upon a wide variety of factors detailed in Risk
Factors in Part I of our Annual Report on Form 10-K for the year ended December
31, 2000. These factors include, among others:
- Cyclical nature of both the Semiconductor and the Storage Area
Network ("SAN") Systems industries and the markets addressed by our
products;
- Availability and extent of utilization of manufacturing capacity;
- Price erosion;
- Competitive factors;
- Timing of new product introductions;
- Changes in product mix;
- Fluctuations in manufacturing yields;
- Product obsolescence;
- Business and product market cycles;
- Economic and technological risks associated with our acquisition and
alliance activities; and
- The ability to develop and implement new technologies.
Our operating results could also be impacted by sudden fluctuations in
customer requirements, currency exchange rate fluctuations and other economic
conditions affecting customer demand and the cost of operations in one or more
of the global markets in which we do business. We operate in a technologically
advanced, rapidly changing and highly competitive environment. We predominantly
sell custom products to customers operating in a similar environment.
Accordingly, changes in the conditions of any of our customers may have a
greater impact on our operating results and financial condition than if we
predominantly offered standard products that could be sold to many purchasers.
While we cannot predict what effect these various factors may have on our
financial results, the aggregate effect of these and other factors could result
in significant volatility in our future performance. To the extent our
performance may not meet expectations published by external sources, public
reaction could result in a sudden and significantly adverse impact on the market
price of our securities, particularly on a short-term basis.
We have international subsidiaries and distributors that operate and sell
our products globally. Further, we purchase a substantial portion of our raw
materials and manufacturing equipment from foreign suppliers and incur labor and
other operating costs in foreign currencies, particularly in our Japanese
manufacturing facilities. As a result, we are exposed to the risk of changes in
foreign currency exchange rates or declining economic conditions in these
countries. We utilize forward exchange and purchased currency option contracts
to manage our exposure associated with net asset and liability positions and
cash flows denominated in non-functional currencies. (See Note 6 of the Notes to
Unaudited Consolidated Financial Statements referred to hereafter as "Notes.")
There is no assurance that these hedging transactions will eliminate exposure to
currency rate fluctuations that could affect our operating results.
Our corporate headquarters and some of our manufacturing facilities are
located near major earthquake faults. As a result, in the event of a major
earthquake, we could suffer damages that could significantly and adversely
affect our operating results and financial condition.
Our operations depend upon a continuing adequate supply of electricity,
natural gas and water. These energy sources have historically been available on
a continuous basis and in adequate quantities for our needs. However, given the
current power shortage in California, it is possible that the shortage may
spread to other areas of the country, including Oregon. An interruption in the
supply of raw materials or energy inputs for any reason would have an adverse
effect on our manufacturing operations.
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20
While management believes that the discussion and analysis in this report
is adequate for a fair presentation of the information, we recommend that you
read this discussion and analysis in conjunction with our Annual Report on Form
10-K for the year ended December 31, 2000.
Statements in this discussion and analysis include forward looking
information statements within the meaning of Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934,
as amended. These statements involve known and unknown risks and uncertainties.
Our actual results in future periods may be significantly different from any
future performance suggested in this report. Risks and uncertainties that may
affect our results may include, among others:
- Fluctuations in the timing and volumes of customer demand;
- Currency exchange rates;
- Availability and utilization of our manufacturing capacity;
- Timing and success of new product introductions; and
- Unexpected obsolescence of existing products.
We operate in an industry sector where security values are highly volatile
and may be influenced by economic and other factors beyond our control. See
additional discussion contained in "Risk Factors" set forth in Part I of our
Annual Report on Form 10-K for the year ended December 31, 2000.
ACQUISITION AND OTHER
On March 26, 2001, we signed a definitive merger agreement ("Merger
Agreement") to acquire C-Cube Microsystems Inc. ("C-Cube") in a transaction
accounted for as a purchase (See Note 2 of the Notes). In accordance with the
Merger Agreement, we commenced an exchange offer whereby we offered 0.79 of a
share of common stock for each outstanding share of C-Cube common stock. Under
the terms of the Merger Agreement, the exchange offer was followed by a merger
in which we acquired, at the same exchange ratio, the remaining shares of C-Cube
common stock not previously acquired in the exchange offer. The acquisition was
effective as of May 11, 2001.
On April 4, 2001, we announced a co-development and foundry supply
agreement with Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC") to
combine their efforts for development of advanced process technologies and to
collaborate on state-of-the-art manufacturing. Under the agreement, both
companies will deploy a jointly developed 0.13-micron process technology. We
will support customer design programs for leading-edge system-on-a-chip products
using this advanced process. Resulting products will be produced in both ours
and TSMC's manufacturing facilities. The two companies have also agreed to
explore collaborative opportunities on next generation process technology nodes,
which will be ahead of published industry roadmaps.
RESULTS OF OPERATIONS
Where more than one significant factor contributed to changes in results
from year to year, we have quantified material factors throughout the MD&A where
practicable.
REVENUE: We operate in two reportable segments: the Semiconductor segment
and the Storage Area Network ("SAN") Systems segment. In the Semiconductor
segment, we design, develop, manufacture and market integrated circuits,
including application-specific integrated circuits, (commonly known in the
industry as ASICs), application-specific standard products and related products
and services. Semiconductor design and service revenues include engineering
design services, licensing of our advanced design tools software, and technology
transfer and support services. Our customers use these services in the design of
increasingly advanced integrated circuits characterized by higher levels of
functionality and performance. The proportion of revenues from ASIC design and
related services compared to semiconductor product sales varies among customers
depending upon their specific requirements. In the SAN Systems segment, we
design, manufacture, market and support high-performance data
20
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storage management and storage systems solutions and a complete line of
Redundant Array of Independent Disk ("RAID") systems, subsystems and related
software. (See Note 11 of the Notes.)
Total revenues for the second quarter of 2001 decreased $179.1 million or
28% to $465.2 million from $644.3 million for the same period of 2000 on a
consolidated basis. Revenues for the Semiconductor segment decreased $133.4
million or 24% to $413.9 million for the second quarter of 2001 from $547.3
million for the same period of 2000. The decrease was primarily attributable to
decreased demand for products used in broadband access and networks, networking
infrastructure and storage infrastructure applications. Revenues for the SAN
Systems segment decreased $45.7 million or 47% to $51.3 million for the second
quarter of 2001 from $97.0 million for the same period of 2000 due to decreased
demand for all products sold in the SAN Systems segment. There were no
significant intersegment revenues during the periods presented.
Total revenues for the first half of 2001 decreased $277.1 million or 22%
to $982.4 million from $1,259.5 million for the same period of 2000 on a
consolidated basis. Revenues for the Semiconductor segment decreased $208.8
million or 19% to $868.9 million for the first half of 2001 from $1,077.7
million for the same period of 2000. The decrease was primarily attributable to
decreased demand for products used in broadband access and networks, networking
infrastructure and storage infrastructure applications. Revenues for the SAN
Systems segment decreased $68.2 million or 38% to $113.6 million for the first
half of 2001 from $181.8 million for the same period of 2000 due to decreased
demand for all products sold in the SAN Systems segment. There were no
significant intersegment revenues during the periods presented.
We expect revenues to decline approximately 10% to 15% in the third quarter
of 2001 as compared to the second quarter of 2001.
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22
OPERATING COSTS AND EXPENSES: Key elements of the consolidated statements
of operations, expressed as a percentage of revenues, were as follows:
Three months ended June 30, Six months ended June 30,
CONSOLIDATED: 2001 2000 2001 2000
-------- -------- -------- --------
Gross profit margin 16% 43% 28% 42%
Research and development 27% 13% 25% 13%
Selling, general and administrative 17% 12% 16% 12%
(Loss)/income from operations (73)% 13% (39)% 13%
Key elements of the statement of operations for the Semiconductor and SAN
Systems segments, expressed as a percentage of revenues, were as follows:
Three months ended June 30, Six months ended June 30,
SEMICONDUCTOR SEGMENT: 2001 2000 2001 2000
-------- -------- -------- --------
Gross profit margin 15% 44% 28% 42%
Research and development 29% 15% 27% 14%
Selling, general and administrative 15% 12% 14% 11%
(Loss)/income from operations (77)% 14% (40)% 14%
Three months ended June 30, Six months ended June 30,
SAN SYSTEMS SEGMENT: 2001 2000 2001 2000
-------- -------- -------- --------
Gross profit margin 20% 39% 28% 38%
Research and development 14% 7% 14% 7%
Selling, general and administrative 34% 12% 30% 12%
(Loss)/income from operations (41)% 8% (26)% 11%
GROSS PROFIT MARGIN: We have advanced wafer manufacturing operations in
Oregon, California and Japan. This allows us to maintain our ability to provide
products to customers with minimal disruption in the manufacturing process due
to economic and geographic risks associated with each geographic location.
The gross profit margin percentage decreased to 16% in the second quarter
of 2001 from 43% in the same period of 2000 on a consolidated basis. The gross
profit margin percentage for the Semiconductor segment decreased to 15% from 44%
in the same period of 2000.
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23
The gross profit margin percentage decreased to 28% in the first half of
2001 from 42% in the same period of 2000 on a consolidated basis. The gross
profit margin percentage for the Semiconductor segment decreased to 28% from 42%
in the same period of 2000. The decrease for the Semiconductor segment for the
three and six month periods ended June 30, 2001 as compared to the same periods
of the prior year are primarily a result of the following factors:
- Decreased revenue for higher margin products;
- Additional excess inventory charges of $102 million.
The additional excess inventory charge was due to a sudden and significant
decrease in forecasted revenue and was calculated in accordance with our policy,
which is primarily based on inventory levels in excess of 12-month demand for
each specific product and use of management judgement.
The gross profit margin percentage for the SAN Systems segment decreased to
20% in the second quarter of 2001 from 39% in the same period of 2000. The gross
profit margin percentage for the SAN Systems segment decreased to 28% in the
first half of 2001 from 38% in the same period of 2000. The decrease was
primarily attributable to decreased revenue for higher margin products and
additional excess inventory charges of approximately $6 million recorded during
the quarter.
Our operating environment, combined with the resources required to operate
in the semiconductor industry, requires that we manage a variety of factors.
These factors include, among other things:
- Product mix;
- Factory capacity and utilization;
- Manufacturing yields;
- Availability of certain raw materials;
- Terms negotiated with third-party subcontractors; and
- Foreign currency fluctuations.
These and other factors could have a significant effect on our gross profit
margin in future periods.
Changes in the relative strength of the yen may have a greater impact on
our gross profit margin than other foreign exchange fluctuations due to our
wafer fabrication operations in Japan. Although the yen weakened (the average
yen exchange rate for the second quarter of 2001 depreciated 15% from the same
period of 2000), the effect on gross profit margin and net income was not
significant because yen-denominated sales offset a substantial portion of
yen-denominated costs during the period. Moreover, we hedged a portion of our
remaining yen exposure. (See Note 6 of the Notes.) Future changes in the
relative strength of the yen or mix of foreign currency denominated revenues and
costs could have a significant effect on our gross profit margin or operating
results.
RESEARCH AND DEVELOPMENT: Research and development ("R&D") expenses
increased $40.6 million or 47% to $127.4 million during the second quarter of
2001 as compared to $86.8 million during the same period of 2000 on a
consolidated basis. R&D expenses for the Semiconductor segment increased $40.3
million or 50% to $120.0 million in the second quarter of 2001 from $79.7
million in the same period of 2000.
Research and development ("R&D") expenses increased $79.2 million or 47% to
$246.2 million during the first half of 2001 as compared to $167.0 million
during the same period of 2000 on a consolidated basis. R&D expenses for the
Semiconductor segment increased $76.7 million or 50% to $230.6 million in the
first half of 2001 from $153.9 million in the same period of 2000. The increase
for the semiconductor segment for the three and six month periods as compared to
the same periods of the prior year was primarily attributable to an increase in
expenditures related to continued R&D activities of C-Cube's business included
in our consolidated financial statements as of May 11, 2001 and continued
development of our already existing advanced sub-micron products and process
technologies.
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The R&D expenses were offset in part by the research and development
benefits associated with a technology transfer agreement entered into with
Silterra in Malaysia during 1999. (See Note 4 of the Notes.) A benefit of $6.0
million was recorded during each of the three month periods ended June 30, 2001
and 2000, respectively. A benefit of $12.0 million was recorded during each of
the six month periods ended June 30, 2001 and 2000, respectively. We will
receive an additional $14.0 million in cash from Silterra over the remaining
contract term of approximately one year as consideration for technology to be
transferred.
R&D expenses for the SAN Systems segment increased $0.3 million or 4% to
$7.4 million in the second quarter of 2001 from $7.1 million in the same period
of 2000. R&D expenses for the SAN Systems segment increased $2.5 million or 19%
to $15.6 million in the first half of 2001 from $13.1 million in the same period
of 2000. The increase for the three and six month periods reflect higher
compensation related expenses due to an increase in average headcount during the
periods presented in 2001 as compared to the prior year.
As a percentage of revenues, R&D expenses increased to 27% in the second
quarter of 2001 from 13% in the same period of 2000 on a consolidated basis. R&D
expenses as a percentage of revenues for the Semiconductor segment increased to
29% in the second quarter of 2001 from 15% in the same period of 2000. R&D
expenses as a percentage of revenues for the SAN Systems segment increased to
14% in the second quarter of 2001 from 7% in the same period of 2000. The
increase in R&D expenses as a percentage of revenues for both segments are
primarily a result of lower revenues for the periods presented in 2001 as
compared to 2000 and the effects of R&D spending changes as discussed above.
As a percentage of revenues, R&D expenses increased to 25% in the first
half of 2001 from 13% in the same period of 2000 on a consolidated basis. R&D
expenses as a percentage of revenues for the Semiconductor segment increased to
27% in the first half of 2001 from 14% in the same period of 2000. R&D expenses
as a percentage of revenues for the SAN Systems segment increased to 14% in the
second quarter of 2001 from 7% in the same period of 2000. The increase in R&D
expenses as a percentage of revenues for both segments are primarily a result of
lower revenues for the periods presented in 2001 as compared to 2000 and the
effects of R&D spending changes as discussed above.
SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative
("SG&A") expenses increased $2.4 million or 3% to $77.5 million during the
second quarter of 2001 as compared to $75.1 million in the same period of 2000
on a consolidated basis. SG&A expenses for the Semiconductor segment decreased
$3.3 million or 5% to $60.1 million in the second quarter of 2001 from $63.4
million in the same period of 2000. SG&A expenses for the SAN Systems segment
increased $5.6 million or 48% to $17.3 million in the second quarter of 2001
from $11.7 million in the same period of 2000. The increase on a consolidated
basis was primarily attributable to the following factors:
- Continued SG&A expenses for the C-Cube business, which is part of the
Semiconductor segment and included in our consolidated financial
statements as of May 11, 2001, and
- An increase in compensation related expenses for the SAN Systems segment
due to an increase in average headcount during the second quarter of
2001.
The above increases were offset in part by the positive effects of cost
reduction programs in both segments in the second quarter of 2001.
SG&A expenses increased $11.2 million or 8% to $156.5 million during the
first half of 2001 as compared to $145.3 million in the same period of 2000 on a
consolidated basis. SG&A expenses for the Semiconductor segment increased $0.2
million or 0.1% to $122.9 million in the first half of 2001 from $122.7 million
in the same period of 2000. SG&A expenses for the SAN Systems segment increased
$11.0 million or 49% to $33.6 million in the first half of 2001 from $22.6
million in the same period of 2000. The increase on a consolidated basis and by
segment was primarily attributable to the same factors noted above.
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As a percentage of revenues, SG&A expenses increased to 17% in the second
quarter of 2001 from 12% in the same period of 2000 on a consolidated basis.
SG&A expenses as a percentage of revenues for the Semiconductor segment
increased to 15% in the second quarter of 2001 from 12% in the same period of
2000. SG&A expenses as a percentage of revenues for the SAN Systems segment
increased to 34% in the second quarter of 2001 from 12% in the same period of
2000. The increase in SG&A expenses as a percentage of revenues for both
segments are primarily a result of lower revenues for the periods presented in
2001 as compared to 2000 and the effects of SG&A spending changes as discussed
above.
As a percentage of revenues, SG&A expenses increased to 16% in the first
half of 2001 from 12% in the same period of 2000 on a consolidated basis. SG&A
expenses as a percentage of revenues for the Semiconductor segment increased to
14% in the first half of 2001 from 11% in the same period of 2000. SG&A expenses
as a percentage of revenues for the SAN Systems segment increased to 30% in the
first half of 2001 from 12% in the same period of 2000. The increase in SG&A
expenses as a percentage of revenues for both segments are primarily a result of
lower revenues for the periods presented in 2001 as compared to 2000 and the
effects of spending changes as discussed above.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT: In connection with the
acquisition of C-Cube during the second quarter of 2001 (See Note 2 of the
Notes), we recorded a $77.5 million charge associated with acquired in-process
research and development ("IPR&D"). The amount of IPR&D was determined by
identifying research projects for which technological feasibility had not been
established and no alternative future uses existed as of the acquisition date.
On March 26, 2001, we signed a definitive merger agreement ("Merger
Agreement") to acquire C-Cube Microsystems Inc. ("C-Cube") in a transaction to
be accounted for as a purchase. In accordance with the Merger Agreement, we
commenced an exchange offer whereby it would offer 0.79 of a share of common
stock for each outstanding share of C-Cube common stock. Under the terms of the
Merger Agreement, the exchange offer was followed by a merger in which we
acquired, at the same exchange ratio, the remaining shares of C-Cube common
stock not previously acquired in the exchange offer. Upon completion of the
merger, we assumed all options and warrants to purchase shares of C-Cube common
stock and converted them into options and warrants to purchase shares of our
common stock (See Note 2 of the Notes). We issued approximately 40.2 million
shares of its common stock, 10.6 million options and 0.8 million warrants in
exchange for the outstanding ordinary shares, options and warrants of C-Cube,
respectively. The acquisition is intended to enhance and accelerate our DVD
product offerings in the Semiconductor segment.
The total purchase price for C-Cube was $893.7 million, which includes
deferred compensation on unvested stock options and stock awards assumed as part
of the purchase. The acquisition was accounted for as a purchase. Accordingly,
the results of operations of C-Cube and estimated fair value of assets acquired
and liabilities assumed were included in our consolidated financial statements
as of May 11, 2001, the effective date of the purchase, through the end of the
period.
In connection with the purchase of C-Cube, we recorded a $77.5 million
charge to in-process research and development. The amount was determined by
identifying research projects for which technological feasibility had not been
established and no alternative future uses existed. As of the acquisition date,
there were various projects that met the above criteria. The majority of the
projects identified consist of Digital Video Disc Player ("DVD"), DVD Recorder
("DVD-R"), Consumer Set-Top Box and Cable Modem.
The value of the projects identified to be in progress was determined by
estimating the future cash flows from the projects once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value. The net cash flows from the
identified projects were based on estimates of revenues, cost of revenues,
research and development costs, selling general and administrative costs and
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applicable income taxes for the projects. These estimates do not account for any
potential synergies that may be realized as a result of the acquisition and are
in line with industry averages and growth estimates in the semiconductor
industry. Total revenues for the projects are expected to extend through 2005,
2006, 2004 and 2003 for DVD, DVD-R, Consumer Set-Top Box and Cable Modem,
respectively. These projections were based on estimates of market size and
growth, expected trends in technology and the expected timing of new product
introductions by our competitors and us.
The discount rate used was 27.5% for the projects, a rate of 210 basis
points higher than the industry weighted average cost of capital estimated at
approximately 25.4% to account for the risks associated with the inherent
uncertainties surrounding the successful development of the IPR&D, market
acceptance of the technology, the useful life of the technology, the
profitability level of such technology and the uncertainty of technological
advances, which could impact the estimates described above.
The percentage of completion for the project was determined based on
research and development expenses incurred as of May 11, 2001 for the projects
as a percentage of total research and development expenses to bring the project
to technological feasibility. Development of these projects started in early
1999.
As of May 11, 2001, we estimated the projects were approximately 84%, 62%,
61% and 69% complete for DVD, DVD-R, Consumer Set-Top Box and Cable Modem,
respectively. As of the acquisition date, the cost to complete these projects is
estimated at $22.7 million and $9.1 million for 2001 and 2002, respectively.
RESTRUCTURING OF OPERATIONS AND OTHER NON-RECURRING ITEMS: The Company
recorded approximately $60 million in restructuring and other non-recurring
charges during the three months ended June 30, 2001. Total restructuring charges
were $52 million and other non-recurring charges were approximately $8 million
for the three months ending June 30, 2001.
Restructuring:
In April of 2001, we announced the closure of our Colorado Springs
fabrication facility ("the facility") in August of 2001. In May of 2001, we
entered into a definitive agreement to sell the facility to X-FAB Semiconductor
Foundries AG ("X-Fab"), a German corporation. As part of the agreement, we
agreed to purchase a minimum amount of production wafers and die from the
facility for a period of 18 months following the close of the transaction.
During the quarter ended June 30, 2001, we recorded an impairment charge of $71
million relating to the facility of which approximately $35 million was recorded
in cost of sales and $36 million was recorded in restructuring charges. The
restructuring charges consisted of fixed asset write-downs due to impairment,
losses on an operating lease for equipment, severance for approximately 413
employees and other exit costs. On August 1, 2001, we announced the termination
of the agreement to sell the facility because X-Fab was unable to secure the
required funding to close the transaction. The facility is currently scheduled
to close in October of 2001. We are continuing our efforts to dispose of the
facility and estimate that our reserves as of June 30, 2001 are adequate to
cover losses associated with the disposal of the facility. We reclassified
approximately $96 million from property, plant and equipment to other current
assets to reflect our intention to dispose of the facility within the next
twelve months.
We recorded approximately $16 million in additional restructuring charges
primarily associated with the write-down of fixed assets in the U.S., Japan and
Hong Kong that will be disposed of and severance charges for approximately 243
employees in the U.S., Europe and Asia Pacific.
The fair value of assets determined to be impaired was the result of
independent appraisals and use of management estimates. Given that current
market conditions for the sale of older fabrication facilities and related
equipment may continue to deteriorate, there can be no assurance that we will
realize the current net book value for the assets. We will reassess the
realizability of the carrying value of these assets at the end of each quarter
until the assets are sold or otherwise disposed of and additional adjustments
may be necessary.
As a result of the restructuring actions taken during the second quarter of
2001, we expect to reduce employee expenses by $129.8 million during the
remainder of 2001. As a result of the closure of the Colorado Springs facility,
depreciation expense will be reduced by approximately $3 million during the
remainder of 2001.
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NOTE 4 -- LICENSE AGREEMENT
The following table sets forth our restructuring reserves as of June 30,
2001:
(In thousands) Restructuring Balance
Expense June 30,
June 30, 2001 Utilized 2001
------------- --------- ---------
Write-down of excess assets(a) $ 22,920 $ (21,513) $ 1,407
Lease terminations and maintenance contracts 14,253 14,253
Other exit costs 7,742 7,742
Payments to employees for severance(b) 6,848 (2,764) 4,084
--------- --------- ---------
Total $ 51,763 $ (24,277) $ 27,486
========= ========= =========
(a) Amounts utilized in 2001 reflect a write-down of fixed assets in the U.S.,
Japan and Hong Kong due to impairment. The amounts were accounted for as a
reduction of the assets and did not result in a liability. The $1.4 million
balance as of June 30, 2001 relates to machinery and equipment
decommissioning costs in the U.S.
(b) Amounts utilized represent cash payments related to the severance of 230
employees during the second quarter of 2001.
Other non-recurring:
We recorded approximately $8 million in other non-recurring charges
associated with the write-down of intangible assets due to impairment. The
majority of the intangible assets were originally acquired in the purchase of a
division of Neomagic in the second quarter of 2000.
During the first quarter of 2000, we recorded other non-recurring net
charges of $2.8 million. The net charges reflected the combination of the
following:
- On February 22, 2000, we entered into an agreement with a third party to
outsource certain testing services performed by us at our Fremont,
California facility. The agreement provided for the sale and transfer of
certain test equipment and related peripherals for total proceeds of
approximately $10.7 million. We recorded a loss of approximately $2.2
million associated with the agreement. (See Note 4 of the Notes.)
- In March 2000, we recorded approximately $1.1 million of non-cash
compensation related expenses resulting from a separation agreement
entered into during the quarter with a former employee and a $0.5
million benefit for the reversal of reserves established in the second
quarter of 1999 for merger related expenses in connection with the
merger with SEEQ Technology, Inc.
AMORTIZATION OF INTANGIBLES: Amortization of goodwill and other intangibles
increased $29.7 million or 215% to $43.5 million in the second quarter of 2001
from $13.8 million in the same period of 2000. Amortization of goodwill and
other intangibles increased to $70.6 million in the first half of 2001 from
$25.7 million in the same period of 2000. The increase was primarily related to
additional amortization of goodwill associated with the acquisitions of C-Cube
in the second quarter of 2001 and ParaVoice and Syntax in the fourth quarter of
2000.
AMORTIZATION OF NON-CASH DEFERRED STOCK COMPENSATION: Amortization of
non-cash deferred stock compensation of $27.8 million and $49.1 million for the
three and six month period ended June 30, 2001, respectively, is due to the
amortization of non-cash deferred stock compensation recorded in connection with
the acquisitions of C-Cube during the second quarter of 2001(See Note 2 of the
Notes), Syntax in the fourth quarter of 2000 and DataPath in the third quarter
of 2000.
INTEREST EXPENSE: Interest expense decreased $0.4 million to $9.9 million
in the second quarter of 2001 from $10.3 million in the same period of 2000.
Interest expense decreased $1.4 million to $19.8 million in the first half of
2001 from $21.2 million in the same period of 2000. The decrease was primarily
attributable to lower interest rates on outstanding debt in the first half of
2001 as compared to the same period in 2000.
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INTEREST INCOME AND OTHER, NET: Interest income and other decreased $7.8
million to $3.7 million in the second quarter of 2001 from $11.5 million in the
same period of 2000. The decrease was primarily attributable to the write-down
of a marketable equity investment due to impairment and the time value of
purchased option contracts in the second quarter of 2001. (See Notes 5 and 6 of
the Notes.)
Interest income and other decreased $5.9 million to $12.7 million in the
first half of 2001 from $18.6 million in the same period of 2000. We recorded
approximately $7 million higher interest income in the first half of 2001 as
compared to the same period in 2000 due to higher average balances of
interest-generating cash, cash equivalents and short-term investments which was
offset in part by lower interest rates during the period. The increase in
interest income and other was offset by the write-down of a marketable equity
investment due to impairment and the time value of purchased option contracts.
(See Notes 5 and 6 of the Notes.)
GAIN ON SALE OF EQUITY SECURITIES: We did not sell marketable equity
securities during the second quarter of 2001. During the first quarter of 2001,
we sold certain marketable equity securities for $7.9 million in the open
market, realizing a pre-tax gain of approximately $5.3 million. During the
second quarter of 2000, we sold certain marketable equity securities for $15.8
million in the open market, realizing a pre-tax gain of approximately $15.3
million. During the first half of 2000, we sold certain marketable equity
securities for $45.7 million in the open market, realizing a pre-tax gain of
approximately $42.7 million. In the first quarter of 2000, we also recognized a
$6.8 million pre-tax gain associated with equity securities of a certain
technology company that was acquired by another technology company.
PROVISION FOR INCOME TAXES: During the three and six months ended June 30,
2001, we recorded an income tax benefit of $34.7 million and $39.2 million,
respectively, which represents an effective tax rate of 10%. This rate differs
from the U.S. statutory rate primarily due to losses of our foreign
subsidiaries, which are benefited at lower rates, and items related to
acquisitions, which are non-deductible for tax purposes. For the three and six
months ended June 30, 2000, an income tax provision was recorded at an effective
rate of 30% and 27%, respectively. These rates differ from the U.S. statutory
rate primarily due to merger and restructuring charges, the recognition of
taxable gains offset in part by earnings of our foreign subsidiaries taxed at
lower rates and the utilization of tax credits.
FINANCIAL CONDITION AND LIQUIDITY
Cash, cash equivalents and short-term investments increased $8.5 million or
0.8% to $1,141.7 million as of June 30, 2001 from $1,133.2 million as of
December 31, 2000.
WORKING CAPITAL: Working capital increased $23.7 million or 2% to $1,469.0
million as of June 30, 2001 from $1,445.3 million as of December 31, 2000. The
increase was primarily a result of the following factors:
- Higher cash and cash equivalents due to the C-Cube acquisition during
the second quarter of 2001. (See Note 2 of the Notes.)
- Higher inventory due to lower than expected sales in the second quarter
of 2001 offset in part by a write-down of certain inventory. (See Note
7 of the Notes.)
- Higher prepaid expenses and other current assets due to a
reclassification of assets held for sale from property, plant and
equipment to other current assets. (See Note 3 of the Notes.)
- Lower accounts payable that primarily reflect lower purchases during the
second quarter of 2001 as compared to the fourth quarter of 2000.
- Lower accrued salaries, wages and benefits; and
- Lower income taxes payable due to the timing of tax payments and the tax
benefit recorded during the second quarter of 2001.
The increase in working capital was offset in part by lower accounts
receivable due to decreased revenue during the second quarter of 2001 as
compared to the fourth quarter of 2000, lower short-term investments primarily
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attributable to certain marketable equity securities reclassified into long-term
assets and higher other accrued liabilities resulting primarily from
restructuring related accruals and accruals related to tax liabilities
associated with the acquisition of C-Cube.
CASH AND CASH EQUIVALENTS PROVIDED BY OPERATING ACTIVITIES: During the six
month period ended June 30, 2001, we generated $104.0 million of cash and cash
equivalents from operating activities compared to $131.6 million generated
during the same period in 2000. The decrease in cash and cash equivalents
provided by operating activities was primarily attributable to a net loss for
the six month period ended June 30, 2001 compared to net income for the same
period of 2000, an increase in inventory and prepaid and other assets and a
decrease in accounts payable, accrued salaries, wages and benefits and income
tax payable. The increase in inventories reflects lower than expected sales in
the first half of 2001, partly offset by a write-down of certain inventory. (See
Note 7 of the Notes.) The increase in prepaid expenses and other assets was
primarily attributable to a reclassification of assets held for sale from
property, plant and equipment to other current assets (See Note 3 of the Notes)
and a decrease in deferred tax assets during the period. The decrease in
accounts payable reflects lower purchases during the first half of 2001 as
compared to the same period of 2000 and the timing of invoice receipt and
payments. The decrease in income tax payable is due to the tax benefit recorded
during the first half of 2001.
CASH AND CASH EQUIVALENTS USED IN INVESTING ACTIVITIES: Cash and cash
equivalents used in investing activities was $66.2 million during the six months
ended June 30, 2001, compared to $280.1 million in the same period of 2000. The
decrease was primarily related to higher sales and maturities of debt and equity
securities available-for-sale and others, net of purchases during the six month
period ended June 30, 2001 compared to the same period of 2000.
The decrease was offset in part by higher capital expenditures and lower
proceeds from the sale of marketable equity securities during the six month
period ended June 30, 2001 compared to the same period of 2000. The decrease was
also offset by an increase in cash and cash equivalents due to the acquisition
of C-Cube.
We believe that maintaining technological leadership in the highly
competitive worldwide semiconductor industry requires substantial ongoing
investment in advanced manufacturing capacity. Net capital additions were $125.6
million during the six month period ended June 30, 2001 and $83.5 million in the
same period of 2000. In order to maintain our position as a technological market
leader, we expect the level of capital expenditures to be approximately $400
million in 2001.
CASH AND CASH EQUIVALENTS PROVIDED BY FINANCING ACTIVITIES: Cash and cash
equivalents provided by financing activities during the six month period ended
June 30, 2001 was $43.5 million compared to $199.1 million in the same period of
2000. During the six month period ended June 30, 2001, we generated cash
proceeds of $44.4 million from our employee stock option and purchase plans,
which were offset in part by the repayment of debt obligations. During the six
month period ended June 30, 2000, we generated cash proceeds of $124.2 million
from the issuance of the 2000 Convertible Notes, net of repayment of the
Revolver, and $90.2 million from our employee stock option and purchase plans,
which was offset in part by the debt issuance costs associated with the 2000
Convertible Notes. (see Note 8 of the Notes)
On March 14, 2001, the Second Amended and Restated Credit Agreement was
amended to reduce the total revolving commitment by $165 million from $240
million to $75 million. On the effective date of this reduction, the revolving
commitment of each lender was reduced accordingly.
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In accordance with the terms of our existing credit arrangement, we must
comply with certain financial covenants related to profitability, tangible net
worth, liquidity, senior debt leverage, debt service coverage and subordinated
indebtedness.
In order to remain competitive, we must continue to make significant
investments in new facilities and capital equipment. We may seek additional
equity or debt financing from time to time. We believe that our existing liquid
resources and funds generated from operations, combined with funds from such
financing and our ability to borrow funds, will be adequate to meet our
operating and capital requirements and obligations through the foreseeable
future. However, we cannot be certain that additional financing will be
available on favorable terms. Moreover, any future equity or convertible debt
financing will decrease the percentage of equity ownership of existing
stockholders and may result in dilution, depending on the price at which the
equity is sold or the debt is converted.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued FASB
Statements Nos. 141 and 142 (SFAS 141 and SFAS 142), "Business Combinations" and
"Goodwill and Other Intangible Assets." SFAS 141 replaces APB 16 and eliminates
pooling-of-interests accounting prospectively. It also provides guidance on
purchase accounting related to the recognition of intangible assets and
accounting for negative goodwill. SFAS 142 changes the accounting for goodwill
from an amortization method to an impairment-only approach. Under SFAS 142,
goodwill will be tested annually and whenever events or circumstances occur
indicating that goodwill might be impaired. SFAS 141 and SFAS 142 are effective
for all business combinations completed after June 30, 2001. Upon adoption of
SFAS 142, amortization of goodwill recorded for business combinations
consummated prior to July 1, 2001 will cease, and intangible assets acquired
prior to July 1, 2001 that do not meet the criteria for recognition under SFAS
141 will be reclassified to goodwill. Companies are required to adopt SFAS 142
for fiscal years beginning after December 15, 2001, but early adoption is
permitted. The Company will adopt SFAS 142 on January 1, 2002, the beginning of
fiscal 2002. In connection with the adoption of SFAS 142, the Company will be
required to perform a transitional goodwill impairment assessment. The Company
has not yet determined the impact these standards will have on its results of
operations and financial position.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes in the market risk disclosures during the
six month period ended June 30, 2001 as compared to the discussion in Part II of
our Annual Report on Form 10-K for the year ended December 31, 2000.
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PART II
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Item 3, Legal Proceedings, of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000 for a discussion
of certain pending legal proceedings. In addition, the Company is a party to
other litigation matters and claims that are normal in the course of its
operations. The information provided at such reference regarding those matters
remains substantially unchanged except as set forth herein.
Regarding the pending litigation initiated by the Lemelson Medical,
Education & Research Foundation, Limited Partnership against certain electronics
industry companies, including LSI, that was described in the Company's prior
reports, the court has completed its review of motion papers filed in connection
with Cypress Semiconductor's and plaintiff's cross-motions for summary judgment
with respect to the 4,390,586 patent and granted a motion for oral arguments to
be held in mid-December. These activities are ongoing and, as of yet, no trial
date has been set. In addition, the Company is a party to other litigation
matters and claims which are normal in the course of its operations. The Company
continues to believe that the final outcome of such matters will not have a
material adverse effect on the Company's consolidated financial position or
results of operations. No assurance can be given, however, that these matters
will be resolved without the Company becoming obligated to make payments or to
pay other costs to the opposing parties, with the potential for having an
adverse effect on the Company's financial position or its results of operations.
The information in Item 3 pertaining to the proceedings that are pending in
the Court of Queen's Bench of Alberta, Judicial District of Calgary (the
"Court") between the Company, its Canadian subsidiary ("LSI Canada") and certain
former shareholders of LSI Canada is updated as follows. Following a hearing
held in March 2001, the Court dismissed the motion of the former shareholders
that challenged the propriety of the fair value proceedings initiated by LSI
Canada and the jurisdiction of the Court to adjudicate the matter. In addition,
the Court ruled that the portions of the application of the former shareholders
to initiate a claim based upon allegations that actions of LSI Logic Corporation
and certain named (former) directors and a (former) officer of LSI Canada were
oppressive of the rights of minority shareholders in LSI Canada are struck and
the balance are stayed. The Court also directed the litigants to recommence
preparation for trial in the fair value proceeding and advised the litigants of
the Court's intention to schedule a date for trial of that matter as soon as
practicable. While we cannot give any assurances regarding the resolution of
these matters, we believe that the final outcome will not have a material
adverse effect on our consolidated results of operations or financial condition.
No assurance can be given, however, that these matters will be resolved without
the Company becoming obligated to make payments or to pay other costs to the
opposing parties, with the potential for having an adverse effect on the
Company's financial position or its results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of LSI Logic Corporation was held on May
2, 2001 in San Francisco, California. Proxies representing 275,713,617 shares of
common stock or 85% of the total outstanding shares were voted at the meeting.
The table below presents the voting results of election of the Company's Board
of Directors:
Votes For Votes Withheld
--------- --------------
Wilfred J. Corrigan 273,278,527 2,435,090
T.Z. Chu 273,342,721 2,370,896
Malcolm R. Currie 273,174,096 2,539,521
James H. Keyes 273,385,086 2,328,531
R. Douglas Norby 273,270,650 2,442,967
Matthew J. O'Rourke 273,307,670 2,405,947
Larry W. Sonsini 273,042,512 2,671,105
The stockholders approved an amendment to the Amended and Restated Employee
Stock Purchase Plan to increase the number of shares of common stock reserved
for issuance thereunder by 10,000,000. The proposal received 257,814,857
affirmative notes, 16,297,869 negative votes, 1,600,890 abstentions, and one
broker non-vote.
The stockholders approved an amendment to the 1991 Equity Incentive Plan to
increase the number of shares of common stock reserved for issuance thereunder
by 5,000,000. The proposal received 196,098,621 affirmative votes, 77,933,995
negative votes, 1,680,700 abstentions, and 301 broker non-votes.
The stockholders approved the appointment of PricewaterhouseCoopers LLP as
independent accountants of the Company for the fiscal year 2001. The proposal
received 273,618,230 affirmative votes, 938,334 negative votes, 1,157,052
abstentions, and one broker non-vote.
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ITEM 5. OTHER INFORMATION
Proposals of stockholders intended to be presented at the Company's 2002
annual meeting of stockholders must be received at the Company's principle
executive offices not later than November 26, 2001 in order to be included in
the Company's proxy statement and form of proxy relating to the 2002 annual
meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - None
(b) Reports on Form 8-K
On April 4, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated March 26, 2001.
On April 25, 2001, pursuant to Item 5 to report information set forth in
the Registrant's press release dated April 24, 2001.
On May 21, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated May 11, 2001.
On June 5, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated May 29, 2001.
On June 15, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated June 11, 2001.
On June 18, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated June 11, 2001.
On June 26, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated June 18, 2001.
On July 20, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated May 11, 2001.
On July 20, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated June 11, 2001.
On July 30, 2001, pursuant to Item 5 to report information set forth in the
Registrant's press release dated July 26, 2001.
On August 6, 2001, pursuant to Item 5 to report information set forth in
the Registrant's press release dated August 1, 2001.
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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.
LSI LOGIC CORPORATION
(Registrant)
Date: August 14, 2001 By /s/ Bryon Look
--------------------------------
Bryon Look
Executive Vice President and
Chief Financial Officer
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