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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the Quarter Ended September 30, 1999
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 November 8, 1999 there were 148,725,266 of the registrant's Common Stock,
$.01 par value, outstanding.
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LSI LOGIC CORPORATION
Form 10-Q
For the Quarter Ended September 30, 1999
INDEX
PAGE
NO.
----
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Condensed Balance Sheets - September 30, 1999 and
December 31, 1998 3
Consolidated Condensed Statements of Operations - Three-Month
and Nine-Month Periods Ended September 30, 1999 and 1998 4
Consolidated Condensed Statements of Cash Flows - Nine-Month
Periods Ended September 30, 1999 and 1998 5
Notes to Consolidated Condensed Financial Statements 6
Item 2 Management's Discussion and Analysis of Results of Operations
and Financial Condition 19
PART II OTHER INFORMATION
Item 1 Legal Proceedings 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 CONDENSED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
ASSETS
Cash and cash equivalents $ 185,977 $ 210,306
Short-term investments 271,010 81,220
Accounts receivable, less allowance for doubtful
accounts of $7,451 and $3,537 369,754 249,106
Inventories 217,489 181,440
Deferred tax assets 62,699 62,699
Prepaid expenses and other current assets 45,024 52,250
---------- ----------
Total current assets 1,151,953 837,021
---------- ----------
Property and equipment, net 1,297,180 1,486,256
Goodwill and other intangibles 305,485 332,779
Other assets 220,684 167,749
---------- ----------
Total assets $2,975,302 $2,823,805
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 209,354 $ 195,228
Accrued salaries, wages and benefits 78,478 47,988
Other accrued liabilities 102,508 109,236
Income taxes payable 57,243 57,993
Current portion of long-term obligations 84,051 187,852
---------- ----------
Total current liabilities 531,634 598,297
---------- ----------
Long-term obligations and deferred taxes liabilities 811,049 695,797
---------- ----------
Minority interest in subsidiaries 6,019 5,238
---------- ----------
Commitments and contingencies -- --
Stockholders' equity:
Preferred shares; $.01 par value; 2,000 shares
authorized -- --
Common stock; $.01 par value; 450,000 shares
authorized; 147,311 and 143,867 shares outstanding 1,473 1,439
Additional paid-in capital 1,183,971 1,135,219
Retained earnings 342,369 368,378
Accumulated other comprehensive income 98,787 19,437
---------- ----------
Total stockholders' equity 1,626,600 1,524,473
---------- ----------
Total liabilities and stockholders' equity $2,975,302 $2,823,805
========== ==========
See accompanying notes to unaudited consolidated condensed financial statements.
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LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues $ 539,959 $ 396,871 $ 1,504,588 $ 1,065,873
----------- ----------- ----------- -----------
Costs and expenses:
Cost of revenues 325,785 225,400 942,074 592,792
Research and development 71,878 79,301 223,447 210,158
Selling, general and administrative 66,881 61,146 191,153 158,747
Acquired in-process research and development -- 145,500 4,600 145,500
Restructuring of operations and other
non-recurring (benefits)/charges, net (7,934) 75,400 (2,063) 75,400
Amortization of intangibles 11,767 7,338 34,789 10,110
----------- ----------- ----------- -----------
Total costs and expenses 468,377 594,085 1,394,000 1,192,707
----------- ----------- ----------- -----------
Income/(loss) from operations 71,582 (197,214) 110,588 (126,834)
Interest expense (9,404) (6,028) (29,604) (6,203)
Interest income and other, net 7,006 (23,395) 11,201 (9,915)
----------- ----------- ----------- -----------
Income/(loss) before income taxes and cumulative
effect of change in accounting principle 69,184 (226,637) 92,185 (142,952)
Provision for/(benefits of) income taxes 17,260 (14,607) 26,420 6,283
----------- ----------- ----------- -----------
Income/(loss) before cumulative effect of change in
accounting principle 51,924 (212,030) 65,765 (149,235)
Cumulative effect of change in accounting
principle -- -- (91,774) --
----------- ----------- ----------- -----------
Net income/(loss) $ 51,924 $ (212,030) $ (26,009) $ (149,235)
=========== =========== =========== ===========
Basic earnings per share:
Income/(loss) before cumulative effect of change
in accounting principle $ 0.35 $ (1.48) $ 0.45 $ (1.04)
Cumulative effect of change in accounting
principle -- -- (0.63) --
----------- ----------- ----------- -----------
Net income/(loss) $ 0.35 $ (1.48) $ (0.18) $ (1.04)
=========== =========== =========== ===========
Diluted earnings per share:
Income/(loss) before cumulative effect of change
in accounting principle $ 0.33 $ (1.48) $ 0.43 $ (1.04)
Cumulative effect of change in accounting
Principle -- -- (0.60) --
----------- ----------- ----------- -----------
Net income/(loss) $ 0.33 $ (1.48) $ (0.17) $ (1.04)
=========== =========== =========== ===========
Shares used in computing per share amounts:
Basic 146,767 143,159 145,514 142,852
=========== =========== =========== ===========
Diluted 166,471 143,159 152,023 142,852
=========== =========== =========== ===========
See accompanying notes to unaudited consolidated condensed financial statements.
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LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
1999 1998
--------- ---------
Operating activities:
Net loss $ (26,009) $(149,235)
Adjustments:
Depreciation and amortization 269,267 152,321
Write-off of unamortized preproduction costs 97,356 --
Acquired in-process research and development 4,600 145,500
Non-cash restructuring (benefits)/charges, net (7,107) 75,400
Common stock issued for litigation -- 1,406
(Gain)/loss from stock investments (3,558) 14,338
Changes in:
Accounts receivable (111,017) (16,549)
Inventories (31,848) (4,225)
Prepaid expenses and other assets 9,655 (28,314)
Accounts payable 6,549 (43,923)
Accrued and other liabilities 24,308 (5,133)
--------- ---------
Net cash provided by operating activities 232,196 141,586
--------- ---------
Investing activities:
Purchases of debt and equity securities available-for-sale (353,776) (301,782)
Maturities and sales of debt and equity securities available-for-sale 188,756 594,546
Purchase of equity securities -- (7,216)
Purchases of property and equipment, net of retirements (104,795) (232,377)
Acquisition of a non-public technology company (6,779) --
Acquisition of Symbios, net of cash acquired -- (759,684)
Acquisition of stock from minority interest holders -- (599)
--------- ---------
Net cash used for investing activities (276,594) (707,112)
--------- ---------
Financing activities:
Proceeds from borrowings 345,000 694,682
Repayment of debt obligations (368,738) (100,628)
Debt issuance costs (9,488) --
Purchase of common stock under repurchase program -- (5,661)
Issuance of common stock, net 48,786 12,833
--------- ---------
Net cash provided by financing activities 15,560 601,226
--------- ---------
Effect of exchange rate changes on cash and cash equivalents 4,509 (4,902)
--------- ---------
(Decrease)/increase in cash and cash equivalents (24,329) 30,798
Cash and cash equivalents at beginning of period 210,306 114,087
--------- ---------
Cash and cash equivalents at end of period $ 185,977 $ 144,885
========= =========
See accompanying notes to unaudited consolidated condensed financial statements.
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LSI LOGIC CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
In the opinion of the Company, the accompanying unaudited consolidated
condensed financial statements contain all adjustments (consisting only of
normal recurring adjustments except as noted below for unamortized preproduction
as discussed in Note 9, acquired in-process research and development as
discussed in Note 3, and the restructuring expenses as discussed in Note 5
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/A for the year ended
December 31, 1998.
On June 22, 1999, the Company completed a merger of Stealth Acquisition
Corporation, a wholly-owned subsidiary of the Company, with SEEQ Technology,
Inc. ("SEEQ") in a transaction accounted for as a pooling of interests, and SEEQ
became a wholly owned subsidiary of the Company. All financial information has
been restated retroactively to reflect the combined operations of the Company
and SEEQ as if the merger had occurred at the beginning of the earliest period
presented (see Note 2). Prior to the merger, SEEQ's fiscal year-end was the last
Sunday in September of each year whereas the Company operates on a year ending
on December 31.
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 condensed financial statements refer to the quarter's calendar
month end for convenience. The results of operations for the quarter ended
September 30, 1999 are not necessarily indicative of the results to be expected
for the full year.
On April 14, 1999, the Company acquired all of outstanding capital stock
of ZSP Corporation. ("ZSP") in a merger transaction accounted for as a purchase.
Accordingly, the results of operations of ZSP and estimated fair value of assets
acquired and liabilities assumed were included in the Company's consolidated
condensed financial statements as of April 14, 1999, the effective date of the
purchase, through the end of the period (see Note 3). There were no significant
differences between the accounting policies of the Company and ZSP.
In April 1998, the Accounting Standards Executive Committee ("AcSEC")
released Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of
Start-up Activities." The SOP is effective for fiscal years beginning after
December 15, 1998 and requires companies to expense all costs incurred or
unamortized in connection with start-up activities. Accordingly, the Company
expensed the unamortized preproduction balance of $92 million associated with
the Gresham manufacturing facility, net of tax, on January 1, 1999 and has
presented it as a cumulative effect of a change in accounting principle in
accordance with SOP No. 98-5.
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
condensed financial statements and the reported amounts of revenues and expenses
during the reported period. Actual results could differ from those estimates.
Certain items previously reported in specific financial statement captions
have been reclassified to conform with the 1999 presentation.
One customer represented 11% and 10% of the Company's consolidated
revenues for the three and nine months ended September 30, 1999, respectively.
In the Storage Systems segment, three customers represented 30%, 28% and 14% of
Storage Systems revenues, respectively, during the three months ended September
30, 1999. There were four customers, representing 29%, 25%, 15% and 10% of our
Storage Systems revenues, respectively, during
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the nine months ended September 30, 1999. In the Semiconductor segment, there
were no customers who represented 10% or more of our semiconductor revenues for
the three and nine months ended September 30, 1999.
NOTE 2 - ACQUISITION OF SEEQ
As discussed in Note 1, on June 22, 1999, the Company completed a merger
with SEEQ. SEEQ was formed in January 13, 1981 to engage in the development,
production and sale of state-of-the-art, high technology semiconductor devices.
The stock for stock transaction was approved by the shareholders of SEEQ. As a
result of the merger, the separate existence of SEEQ ceased. Under the terms of
the Agreement and Plan of Reorganization and Merger, SEEQ's shareholders
received 0.0759 of a share of the Company's common stock for each SEEQ share.
Accordingly, the Company issued 2.5 million shares of its common stock for all
the outstanding shares of SEEQ common stock. Additionally, outstanding options
to acquire SEEQ common stock were converted to options to acquire 0.4 million
shares of the Company's common stock.
The merger was accounted for as a pooling of interests. Accordingly, the
Company's financial statements have been restated retroactively to include the
financial results of SEEQ for all periods presented. SEEQ's results of
operations were insignificant to the combined financial results (less than 3% by
income statement line item for the nine months ended September 30, 1999), and
accordingly, separate results of operations of SEEQ and LSI are not presented.
Adjustments to conform accounting policies of SEEQ to those of LSI were
not significant to the combined financial results. There were no inter-company
transactions between the two companies for the periods presented.
Restructuring and merger related expenses associated with the SEEQ merger:
In connection with the merger with SEEQ on June 22, 1999, the Company
recorded approximately $2.9 million in restructuring charges and $5.4 million in
merger related expenses which included $0.5 million recorded by SEEQ in the
first quarter of 1999. The merger expenses related primarily to investment
banking and other professional fees directly attributable to the merger with
SEEQ. The restructuring charge was comprised of $1.9 million in write-downs of
fixed assets which were duplicative to the combined company, $0.5 million of
exit costs relating to non-cancelable building lease contracts and $0.5 million
provision for severance costs related to the involuntary termination of certain
employees. The exit costs and employee severance costs were recorded in
accordance with Emerging Issues Task Force ("EITF") No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity." The fixed and other assets write-downs were recorded in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of." The restructuring actions as outlined by the restructuring plan are
intended to be completed by June 30, 2000, one year from the date the reserve
was taken. Approximately $0.5 million of severance were paid to three employees
terminated during the quarter.
The following table sets forth the SEEQ restructuring reserves as of June
22, 1999, the acquisition date, and activity against the reserve since then:
(In thousands)
BALANCE BALANCE BALANCE
6/22/99 UTILIZED 6/30/99 UTILIZED 9/30/99
------- -------- ------- -------- -------
Write-down of fixed assets....................... $1,854 $(1,854) $ -- $ -- $ --
Noncancelable building lease contracts .......... 490 -- 490 -- 490
Payments to employees for severance (a) ......... 516 -- 516 (516) --
------- ------- ------- ------- -------
Total.................................. $2,860 $(1,854) $ 1,006 $ (516) $ 490
======= ======= ======= ======= =======
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(a) The amount utilized represents cash payments related to the severance
of 3 employees in Q3, 1999.
NOTE 3 - ACQUISITION OF ZSP
As discussed in Note 1, on April 14, 1999, the Company acquired all of
outstanding capital stock of ZSP, a semiconductor company without a fabrication
facility that designs and markets programmable Digital Signal Processors
("DSPs"). The acquisition was accounted for as a purchase. Accordingly, the
results of operations of ZSP and estimated fair value of assets acquired and
liabilities assumed were included in the Company's consolidated condensed
financial statements as of April 14, 1999, the effective date of the purchase,
through the end of the period. There were no significant differences between the
accounting policies of the Company and ZSP.
The Company paid approximately $7 million in cash which included direct
acquisition costs of $0.6 million for investment banking, legal and accounting
fees in addition to liabilities assumed of $4.3 million. The total purchase
price of $11.3 million was allocated to the estimated fair value of assets
acquired and liabilities assumed based on independent appraisals, where
appropriate, and management estimates as follows:
(In thousands)
Fair value of tangible net liabilities $ (301)
In-process research and development 4,600
Other current technology 2,600
Excess of purchase price over net assets acquired 4,370
--------
$ 11,269
========
The Company accrued approximately $0.7 million of exit costs for a
non-cancelable building lease contract and to prepare the building for sublease.
The exit costs were accrued as a liability assumed in the purchase price
allocation in accordance with EITF No. 95-3, "Recognition of Liabilities in
Connection with a Purchase Business Combination." The Company expects no other
additional liabilities that may result in an adjustment to the allocation of the
purchase price. There were no significant adjustments made to the reserve during
the three and nine months ended September 30, 1999.
In-process research and development:
In connection with the purchase of ZSP, the Company recorded a $4.6
million charge to in-process research and development ("IPR&D") during the
second quarter of 1999. The amount was determined by identifying research
projects for which technological feasibility had not been established and no
alternative future uses existed. The Company acquired ZSP's in-process DSP
research and development project that was targeted at the telecommunications
market. This product was being developed specifically for voice over net or
voice over internet protocol applications and was intended to have substantial
incremental functionality, greatly improved speed and a wider range of
interfaces than ZSP's current technology.
The value of the one project identified to be in progress was determined
by estimating the future cash flows from the project 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 percentage of completion
for the project was determined using milestones representing management's
estimate of effort, value added and degree of difficulty of the portion of the
project completed as of April 14, 1999, as compared to the remaining research
and development to be completed to bring the project to technical feasibility.
The development process was grouped into three phases with each phase containing
between one and five milestones. The three phases were (i) researching the
market requirements and the engineering architecture and feasibility studies,
(ii) design and verification, and (iii) prototyping and testing the product
(both internal and customer testing). Development of ZSP's digital signal
processor project started in May 1998. As of April 14, 1999, the Company
estimated that the project was 65% complete.
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However, development of the technology remains a substantial risk to the
Company due to factors including the remaining effort to achieve technical
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired. Company management believes that the IPR&D charge of $4.6
million is valued consistently with the SEC staff's view regarding valuation
methodologies. There can be no assurance, however, that the SEC staff will not
take issue with any assumptions used in the Company's valuation model and
require the Company to revise the amount allocated to IPR&D.
Useful life of intangible assets:
The amount allocated to current technology and residual goodwill is being
amortized over their estimated weighted average useful life of seven years using
a straight-line method.
NOTE 4 - LICENSE AGREEMENT
The Company and Wafer Technology (Malaysia) Sdn. Bhd. ("WTM") have a
technology transfer agreement under which the Company grants licenses to WTM
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. During the second and third quarters of 1999, the Company transferred
technology to WTM valued at $3 million and $6 million respectively. These
amounts were recorded as an offset to the Company's research and development
expenses. In addition, the Company provided engineering training during the
third quarter of 1999 with a value of $1 million. The amount was recorded as an
offset to cost of sales. During the nine months ended September 30, 1999, the
Company billed a total of $10 million, $9 million of which was recorded as an
offset to the Company's research and development expenses and $1 million to cost
of sales.
NOTE 5 - 1998 RESTRUCTURING
1998 restructuring reserve activity:
During the third quarter of 1999, the Company completed the activities
underlying the restructuring plan which was originally established in the third
quarter of 1998. During the three month period ended September 30, 1999, the
Company utilized $2.4 million of restructuring reserves which reflected
severance payments of $1.2 million for 8 employees terminated during the quarter
in the U.S., Europe and Korea, $1.3 million for lease termination costs
primarily in the U.S., Europe and Japan, and $0.2 million for manufacturing
facility decommissioning costs in Japan, offset in part by currency translation
adjustments of $0.3 million.
During the quarter, the Company determined that $7.9 million of the
restructuring reserve originally established in the third quarter of 1998 would
not be utilized because of a change in management's estimate of the reserve
requirements. The amount consisted of the following:
- - - $2.8 million of excess severance reserves in Japan and Europe;
- - - $3.8 million of lease termination and non-cancelable purchase commitment
reserves primarily in U.S. and Europe;
- - - $1.3 million of other exit costs and manufacturing facility
decommissioning costs primarily in the U.S. and Japan and translation
adjustments.
The change in management estimates of the reserve requirements stemmed
primarily from the following factors:
- - - A significant increase in the requirement for manufacturing capacity to
meet expected sales growth which resulted in retention of certain
employees originally targeted for termination of employment and in
reversal of decommissioning costs as a result of retention of a U.S.
operations facility originally targeted for sale; and
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- - - The Company's ability to exit lease commitments and non-cancelable
purchase commitments more favorably than originally anticipated in the
U.S. and Europe.
Accordingly, the restructuring reserve reversal was included in the
determination of income from operations for the three month and nine month
periods ended September 30, 1999. The nine month period ended September 30, 1999
also included $2.5 million of restructuring reserve reversal recorded in the
first quarter of 1999 due to a change in management's estimate of the reserve
requirements in the U.S., Europe and Japan.
Description of 1998 restructuring:
The Company remains committed to improving profitability and strengthening
competitiveness. As a result of identifying opportunities to streamline
operations and maximize the integration of Symbios, Inc. ("Symbios") acquired on
August 6, 1998 (see Note 6) into the Company's operations, the Company's
management, with the approval of the Board of Directors, committed itself to a
restructuring plan and recorded a $75.4 million restructuring charge in the
third quarter of 1998. The action undertaken included a worldwide realignment of
manufacturing capacity, the consolidation of certain design centers and
administrative offices, and a streamlining of the Company's overhead structure
to reduce operating expenses. The restructuring charge excluded any integration
costs relating to Symbios. As discussed in Note 6 of Notes to the Unaudited
Consolidated Condensed Financial Statements, integration costs relating to
Symbios were accrued as a liability assumed in the purchase in accordance with
EITF No. 95-3, "Recognition of Liabilities in Connection with a Purchase
Business Combination."
Restructuring costs had included $37.2 million related primarily to fixed
assets impaired as a result of the decision to close a manufacturing facility in
Tsukuba, Japan by the third quarter of 1999; $4.7 million for termination of
leases and maintenance contracts primarily in the U.S. and Europe; $1.7 million
for non-cancelable purchase commitments primarily in Europe; $13.1 million in
fixed asset and other asset write-downs primarily in the U.S., Japan and Europe;
approximately $2.4 million in other exit costs, which resulted principally from
the consolidation and closure of certain design centers, sales facilities and
administrative offices primarily in the U.S. and Europe; and work force
reduction costs of $16.3 million.
Other exit costs included $0.9 million related to payments made for early
lease contract terminations and the write-down of surplus assets to their
estimated realizable value; $0.7 million for the write-off of excess licenses
for closed locations in Europe and $0.8 million of other exit costs associated
with the consolidation of design centers worldwide.
The workforce reduction costs primarily included severance costs related
to involuntary termination of employment for approximately 900 employees from
manufacturing in Japan, and engineering, sales, marketing and finance personnel
located primarily in the U.S., Japan and Europe. The fair value of assets
determined to be impaired in accordance with the guidance for assets to be held
and used in SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of," were the result of independent
appraisals and use of management estimates. Severance costs and other above
noted exit costs were determined in accordance with EITF No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity."
The following table sets forth the Company's 1998 restructuring reserves
as of December 31, 1998 and activity against the reserve for three and nine
month periods ended September 30, 1999:
(In thousands)
FOR THREE MONTHS ENDED FOR NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1999
----------------------------------- ----------------------------------
BALANCE RESERVE RESERVE BALANCE
12/31/98 UTILIZED REVERSAL UTILIZED REVERSAL 9/30/99
-------- -------- -------- -------- -------- -------
Write-down of manufacturing facility (a).......... $ 1,500 $ (210) $ (190) $ (210) $ (1,290) $ --
Other fixed asset related charges................. -- -- -- -- -- --
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Payments to employees for severance (b) ........... 11,600 (1,168) (2,832) (7,948) (3,652) --
Lease terminations and maintenance contracts (c) .. 4,600 (1,340) (2,260) (2,257) (2,343) --
Noncancelable purchase commitments ................ 1,600 -- (1,520) (80) (1,520) --
Other exit costs .................................. 1,200 -- (220) (450) (750) --
Cumulative currency translation adjustment ........ 1,512 300 (912) (600) (912) --
-------- -------- -------- -------- -------- ---------
Total ................................... $ 22,012 $ (2,418) $ (7,934) $(11,545) $(10,467) $ --
======== ======== ======== ======== ======== =========
(a) The $1.5 million balance at 12/31/98 for the write-down of the
facility and the amount utilized related to machinery and equipment
decommissioning costs in Japan.
(b) The amount utilized in the third quarter of 1999 consisted of $1.2
million of cash payments related to the severance of approximately
358 employees since 12/31/98 (approximately 8 in Q3 1999 in the U.S.,
Europe and Korea.)
(c) The amount utilized in the third quarter of 1999 consisted of $1.3
million of lease termination costs primarily in the U.S., Europe and
Japan.
NOTE 6 - INTEGRATION OF SYMBIOS
On August 6, 1998, the Company completed the acquisition of all of the
outstanding capital stock of Symbios from Hyundai Electronics America ("HEA").
HEA is a majority-owned subsidiary of Hyundai Electronics Industries Co., Ltd.
("HEI"), a Korean corporation. The transaction was accounted for as a purchase,
and accordingly, the results of operations of Symbios and estimated fair value
of assets acquired and liabilities assumed were included in the Company's
consolidated financial statements as of August 6, 1998, the effective date of
the purchase, through the end of the period. There were no significant
differences between the accounting policies of the Company and Symbios. The
allocation of the purchase price was disclosed in the Report on Form 10K/A for
the year ended December 31, 1998 previously filed with the Securities and
Exchange Commission.
The Company has taken certain actions to combine the Symbios operations
with those of LSI Logic and, in certain instances, to consolidate duplicative
operations. Adjustments to accrued integration costs related to Symbios were
recorded as an adjustment to the fair value of net assets in the purchase price
allocation. The Company finalized the integration plan as of December 31, 1998.
Accrued integration charges included $4 million related to involuntary
separation and relocation benefits for approximately 200 Symbios employees and
$1.4 million in other exit costs primarily relating to the closing of Symbios
sales offices and the termination of certain contractual relationships. The
Symbios integration related accruals were based upon management's current
estimate of integration costs and were in accordance with EITF No. 95-3,
"Recognition of Liabilities in Connection with a Purchase Business Combination."
During the third quarter of 1999, the Company completed the activities
underlying the integration plan outlined above. The following table sets forth
the Company's Symbios integration reserve as of December 31, 1998 and activity
against the reserve for the three and nine month periods ended September 30,
1999:
(In thousands)
BALANCE BALANCE
12/31/98 UTILIZED 9/30/99
-------- --------- --------
Payments to employees for severance and relocation (a) ... $ 2,360 $(2,360) $ --
Other exit costs (b) ..................................... 1,002 (1,002) --
------- ------- --------
Total .......................................... $ 3,362 $(3,362) $ --
======= ======= ========
(a) The amount utilized represents cash payments related to the
severance and relocation of 199 employees since December 31, 1998
(approximately $736K for 39 employees in the third quarter of 1999).
(b) The amount utilized reflects $528K in the third quarter of 1999.
No significant adjustments were made to the reserve during the period
presented.
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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
Symbios been a consolidated entity during the period presented. The summary
combines the results of operations as if Symbios had been acquired as of January
1, 1998.
The summary includes the impact of certain adjustments such as goodwill
amortization, changes in depreciation, estimated changes in interest income
because of cash outlays associated with the acquisition of Symbios and
elimination of certain notes receivable assumed to be repaid as of the beginning
of the periods presented, changes in interest expense because of the new debt
entered into with the purchase (see discussion in Note 10) and the repayment of
certain debt assumed to be repaid as of the beginning of the periods presented.
Additionally, in-process research and development of $145.5 million has been
excluded from the period presented as it arose from the acquisition of Symbios.
The charge of $75.4 million did not relate to the acquisition of Symbios (see
Note 5) and accordingly was included in the preparation of the pro forma
results.
(in thousands, except per-share amounts)
NINE MONTHS ENDED
SEPTEMBER 30, 1998
------------------
(UNAUDITED)
Revenue $ 1,424,229
Net loss $ (34,678)
Basic EPS $ (0.24)
Diluted EPS $ (0.24)
NOTE 7 - INVESTMENTS
The Company classifies its debt and equity investments into an
available-for-sale category and values them at fair value in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," with unrealized gains and losses, net of taxes, reported in
shareholders' equity until realized. For all investment securities, unrealized
losses that are other than temporary are recognized in net income. Gains and
losses on securities sold are based on the specific identification method and
are reflected in net income. The Company currently does not actively trade
securities.
As of September 30, 1999 and December 31, 1998, the Company held $55
million and $45 million of debt securities, respectively, that were classified
as cash equivalents and $271 million and $81 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, and U.S., municipal and foreign government and agency
securities. Debt securities approximated fair market value at September 30, 1999
and December 31, 1998, and thus no unrealized gains or losses were recorded for
these securities. The contract maturities of these securities were within one
year. Realized gains and losses for these securities were not significant during
the three and nine month periods ended September 30, 1999 and 1998.
As of September 30, 1999, the Company held marketable equity securities
with an aggregate carrying value of $86 million, $25 million of which were
classified as short-term investments on the Company's consolidated balance
sheet. The remaining balance was included in other long-term assets. In the
third quarter of 1999, the Company adopted a program of regular selling of
marketable equity securities. There were no significant investments in
marketable equity securities as of December 31, 1998. Total unrealized gains of
$53 million, net of the related tax effect of $28 million, on these equity
securities were included in accumulated other comprehensive income as of
September 30, 1999.
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During the third quarter of 1999, the Company sold equity securities for $2.5
million on the open market, realizing a pre-tax gain of approximately $2.2
million. Gross realized gains on available-for-sale securities for the nine
month period ended September 30, 1999 were approximately $3.6 million.
The Company wrote down to estimated fair value two long-term
non-marketable equity investments during the third quarter of 1998. They
consisted of a $12 million write-down of the Company's 2.4% equity investment in
a non-public foundry company and a $2.5 million write-down of the Company's
equity investment in a non-public technology company. The estimated fair values
established for the investments was determined by use of management estimates.
The decline in value of the investments was not considered by management to be
temporary.
NOTE 8 - DERIVATIVE FINANCIAL INSTRUMENTS
The Company has foreign subsidiaries which 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 contract, interest rate
swap 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. As of September 30,
1999 and December 31, 1998, there were no interest rate swap or currency swap
contracts outstanding.
The Company enters into forward contracts and currency swaps to hedge firm
intercompany asset and liability positions denominated in non-functional
currencies. The following table summarizes by major currency the forward
exchange contracts outstanding as of September 30, 1999 and December 31, 1998.
The buy amount represents the U.S. dollar equivalent of commitments to purchase
foreign currencies, and the sell amount represents the U.S. dollar equivalent of
commitments to sell foreign currencies. Foreign currency amounts were translated
at rates current at September 30, 1999 and December 31, 1998.
(In thousands)
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
Buy/(Sell):
Japanese Yen $ 20,575 $ --
Japanese Yen (25,335) --
These forward contracts are considered identifiable hedges and realized
and unrealized gains and losses are deferred until settlement of the underlying
commitments. They are recorded as other gains or losses when the underlying
exposure materializes or the hedged transaction is no longer expected to occur.
Deferred foreign gains and losses were not significant at September 30, 1999 and
December 31, 1998. Foreign currency transaction gains and losses included in
interest income and other were insignificant for the three and nine month
periods ended September 30, 1999 and 1998.
Currency option contracts were treated as hedges of third-party yen
revenue exposures. At September 30, 1999, total outstanding purchased currency
option contracts were $12 million. These contracts expire in January 2000. At
December 31, 1998, total outstanding purchased currency option contracts were
$130 million. These contracts expired quarterly through June 1999. The realized
and unrealized gains and losses and option premiums are deferred until the
exposure underlying the option is recorded. The deferred gains and losses were
not significant at September 30, 1999 and December 31, 1998. The deferred
premiums on all outstanding options were $0.4 million as of September 30, 1999
and $6 million as of December 31, 1998. The deferred premiums were included in
other current assets.
On August 5, 1998, the Company recognized a loss of $1.5 million from the
decision to close interest rate swap contracts which converted the interest
associated with yen borrowings by LSI Logic Japan Semiconductor, Inc., a
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wholly owned subsidiary of the Company ("JSI"), from adjustable to fixed rates.
The contracts were closed because the underlying debt was repaid as discussed in
Note 10. Current period gains and losses associated with the interest rate swaps
are included in interest expense, or as other gains and losses at such time as
related borrowings are terminated.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure 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. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000 pursuant to the issuance of SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities-Deferral of the
Effective Date of FASB statement No. 133", which deferred the effective date of
SFAS No. 133 by one year. Upon adoption of SFAS No. 133, the Company will be
required to adjust hedging instruments to fair value in the balance sheet and
recognize the offsetting gain or loss as transition adjustments to be reported
in net income or other comprehensive income, as appropriate, and presented in a
manner similar to the cumulative effect of a change in accounting principle.
While the Company believes the adoption of this statement will not have a
significant effect on the Company's results of operations, the impact of the
adoption of SFAS No. 133 as of the effective date cannot be reasonably estimated
at this time.
NOTE 9 - BALANCE SHEET INFORMATION
(In thousands)
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- --------------
Inventories:
Raw materials $ 40,300 $ 32,347
Work-in-process 124,903 53,042
Finished Goods 52,286 96,051
--------- -----------
Total $217,489 $181,440
========= ===========
The Company had $97 million of unamortized preproduction engineering costs
at December 31, 1998 associated with the construction of a new manufacturing
facility in Gresham, Oregon. This new facility became operational as of December
1, 1998, at which time capitalized preproduction began to be amortized over the
expected useful life of the manufacturing technology of approximately four
years. In April 1998, the AcSEC released SOP No. 98-5, "Reporting on the Costs
of Start-up Activities." SOP No. 98-5 is effective for fiscal years beginning
after December 15, 1998 and requires companies to expense all costs incurred or
unamortized in connection with start-up activities. Accordingly, the Company has
expensed the unamortized preproduction balance of $92 million, net of tax, on
January 1, 1999 and has presented it as a cumulative effect of a change in
accounting principle in accordance with SOP No. 98-5.
NOTE 10 - DEBT
During March 1999, the Company issued $345 million of 4 1/4% Convertible
Subordinated Notes (the "Convertible Notes") due in 2004. The Convertible Notes
are subordinated to all existing and future senior debt, are convertible 60 days
following issuance into shares of the Company's common stock at a conversion
price of $31.353 per share and are redeemable at the option of the Company, in
whole or in part, at any time on or after March 20, 2002. Each holder of the
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 $9.5 million
for debt issuance costs related to the Convertible Notes. The debt issuance
costs are being amortized using the interest method. The net proceeds of the
Convertible Notes were used to repay existing debt obligations as described
below.
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On August 5, 1998, the Company entered into a credit agreement with ABN
AMRO Bank N.V. ("ABN AMRO"). The credit agreement was restated and superseded by
the Amended and Restated Credit Agreement dated as of September 22, 1998 by and
among the Company, JSI, ABN AMRO and thereafter syndicated to a group of lenders
determined by ABN AMRO and the Company. The credit agreement consisted of two
credit facilities: a $575 million senior unsecured reducing revolving credit
facility ("Revolver"), and a $150 million senior unsecured revolving credit
facility ("364 day Facility").
On August 5, 1998, the Company borrowed $150 million under the 364 day
Facility and $485 million under the Revolver. On December 22, 1998, the Company
borrowed an additional $30 million under the Revolver. The credit facilities
allowed for borrowings at adjustable rates of LIBOR/TIBOR with a 1.25% spread.
As of March 31, 1999 the spread changed to 1%. Interest payments are due
quarterly. The 364 day Facility expired on August 3, 1999 by which time
borrowings outstanding were fully paid in accordance with the credit agreement.
The Revolver is for a term of four years with the principal reduced quarterly
beginning on December 31, 1999. The Revolver includes a term loan sub-facility
in the amount of 8.6 billion yen made available to JSI over the same term. The
yen term loan sub-facility is for a period of four years with no required
payments until it expires on August 5, 2002. Pursuant to the restated credit
agreement, on August 30, 1998, JSI repaid its existing 11.4 billion yen ($79
million) credit facility and borrowed 8.6 billion yen ($83 million at September
30, 1999) bearing interest at adjustable rates. In March of 1999, the Company
repaid the full $150 million outstanding under the 364 day Facility and $186
million outstanding under the Revolver primarily using the proceeds from the
Convertible Notes as described above. Borrowings outstanding under the Revolver
including the yen sub-facility were $382 million as of September 30, 1999. As of
September 30, 1999, the interest rate for the Revolver and the yen sub-facility
were 6.31% and 1.12%, respectively. The debt issuance costs associated with
these debt facilities were not significant.
In accordance with the terms of its existing credit agreement, the Company
must comply with certain financial covenants related to profitability, tangible
net worth, liquidity, senior debt leverage, debt service coverage and
subordinated indebtedness. As of September 30, 1999, the Company was in
compliance with these covenants.
NOTE 11 - RECONCILIATION OF BASIC AND DILUTED EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of
the basic and diluted per share computations as required by SFAS No. 128,
"Earnings Per Share ("EPS")."
(In thousands except for per share amounts)
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------------------------
1999 1998
------------------------------------- -----------------------------------
PER-SHARE PER-SHARE
INCOME* SHARES+ AMOUNT INCOME* SHARES+ AMOUNT
---------- ------- --------- --------- -------- ---------
Basic EPS:
Net income available to common
Stockholders.............................. $ 51,924 146,767 $0.35 $(212,030) 143,159 $(1.48)
--------- ---------
Effect of dilutive securities:
Stock options ................................ -- 8,700 -- -- -- --
4 1/4% Convertible Subordinated Notes ........ 2,749 11,004 -- -- -- --
Diluted EPS:
Net income available to common
Stockholders.............................. $ 54,673 166,471 $0.33 $(212,030) 143,159 $(1.48)
--------- ---------
- - ---------------------------------------
*Numerator--+ Denominator
Options to purchase 1,947,413 shares were outstanding at September 30,
1999 but were not included in the calculation of diluted shares for the three
month period ended September 30, 1999 because the exercise prices were greater
than the average market price of common shares. The exercise price of these
options ranged from $55.06 to $58.88 at September 30, 1999. Options to purchase
17,416,099 shares were outstanding at September 30, 1998
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but were not included in the calculation of diluted shares for the three month
period ended September 30, 1998 because of their antidilutive effect on earnings
per share as the Company incurred a loss for the quarter.
(In thousands except for per share amounts)
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------------------------------------------
1999 1998
----------------------------------------- ------------------------------------------
PER-SHARE PER-SHARE
INCOME* SHARES+ AMOUNT INCOME* SHARES+ AMOUNT
---------- ------- --------- --------- ------- ---------
Basic EPS:
Net income before cumulative effect of
change in accounting principle .... $ 65,765 145,514 $0.45 $(149,235) 142,852 $(1.04)
-------- -------
Cumulative effect of change in
accounting principle .............. (91,774) 145,514 $(0.63) -- -- --
--------
Net (loss)/ income available
to common stockholders ............ (26,009) 145,514 $(0.18) (149,235) 142,852 $(1.04)
-------- -------
Effect of dilutive securities:
Stock options ........................ -- 6,509 --
Diluted EPS:
Net income before cumulative effect of
change in accounting principle .... 65,765 152,023 $0.43 (149,235) 142,852 $(1.04)
-------- -------
Cumulative effect of change
in accounting principle ........... (91,774) 152,023 $(0.60) -- -- --
--------
Net (loss)/income available
to common stockholders ............ $ (26,009) 152,023 $(0.17) $(149,235) 142,852 $(1.04)
-------- -------
- - ---------------------------------
*Numerator--+ Denominator
Options to purchase 1,407,060 shares were outstanding at September 30,
1999 but were not included in the calculation of diluted shares for the nine
month periods ended September 30, 1999 because the exercise prices were greater
than the average market price of common shares. The exercise price of these
options ranged from $41.88 to $58.88 at September 30, 1999. Options to purchase
16,425,626 shares were outstanding at September 30, 1998 but were not included
in the calculation of diluted shares for the nine month period ended September
30, 1998 because of their antidilutive effect on earnings per share as the
Company incurred a loss for the period. For the nine month period ended
September 30, 1999, common equivalent shares of 8,017,589 and interest expense
of $5.5 million, net of taxes, associated with the Convertible Notes (see Note
10) were excluded from the computation of diluted earnings per share as a result
of their antidilutive effect on earnings per share.
NOTE 12 - COMPREHENSIVE INCOME
Comprehensive income is defined as the 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 differences between net income and comprehensive income, for the
Company, are due to foreign currency translation adjustments and unrealized
gains on available-for-sale securities, net of applicable taxes. Comprehensive
income for the current reporting periods and comparable periods in the prior
year is as follows:
(In thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------------------------
1999 1998 1999 1998
------------ -------------- ------------- --------------
Comprehensive income/(loss) $ 115,935 $ (203,634) $ 53,341 $ (164,800)
============ ============== ============= ==============
NOTE 13 - SEGMENT REPORTING
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The Company operates in two reportable segments: the Semiconductor segment
and the Storage Systems segment. In the Semiconductor segment, the Company
designs, develops, manufactures and markets integrated circuits, including
application-specific integrated circuits ("ASICs"), application-specific
standard products ("ASSPs") and related products and services. Semiconductor
design and service revenues include engineering design services, licensing of
LSI's 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 Storage 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 Disks ("RAID") storage systems, subsystems and
related software. The Storage Systems segment was added in August 1998 with the
purchase of Symbios (see Note 6).
The following is a summary of operations by segment for the three and nine
month periods ended September 30, 1999 and 1998.
(IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1999
------------------------------------------------------------------------------------------------
Semiconductor Storage Systems TOTAL Semiconductor Storage Systems TOTAL
------------- --------------- ---------- ------------- --------------- ----------
Revenue $ 470,117 $ 69,842 $ 539,959 $1,300,271 $ 204,317 $1,504,588
Income from operations $ 64,213 $ 7,369 $ 71,582 $ 90,968 $ 19,620 $ 110,588
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
---------------------------------------------------------------------------------------------------
Semiconductor Storage Systems TOTAL Semiconductor Storage Systems TOTAL
------------- --------------- ------------ ------------- --------------- ------------
Revenue $ 366,194 $ 30,677 $ 396,871 $ 1,035,196 $ 30,677 $ 1,065,873
(Loss)/income from operations $ (201,647) $ 4,433 $ (197,214) $ (131,267) $ 4,433 $ (126,834)
Intersegment revenues for the three and nine month periods ended September
30, 1999 were not significant. Restructuring of operations and merger related
expenses are included in the semiconductor segment.
The following is a summary of total assets by segment as of September 30,
1999 and December 31, 1998:
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1999 1998
---------- ----------
Assets by segment:
Semiconductor $2,830,545 $2,700,295
Storage Systems 144,757 123,510
---------- ----------
Total assets $2,975,302 $2,823,805
========== ==========
The Storage Systems segment did not meet the requirement for a reportable
segment as defined in SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" for the year ended and as of December 31, 1998.
However, for purposes of comparability, revenue, income/(loss) from operations
by segment for the year ended December 31, 1998 and total assets by segment as
of December 31, 1998 were included in the tables.
NOTE 14 - LEGAL MATTERS
A discussion of certain pending legal proceedings is included in Item 3 of
the Company's Annual Report on Form 10-K/A for the fiscal year ended December
31, 1998. Except as set forth in this Note, the information provided therein
remains unchanged. On February 26, 1999, a lawsuit alleging patent infringement
was filed in the United States District Court for the District of Arizona by the
Lemelson Medical, Education & Research
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Foundation, Limited Partnership, against eighty-eight electronics industry
companies, including the Company. The case number is CIV99-0377PHX RGS. The
patents involved in this lawsuit generally relate to semiconductor manufacturing
and computer imaging, including the use of bar coding for automatic
identification of articles. The relief sought is an injunction and damages in an
unspecified amount. While the Company cannot make any assurances regarding the
eventual resolution of this matter, we do not believe it will have a material
adverse effect on the Company's consolidated results of operations or financial
condition.
The Company continues to believe that the final outcome of matters
discussed in Item 3 of the Company's Annual Report on Form 10-K/A 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, particularly if
viewed on a quarterly basis, for having an adverse effect on the Company's
financial position or its results of operations.
Certain additional claims and litigation against the Company have also
arisen in the normal course of business. The Company believes that it is
unlikely that the outcome of these claims and lawsuits will have a materially
adverse effect on the Company's consolidated financial position or results of
operations.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
GENERAL
We believe that our future operating results will continue to be subject
to quarterly variations based upon a wide variety of factors. These factors
include, among others:
- Cyclical nature of both the semiconductor industry 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; 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 which operate and sell our products in
various global markets. We purchase a substantial portion of our raw materials
and equipment from foreign suppliers and incur labor and other operating costs
in foreign currencies, particularly at our Japanese manufacturing facilities. As
a result, we are exposed to international factors such as changes in foreign
currency exchange rates or weak economic conditions of the respective countries
in which we operate. We utilize forward exchange, interest swap and option
contracts to manage our exposure associated with currency fluctuations on
intercompany transactions and certain foreign currency denominated commitments.
With the exception of purchased option contracts and forward contracts, there
were no interest rate swap contracts outstanding as of September 30, 1999 and
December 31, 1998. (See Note 8 of Notes to the Unaudited Consolidated Condensed
Financial Statements.) 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 which could significantly and
adversely affect our operating results and financial condition.
There have been no significant changes in the market risk disclosures
during the nine month period ended September 30, 1999 as compared to the
discussion in our 1998 Annual Report on Form 10-K/A for the year ended December
31, 1998.
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 Management's Discussion
and Analysis included in our 1998 Annual Report on Form 10-K/A for the year
ended December 31, 1998.
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
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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.
The extent to which our plans for future cost reductions are realized also
may impact our future financial performance. 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 1998 Annual Report on Form 10-K/A for the
year ended December 31, 1998.
YEAR 2000 DISCLOSURE
The following statement is a Year 2000 Readiness Disclosure under the Year
2000 Information and Readiness Disclosure Act of 1998.
As with many other companies, the Year 2000 computer issue presents risks
for us. We use a significant number of computer software programs and operating
systems in our internal operations, including applications used in our
financial, product development, order management and manufacturing systems.
There are areas in which the Year 2000 computer issue could negatively impact us
and our business. If internal systems do not properly recognize and process date
information for years into and beyond the turn of the century, there could be an
adverse impact on our operations. Moreover, if critical suppliers' or customers'
systems or products fail because of a Year 2000 malfunction, there could be an
adverse impact on our operating results. Finally, our products could malfunction
as a result of a failure in date recognition. A Year 2000 problem could arise if
our systems were to fail to properly recognize and process date information for
several reasons, including: they could fail to properly recognize years that
begin with the digits "20" instead of "19"; they could attribute specially
assigned meanings to certain date code digits, such as "99"; or they could fail
to recognize the year 2000 as a leap year. The inability of computer software
programs to accurately recognize, interpret and process date codes designating
the year 2000 and beyond could cause systems to yield inaccurate results or
encounter operating problems, including interruption of the business operations
that such systems control.
We are engaged in a comprehensive program to assess our Year 2000 risk
exposure and to plan and implement remedial and corrective action where
necessary. We have reviewed all of our major internal systems, including human
resources, financial, engineering and manufacturing systems, to assess Year 2000
readiness and to identify critical systems that require correction or
remediation. Assessment of our design engineering systems and products was
completed in the first quarter of 1999. Based on the results of this assessment,
remediation of critical systems was completed and tested by the third quarter of
1999. We believe that our existing HR, financial and business software systems
are Year 2000 ready. We cannot assure you, however, that integration and testing
of new, corrected or updated programs or systems with which they interface will
not result in necessary corrective action to one or more critical systems. A
significant disruption of our financial or business systems would adversely
impact our ability to process orders, manage production and issue and pay
invoices. Our inability to perform these functions for a long period of time
could result in a material impact on our results of operations and financial
condition.
Our manufacturing facilities incorporate sophisticated computer integrated
manufacturing systems which depend on a mix of our proprietary software and
systems and software purchased from third parties. Failure of these systems
would cause a disruption in the manufacturing process and could result in a
delay in completion and shipment of products. Our assessment of the Year 2000
readiness of our manufacturing systems is complete. Based on information
currently available, we believe that our systems will not be materially impacted
by Year 2000 issues. However, we cannot assure you that a significant disruption
in systems resulting from a Year 2000 problem will not
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occur. If the computer integration system fails for this or any other reason,
there could be a material adverse impact on our operating results and financial
condition.
We are working with critical suppliers of products and services to assess
their Year 2000 readiness with respect both to their operations and the products
and services they supply to us. Comprehensive inquiries have been sent and
responses are being monitored, with appropriate follow-up where required. This
analysis will continue well through 1999, with corrective action taken
commensurate with the criticality of affected products and services.
Our assessment program also has encompassed our own product offerings. Our
ASICs are custom-designed chips which implement the customer's functional or
engineering specifications. As designer and manufacturer of the physical
implementation of a customer's design in silicon, we generally do not have
specific knowledge of the role of the customer's ASIC within the complete system
for which it is intended. Whether the chip will operate correctly depends on the
system function and the software design and integration, which will be
determined independently by the customer or other third party suppliers. Our
ASSP and storage systems products, on the other hand, do implement chip and
system functionality designed by us. Such functionality includes graphics
processing, audio/video signal decoding, data transmission, I/O control and data
storage whose functionality generally is not date dependent. We have completed
our assessment of the Year 2000 readiness of these products, and there is no
information to indicate that Year 2000 issues will have a material impact on
sales or functionality of our standard product offerings. Customers are seeking
assurances of our Year 2000 readiness with increasing frequency, and we are
endeavoring promptly and completely to address their concerns. However, we have
no control over a customer's Year 2000 readiness. Customers who believe that the
products they purchase from us may not be Year 2000 compliant may seek
alternative sources of supply. A significant decline in new orders or increase
in cancellations of existing backlog could have a material adverse impact on our
results of operations or financial condition.
We are at work on the development of various types of contingency plans to
address potential problems with critical internal systems and third party
interactions. Our contingency plans include procedures for dealing with a major
disruption of internal business systems, plans for long term factory shutdown
and identification of alternative vendors of critical materials in the event of
Year 2000 related disruption in supply. Contingency planning will continue
through at least 1999, and will depend heavily on the results of the remediation
and testing of critical systems. The potential ramifications of a Year 2000 type
failure are potentially far-reaching and largely unknown. We cannot assure you
that a contingency plan in effect at the time of a system failure will
adequately address the immediate or long term effects of a failure, or that such
a failure would not have a material adverse impact on our operations or
financial results in spite of prudent planning.
Our costs to date related to the Year 2000 issue consist primarily of
reallocation of internal resources to evaluate and assess systems and products
as described above and to plan our remediation and testing efforts. We have not
maintained detailed accounting records, but based on our review of department
budgets and staff allocations, we believe these costs to be insignificant. We
currently estimate that the total cost of ongoing assessment, remediation,
testing and planning directly related to Year 2000 issues will amount to
approximately $15 million. Of this amount, approximately $7 million is expected
to consist of expenses attributed to redeployment of labor resources and
overhead, $3 million for the cost of software and external consulting fees and
$5 million for additional capital expenditures. The capital expenditures
represent the early replacement of information technology equipment and software
to obtain the full benefits of Year 2000 protections versus the normal technical
obsolescence replacement cycle. The estimate is based on the current assessment
of the projects and is subject to change as the projects progress. We cannot
assure you that remediation and testing will not identify issues which require
additional expenditure of material amounts which could result in an adverse
impact on financial results in future reporting periods.
Based on currently available information, management does not believe that
the Year 2000 issues discussed above related to internal systems or products
sold to customers will have a material adverse impact on our financial condition
or overall trends in results of operations. However, we are uncertain to what
extent we may be affected by such matters. In addition, we cannot assure you
that the failure to ensure Year 2000 capability by a supplier not considered
critical or another third party would not have a material adverse effect on us.
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ADOPTION OF THE EURO
In 1998, we established a task force to address the issues raised by the
implementation of the European single currency (the "Euro"). Our primary focus
has been the changes needed to address a mix of Euro and local denomination
transactions during the transition period from January 1, 1999 through January
1, 2002.
As of January 1, 1999, we began transacting business in Euros. We
implemented a new bank account structure throughout Europe to accommodate
customers and vendors and to improve liquidity management in Europe.
We do not presently expect that the introduction and use of the Euro will
materially affect our foreign exchange and hedging activities or our use of
derivative instruments. We do not believe that the introduction of the Euro will
result in any significant increase in costs to us, and all costs associated with
the introduction of the Euro will be expensed in accordance with our policy. We
do not expect that the transition to the Euro will result in any competitive
pricing or will adversely impact any of our internal computer systems. While we
will continue to evaluate the impact of the Euro introduction over time, based
on currently available information, we do not believe that the introduction of
the Euro currency will have a significant adverse impact on our financial
condition or overall trends in results of operations.
RESULTS OF OPERATIONS
On June 22, 1999, we completed a merger of our wholly-owned subsidiary
with SEEQ in a transaction accounted for as a pooling of interests and SEEQ
became a wholly-owned subsidiary. All financial information has been restated
retroactively to reflect SEEQ and our combined operations as if the merger had
occurred at the beginning of the earliest period presented (see Note 2 of Notes
to the Unaudited Consolidated Condensed Financial Statements). Prior to the
merger, SEEQ's fiscal year-end was the last Sunday in September of each year
whereas we operate on a fiscal year ending on December 31.
Where more than one significant factor caused changes in results, we have
quantified each material factor throughout the MD&A where practicable.
REVENUES
Revenues for the third quarter of 1999 increased $143 million or 36% to
$540 million compared to $397 million during the same period of 1998. Revenues
for the Semiconductor segment (see Note 13 of the Notes to the Unaudited
Consolidated Condensed Financial Statements) increased $104 million or 28% for
the three months ended September 30, 1999 as compared to the same period of the
prior year. Significant factors which contributed to the increase included
additional revenues from products used in communications and networking
applications and additional revenues from the acquisition of Symbios on August
6, 1998 (see Note 6 of Notes to the Unaudited Consolidated Condensed Financial
Statements) which included increased demand for products used in storage
components applications. Revenues for the Storage Systems segment (see Note 13
of the Notes to the Unaudited Consolidated Condensed Financial Statements)
increased $39 million or 128% for the three months ended September 30, 1999 as
compared to the same period of the prior year. The increase was primarily
attributed to additional revenues from the acquisition of Symbios on August 6,
1998 (see Note 6 of Notes to the Unaudited Consolidated Condensed Financial
Statements) and increased demand for products used in Storage Systems.
Revenues for the first nine months of 1999 increased $439 million or 41%
to $1,505 million compared to $1,066 million for the same period of the prior
year. Revenues for the Semiconductor segment (see Note 13 of the Notes to the
Unaudited Consolidated Condensed Financial Statements) increased $265 million or
26% for the nine months period ended September 30, 1999 as compared to the same
period of the prior year. Significant factors which contributed to the increase
included increased demand for products used in communications and networking
applications and additional revenues from the acquisition of Symbios on August
6, 1998 (see Note 6 of Notes to the Unaudited Consolidated Condensed Financial
Statements) which included increased demand for products used in storage
components applications, offset in part by decreased demand and lower average
selling prices for products used in computer and consumer applications. Revenues
for the Storage Systems segment (see Note 13 of the Notes
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to the Unaudited Consolidated Condensed Financial Statements) increased $174
million or 566% for the nine months ended September 30, 1999 as compared to the
same period of the prior year. The increase was primarily attributed to
additional revenues from the acquisition of Symbios on August 6, 1998 (see Note
6 of Notes to the Unaudited Consolidated Condensed Financial Statements) and
increased demand for products used in Storage Systems.
One customer represented 11% and 10% of our consolidated revenues for the
three and nine months ended September 30, 1999, respectively. In the Storage
Systems segment, three customers represented 30%, 28% and 14% of our Storage
Systems revenues, respectively, during the three months ended September 30,
1999. There were four customers, representing 29%, 25%, 15% and 10% of our
Storage Systems revenues, respectively, during the nine months ended September
30, 1999. In the Semiconductor segment, there were no customers who represented
10% or more of our Semiconductor revenues for the three and nine months ended
September 30, 1999.
OPERATING COSTS AND EXPENSES
Key elements of the consolidated statements of operations, expressed as a
percentage of revenues, were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------------------------------
1999 1998 1999 1998
-------------- ------------------- ----------------- --------------
Gross margin 40% 43% 37% 44%
Research and development expenses 13% 20% 15% 20%
Selling, general and administrative expenses 12% 15% 13% 15%
Amortization of intangibles 2% 2% 2% 1%
Income/(loss) from operations 13% (50%) 7% (12%)
GROSS MARGIN
The gross margin percentage decreased to 40% during the third quarter of
1999 from 43% in the same period in 1998 and decreased to 37% during the first
nine months of 1999 from 44% in the same period in 1998. The decrease reflected
a combination of the following elements:
- Changes in product mix primarily related to Symbios product
additions from August 6, 1998;
- Lower average selling prices which included the impact from currency
fluctuations; and
- Increased cost of revenues from commencing operations at our new
fabrication facility in Gresham, Oregon in December of 1998.
During the third quarter of 1999, we provided engineering training in
accordance with a technology transfer agreement entered into with WTM in
Malaysia (see Note 4 of Notes to the Unaudited Consolidated Condensed Financial
Statements). The engineering training was valued at $1 million and recorded as a
credit to costs of sales during the third quarter of 1999.
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
margin in future periods.
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Changes in the relative strength of the yen may have a greater impact on
our gross margin than other foreign exchange fluctuations due to our large wafer
fabrication operations in Japan. Although the yen strengthened (the average yen
exchange rate for the third quarter and the first nine months of 1999 increased
18% and 13%, respectively, from the same periods in 1998), the effect on gross
margin and net income was not significant because yen denominated sales offset a
substantial portion of yen denominated costs during the periods. Moreover, we
hedged a portion of our remaining yen exposure. (See Note 8 of Notes to the
Unaudited Consolidated Condensed Financial Statements.) Future changes in the
relative strength of the yen or mix of foreign denominated revenues and costs
could have a significant effect on gross margin or operating results.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") expenses for the third quarter of 1999
decreased approximately $7 million or 9% to $72 million compared to $79 million
for the same period of the prior year. The decrease was primarily attributable
to a $6 million research and development benefit associated with a technology
transfer agreement entered into with WTM in Malaysia during the second quarter
of 1999 (see Note 4 of the Notes to the Unaudited Consolidated Condensed
Financial Statements). Excluding the $6 million dollar benefit during the third
quarter of 1999, research and development expenditures for the third quarter of
1999 declined slightly as compared to the same period in the prior year.
R&D expenses for the nine months ended September 30, 1999 increased $13
million or 6% to $223 million compared to $210 million for the same period of
the prior year. Significant factors which contributed to the increase were the
following:
- Expenditures for research and development activities which were a
continuation of research and development activities of the Symbios
business included in our unaudited consolidated financial statements
in the third quarter and the first nine months of 1999;
- Expenditures related to the continued development of advanced
sub-micron products and process technologies; and
- Increased compensation related costs during 1999.
The above noted increases during the first nine months of 1999 as compared
to the same period of 1998 were offset in part by $9 million which was directly
attributable to an existing technology transfer agreement entered into with WTM
in Malaysia during the second quarter of 1999 (see Note 4 of the Notes to the
Unaudited Consolidated Condensed Financial Statements).
As a percentage of revenues, R&D expenses decreased to 13% and 15% for the
third quarter and the first nine months of 1999, respectively, compared to
approximately 20% for the comparable periods in 1998. The effects of our
restructuring programs established in the third quarter of 1998 primarily
accounted for the decrease (see Note 5 of Notes to the Unaudited Consolidated
Condensed Financial Statements). As we continue our commitment to technological
leadership in our markets and realize the further benefit of cost savings from
our restructuring efforts, we are targeting our R&D investment for the remainder
of 1999 to be approximately 13% of revenues.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expenses increased $6 million
or 9% to $67 million and $32 million or 20% to $191 million for the third
quarter and the first nine months of 1999, respectively, compared to $61 million
and $159 million during the same periods in 1998, respectively.
The increase was primarily attributable to the inclusion of current
expenses relating to the former Symbios business acquired on August 6, 1998 and
increased compensation related costs during 1999. As a percentage of revenues,
SG&A expenses decreased to approximately 12% and 13% for the three and nine
month periods ended September 30, 1999, respectively, from 15% during the same
periods in 1998.
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We expect that SG&A expenses as a percentage of revenues will decline to
approximately 12% of revenues for the remainder of the year as we continue to
realize the benefits of cost savings from the restructuring programs established
in the third quarter of 1998.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
In-process research and development ("IPR&D") was $4.6 million for the
nine month period ended September 30, 1998, compared to $145.5 million for the
three and nine month periods ended September 30, 1998. On April 14, 1999, we
acquired all of the outstanding capital stock of ZSP for a total purchase price
of $11.3 million which consisted of $7 million in cash (including approximately
$0.6 million in direct acquisition costs) and assumed liabilities up to $4.3
million in accordance with the purchase agreement with ZSP. The merger was
accounted for as a purchase (See Note 3 of the Notes to the Unaudited
Consolidated Condensed Financial Statements). ZSP, a development stage
semiconductor company, was involved in the design and marketing of programmable
Digital Signal Processors ("DSPs") for use in wired and wireless communications.
The results of operations of ZSP and estimated fair value of assets acquired and
liabilities assumed were included in our consolidated condensed financial
statements as of April 14, 1999, the effective date of the purchase, through the
end of the period.
In connection with the purchase of ZSP, we recorded a $4.6 million charge
to IPR&D during the second quarter of 1999. The amount was determined by
identifying research projects for which technological feasibility had not been
established and no alternative future uses existed. We acquired ZSP's in-process
DSP research and development project that was targeted at the telecommunications
market. This product was being developed specifically for voice over net or
voice over internet protocol applications and was intended to have substantial
incremental functionality, greatly improved speed and a wider range of
interfaces than ZSP's current technology.
The value of the one project identified to be in progress was determined
by estimating the future cash flows from the project once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value as defined below. The net cash
flows from the identified project were based on our estimates of revenues, cost
of sales, research and development costs, selling, general and administrative
costs and applicable income taxes for the project. These estimates were compared
and found to be in line with industry analysts forecasts of growth in the
telecommunications market. Estimated total revenues are expected to peak in the
years 2002 and 2003 and then decline in 2004 as other new products are expected
to become available. These projections are based on our estimates of market size
and growth, expected trends in technology, and the expected timing of new
product introductions by us and our competitors.
We applied a royalty percentage of 25% of operating income for the project
in process to attribute value for dependency on predecessor core technologies.
The discount rate used was 25% for the project, a rate 1,000 basis points higher
than the industry weighted average cost of capital estimated at approximately
15% 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 using
milestones representing management's estimate of effort, value added and degree
of difficulty of the portion of the project completed as of April 14, 1999, as
compared to the remaining research and development to be completed to bring the
project to technical feasibility. The development process was grouped into three
phases with each phase containing between one and five milestones. The three
phases were:
- Researching the market requirements and the engineering architecture
and feasibility studies;
- Design and verification; and
- Prototyping and testing the product (both internal and customer
testing).
Development of ZSP's digital signal processor project started in May 1998.
As of April 14, 1999, we estimated the project was 65% complete. As of the
acquisition date, the cost to complete the project was estimated at $1 million
for the remainder of 1999.
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However, development of the technology remains a substantial risk to us
due to factors including the remaining effort to achieve technical feasibility,
rapidly changing customer markets and competitive threats from other companies.
Additionally, the value of other intangible assets acquired may become impaired.
Our management believes that the IPR&D charge of $4.6 million is valued
consistently with the SEC staff's view regarding valuation methodologies. There
can be no assurances, however, that the SEC staff will not take issue with any
assumptions used in the valuation model and require us to revise the amount
allocated to IPR&D.
The $145.5 million of IPR&D for the three and nine month periods ended
September 30, 1999 represents the amount of purchase price allocated to IPR&D in
connection with the acquisition of Symbios (see Note 6 of Notes to the Unaudited
Consolidated Condensed Financial Statements). The allocation of the purchase
price and the valuation methodology used to determine the amount allocated to
IPR&D were disclosed in the Report on Form 10K/A for the year ended December 31,
1998 previously filed with the Securities and Exchange Commission.
RESTRUCTURING OF OPERATIONS AND OTHER NON-RECURRING (BENEFITS)/CHARGES, NET
Restructuring of operations and other non-recurring net benefits were $7.9
million and $2.1 million for the three and nine month periods ended September
30, 1999, respectively, compared to a $75.4 million charge during the same
periods in 1998. The benefit of $7.9 million during the third quarter of 1999
was directly attributable to the reversal of restructuring reserves associated
with the restructuring charge originally established in the third quarter of
1998 due to a change in management estimate in the U.S., Japan and Europe (see
Note 5 of the Notes to the Unaudited Consolidated Condensed Financial
Statements). The reversal was primarily comprised of the following:
- $2.8 million of excess severance reserves in Japan and Europe;
- $3.8 million of lease termination and non-cancelable purchase
commitment reserves primarily in U.S. and Europe; and
- $1.3 million of other exit costs and manufacturing facility
decommissioning costs primarily in the U.S. and Japan and
translation adjustments.
The change in management estimates of the reserve requirements stemmed
primarily from the following factors:
- A significant increase in the requirement for manufacturing capacity
to meet expected sales growth which resulted in retention of certain
employees originally targeted for termination of employment and in
reversal of decommissioning costs as a result of retention of a U.S
test and assembly facility originally targeted for sale; and
- Our ability to exit lease commitments and non-cancelable purchase
commitments more favorably than originally anticipated in the U.S.
and Europe.
The net benefit of $2.1 million for the nine months ended September 30,
1999 reflected the combination of the following:
- Approximately $10.4 million of 1998 restructuring reserve reversals
associated with a change in management estimate (see Note 5 of the
Notes to the Unaudited Consolidated Condensed Financial Statements).
In addition to the $7.9 million as noted above, approximately $2.5
million was reversed in the first quarter of 1999 which related to
excess severance and other exit costs primarily in the U.S., Japan
and Europe.
- Approximately $2.9 million in restructuring charges and $5.4 million
in merger related expenses associated in connection with the merger
with SEEQ on June 22, 1999 (see Note 2 of the Notes to the Unaudited
Consolidated Condensed Financial Statements) which includes $0.5
million in merger expenses recorded by SEEQ in the first quarter of
1999. The merger expenses related primarily to investment banking
and other professional fees directly attributable to the merger with
SEEQ. The restructuring charge was
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comprised of $1.9 million in write-downs of fixed assets which were
duplicative to the combined company, $0.5 million of exit costs
relating to non-cancelable building lease contracts and $0.5 million
provision for severance costs related to the involuntary termination
of certain employees. The exit costs and employee severance costs
were recorded in accordance with EITF No. 94-3 "Liability
Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity." The fixed and other assets write-downs
were recorded in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of." The restructuring actions as outlined by the
restructuring plan are intended to be executed to completion by June
30, 2000, one year from the date the reserve was taken.
During the third quarter of 1998, as a result of identifying opportunities
to streamline operations and maximize the integration of Symbios acquired on
August 6, 1998 (see Note 6 of Notes to the Unaudited Consolidated Condensed
Financial Statements) into our operations, our management, with the approval of
the Board of Directors, committed itself to a restructuring plan and recorded a
$75 million restructuring charge. For a description of the restructuring costs
recorded in the third quarter of 1998 and changes to the restructuring reserves
during the three and nine month periods ended September 30, 1999, refer to Note
5 of the Notes to the Unaudited Consolidated Condensed Financial Statements.
During the third quarter of 1999, we completed the activities underlying the
restructuring plan.
As a result of the execution of the restructuring plan announced in the
third quarter of 1998, we expect to realize savings in 1999 of approximately $37
million in reduced employee expenses, $10 million in depreciation savings and $3
million related to reduced lease and maintenance contract expenses primarily
associated with the reduction in the number of engineering design centers and
sales facilities and administrative offices worldwide.
The savings from the restructuring plan associated with the acquisition of
SEEQ are not considered to be significant.
AMORTIZATION OF INTANGIBLES
Amortization of goodwill and other intangibles increased $5 million to $12
million and $25 million to $35 million in the three and nine month periods ended
September 30, 1999, respectively, compared to $7 million and $10 million during
the same periods in 1998, respectively. The increase was primarily related to
additional amortization of goodwill associated with the acquisition of Symbios
in August of 1998 and the acquisition of ZSP in April of 1999.
INTEREST EXPENSE
Interest expense increased $3 million to $9 million and $24 million to $30
million in the three and nine months ended September 30, 1999, respectively,
compared to $6 million during the same periods in 1998. The increase was
attributable to interest expense on the bank debt facility, which we entered
into in August 1998 to fund the purchase of Symbios, and the Convertible Notes
issued in March 1999 (see Note 10 of Notes to the Unaudited Consolidated
Condensed Financial Statements.) Additionally, in 1999, we did not capitalize
any interest associated with the construction of the new fabrication facility in
Gresham, Oregon, as operations of the facility commenced in December 1998.
INTEREST INCOME AND OTHER, NET
Interest income and other increased $30 million to $7 million and $21
million to $11 million in the third quarter and the first nine months of 1999,
respectively, as compared to $23 million and $10 million of net expenses during
the same periods in 1998, respectively. The increase was primarily attributable
to the following:
- A $14 million write-down of our equity investment in two non-public
technology companies with impairment indicators not considered to be
temporary in the third quarter of 1998 (see Note 7 of Notes to the
Unaudited Consolidated Condensed Financial Statements);
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- A $2 million write-down of capitalized software in the third quarter
of 1998;
- An $8 million write down of fixed assets in the third quarter of
1998;
- A $1.5 million loss in the third quarter of 1998, from the decision
to close the interest swap at JSI (see Note 8 of Notes to the
Unaudited Consolidated Condensed Financial Statements); and
- A $2 million and $4 million gain on stock investments in the three
and nine months ended September 30, 1999, respectively. The increase
was offset in part by the following:
- A reduction in interest income attributable to lower average
balances of cash, cash equivalents and short-term investments and
the lower yield during the first nine months of 1999 as compared to
the same period in the prior year. The lower average balances of
cash, cash equivalents and short term investments resulted primarily
from cash outlays associated with the purchase of Symbios in the
third quarter of 1998 and debt repayments, net of borrowings,
primarily during the first quarter of 1999;
- A $2 million of write-down of debt issuance costs in the nine months
ended September 30, 1999; and
- Foreign exchange losses during the three and nine months ended
September 30, 1999 compared to gains for the same periods of 1998.
PROVISION FOR/(BENEFITS OF) INCOME TAXES
The tax provision for the three and nine months ended September 30, 1999
was at an effective rate of 25% and 29%, respectively, compared to a 6% benefit
and a 4% provision for the three and nine months ended September 30, 1998,
respectively. The 1999 rates have been impacted by the write-offs relating to
IPR&D, SEEQ merger costs and restructuring charges during the second quarter of
1999. The 1998 rates were also impacted by the write-offs related to IPR&D and
restructuring charges taken during the third quarter of 1998. Our effective tax
rate can be above or below the U.S. statutory rate primarily due to
non-deductible IPR&D and merger and restructuring charges offset in part by
earnings of our foreign subsidiaries taxed at lower rates and the utilization of
prior loss carryovers and other tax credits.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
In April 1998, the Accounting Standards Executive Committee ("AcSEC")
released SOP No. 98-5, "Reporting on the Costs of Start-up Activities." The SOP
is effective for fiscal years beginning after December 15, 1998 and requires
companies to expense all costs incurred or unamortized in connection with
start-up activities. Accordingly, we expensed the unamortized preproduction
balance of $92 million associated with the Gresham manufacturing facility, net
of tax, on January 1, 1999 and presented it as a cumulative effect of a change
in accounting principle in accordance with SOP No. 98-5.
FINANCIAL CONDITION AND LIQUIDITY
Cash, cash equivalents and short-term investments increased by $165
million during the first nine months of 1999 to $457 million from $292 million
at the end of 1998. The increase was primarily generated from operations
partially offset by purchases of property and equipment and repayment of debt
obligations, net of borrowings.
Working capital increased by $381 million to $620 million at September 30,
1999 from $239 million at December 31, 1998. The increase in working capital was
primarily a result of the following elements:
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- Lower current liabilities as a result of repayment of the short-term
portion of the debt facility in the first quarter of 1999, and lower
accrued liabilities primarily due to utilization and reversal of
restructuring reserves (see Note 5 of the Notes to the Unaudited
Consolidated Condensed Financial Statements); and
- Higher short-term investments, accounts receivable and inventories.
The increase in short-term investments was attributable to purchases
of debt and equity securities, net of sales and maturities, with
excess cash generated from operations. The increase was also due to
the reclassification of $25 million of long-term investments that
were intended to be sold within one year (see Note 7 of the Notes to
the Unaudited Consolidated Condensed Financial Statements). The
increase in accounts receivable was attributable to higher sales in
the third quarter of 1999 compared to the fourth quarter of 1998 and
the timing of payments received in the third quarter of 1999 as
compared to the fourth quarter of 1998. The increase in inventories
reflected the expectation of continued higher sales in 1999 as
compared to 1998.
The increase in working capital was offset in part by lower prepaids and
other current assets, and higher accounts payable and accrued salaries, wages
and benefits as of September 30, 1999 as compared to December 31, 1998. The
decrease in prepaids and other current assets was primarily a result of timing
differences of payments. The increase in accounts payable was attributable to
the timing difference of invoice receipt and payment and higher volumes of
business in the third quarter of 1999 compared to the fourth quarter of 1998.
The increase in accrued salaries, wages and benefits is partially due to
increases in compensation levels and compensation related programs in 1999 as
compared to 1998.
During the first nine months of 1999, we generated $232 million of cash
and cash equivalents from operating activities compared to $142 million during
the same period in 1998. The increase in cash and cash equivalents provided by
operations was primarily attributable to:
- Higher net income (before depreciation and amortization, write-off
of unamortized preproduction costs, acquired in-process research and
development, non-cash restructuring charges and gains and losses on
stock investments);
- A decrease in prepaids and other assets; and
- An increase in accounts payable and accrued and other liabilities.
The decrease in prepaids and other assets primarily related to timing
differences. The increase in accounts payable was attributable to the timing of
invoice receipt and the higher volumes of business in September 1999 compared to
September 1998. The increase in accrued liabilities was partly due to higher
bonus accruals as of September 30, 1999 as compared to September 30, 1998 as a
result of higher net income in the third quarter of the respective year.
The increased cash from operations was offset in part by an increase in
accounts receivable and inventories. The increase in accounts receivable was
primarily a result of higher revenues in the nine months of 1999 as compared to
the same period of 1998 and the timing of payment receipt. Inventories were
higher as revenues are expected to continue to be higher for the fourth quarter
of 1999 as compared to 1998.
Cash and cash equivalents used in investing activities during the first
nine months of 1999 were $277 million compared to $707 million during the same
period in 1998. The primary investing activities during the first nine months of
1999 included the following:
- Purchases and sales of debt and equity securities
available-for-sale;
- The acquisition of a non-public technology company; and
- Purchases of property and equipment.
A decrease in cash used in investing activities during the first nine
months of 1999 as compared to the same period in 1998 was primarily attributable
to the acquisition of Symbios in the third quarter of 1998 (see Note 6 of Notes
to the Unaudited Consolidated Condensed Financial Statements) and higher
purchases of property and equipment in 1998, offset in part by higher maturities
and sales of debt and equity securities available-for-sale in the
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first nine months of 1998 as compared to the same period in 1999. 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 $105 million and $232 million
during the first nine months of 1999 and 1998, respectively. The decrease in
additions from 1998 was primarily attributable to reduced purchases of property
and equipment related to construction of a new wafer fabrication facility in
Gresham, Oregon, which was completed in December 1998. We expect to incur
capital expenditures of no more than $250 million in 1999.
Cash and cash equivalents provided by financing activities during the
first nine months of 1999 totaled $16 million, compared to $601 million in the
same period of 1998. A decrease in cash provided during the first nine months of
1999 was primarily attributable to proceeds from a credit agreement entered into
in August 1998 to finance the acquisition of Symbios (see Note 6 and 10 of Notes
to the Unaudited Consolidated Condensed Financial Statements), net of repayment.
The decrease was offset in part by proceeds from the issuance of the 4 1/4%
Convertible Subordinated Notes in March 1999 (see Note 10 of Notes to the
Unaudited Consolidated Condensed Financial Statements), net of repayment of the
credit facility. The decrease was also offset in part by higher proceeds from
sale of common stock issued pursuant to our employee stock option and purchase
plans in 1999.
During March of 1999, we issued $345 million of 4 1/4% Convertible
Subordinated Notes (the "Convertible Notes") due in 2004. The Convertible Notes
are subordinated to all existing and future senior debt, are convertible 60 days
following issuance into shares of our common stock at a conversion price of
$31.353 per share and are redeemable at our option, in whole or in part, at any
time on or after March 20, 2002. Each holder of the Convertible Notes has the
right to cause us 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. We paid
approximately $9.5 million for debt issuance costs related to the Convertible
Notes. The debt issuance costs are being amortized using the interest method. We
used the net proceeds from the Convertible Notes to repay existing debt
obligations as outlined below.
On August 5, 1998, we entered into a credit agreement with ABN AMRO. The
credit agreement was restated and superseded by the Amended and Restated Credit
Agreement dated as of September 22, 1998 by and among LSI Logic, JSI, ABN ANRO
and thereafter syndicated to a group of lenders determined by ABN AMRO and LSI
Logic. The credit agreement consisted of two credit facilities: a $575 million
senior unsecured reducing revolving credit facility ("Revolver"), and a $150
million senior unsecured revolving credit facility ("364 day Facility").
On August 5, 1998, we borrowed $150 million under the 364 day Facility and
$485 million under the Revolver. On December 22, 1998, we borrowed an additional
$30 million under the Revolver. The credit facilities allowed for borrowings at
adjustable rates of LIBOR/TIBOR with a 1.25% spread. As of March 31, 1999, the
spread changed to 1%. Interest payments are due quarterly. The 364 day Facility
expired on August 3, 1999 by which time borrowings outstanding were fully paid
in accordance with the credit agreement. The Revolver is for a term of four
years with the principal reduced quarterly beginning on December 31, 1999. The
Revolver includes a term loan sub-facility in the amount of 8.6 billion yen made
available to JSI over the same term. The yen term loan sub-facility is for a
period of four years with no required payments until it expires on August 5,
2002. Pursuant to the restated credit agreement, on August 30, 1998, JSI repaid
it's existing 11.4 billion yen ($79 million) credit facility and borrowed 8.6
billion yen ($83 million at September 30, 1999) bearing interest at adjustable
rates. In March of 1999, we repaid the full $150 million outstanding under the
364 day Facility and $186 million outstanding under the Revolver using proceeds
from the Convertible Notes as described above. Borrowings outstanding under the
Revolver including the yen sub-facility were $382 million as of September 30,
1999. As of September 30, 1999, the interest rate for the Revolver and the yen
sub-facility were 6.31% and 1.12%, respectively. Debt issuance costs associated
with these credit facilities were not significant.
In accordance with the terms of our existing credit agreement, we must
comply with certain financial covenants related to profitability, tangible net
worth, liquidity, senior debt leverage, debt service coverage and subordinated
indebtedness. As of September 30, 1999, we were in compliance with these
covenants.
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We believe that our level of financial resources is an important
competitive factor in our industry. Accordingly, we may, from time to time, seek
additional equity or debt financing. 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 can provide no assurance that such additional financing will
be available when needed or, if available, will be on favorable terms. Any
future equity financing will decrease existing stockholders' equity percentage
ownership and may, depending on the price at which the equity is sold, result in
dilution.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure 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. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000 pursuant to the issuance of SFAS No. 137,
"Accounting for Derivative Instruments and Hedging activities Deferral of the
Effective Date of FASB Statement No. 133," which deferred the effective date of
SFAS No. 133 by one year. Upon adoption of SFAS No. 133, we will be required to
adjust hedging instruments to fair value in the balance sheet and recognize the
offsetting gain or loss as transition adjustments to be reported in net income
or other comprehensive income, as appropriate, and presented in a manner similar
to the cumulative effect of a change in accounting principle. While we believe
the adoption of this statement will not have a significant effect on our results
of operations, the impact of the adoption of SFAS No. 133 as of the effective
date cannot be reasonably estimated at this time.
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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/A for the fiscal year ended December 31, 1998 for a
discussion of certain pending legal proceedings. Except as set forth in Note 14,
the information provided at such reference regarding those matters remains
unchanged. 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.46 Technology Transfer Agreement dated September 8, 1999 between the
Registrant and Wafer Technology (Malaysia) Sdn. Bhd.
27.1 Financial Data Schedules
(b) Reports on Form 8-K
On August 11, 1999, pursuant to Item 5 to report information set forth in
the Registrant's press release dated August 4, 1999.
On October 25, 1999, pursuant to Item 5 to report information set forth in
the Registrant's press release dated October 21, 1999.
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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: November 10, 1999 By /s/ R. DOUGLAS NORBY
------------------------------------------
R. Douglas Norby
Executive Vice President Finance &
Chief Financial Officer
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- - ------ -----------
10.46 Technology Transfer Agreement
27.1 Financial Data Schedule
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