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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report: February 11, 1998
ZILOG, INC.
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(Exact name of registrant as specified in its charter)
Delaware 0-18738 13-3092996
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(State or other (Commission File Number) (I.R.S. Employer
jurisdiction of Identification No.)
incorporation)
210 East Hacienda Avenue, Campbell, CA 95008-6600
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(Address of principal executive offices) (Zip Code)
(408) 370-8000
(Registrant's telephone number,
including area code)
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Item 5. Other Events.
The following contains certain financial and other information with respect
to the Registrant.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Current Report on Form 8-K includes "forward-looking statements"
within the meaning of various provisions of the Securities Act and the Exchange
Act. All statements, other than statements of historical facts, included herein
that address activities, events or developments that Zilog expects or
anticipates will or may occur in the future, including such things as future
capital expenditures (including the amount and nature thereof), business
strategy and measures to implement strategy, competitive strengths, goals,
expansion and growth of Zilog's and its subsidiaries' business and operations,
product introduction schedules, plans, references to future success and other
such matters, are forward-looking statements. These statements are based on
certain assumptions and analyses made by Zilog in light of its experience and
its perception of historical trends, current conditions and expected future
developments as well as other factors it believes are appropriate in the
circumstances. However, whether actual results and developments will conform to
Zilog's expectations and predictions is subject to a number of risks and
uncertainties that may cause actual results to differ materially, including the
significant considerations and risks discussed herein; general economic, market
or business conditions; the opportunities (or lack thereof) that may be
presented to and pursued by Zilog and its subsidiaries; competitive actions by
other companies; changes in laws or regulations; and other factors, many of
which are beyond the control of Zilog and its subsidiaries. Consequently, all of
the forward-looking statements made in this Current Report on Form 8-K are
qualified by these cautionary statements and there can be no assurance that the
results or developments anticipated by Zilog will be realized or, even if
substantially realized, that they will have the expected consequences to or
effects on Zilog and its subsidiaries or their business or operations. The
Company expressly disclaims any obligation or undertaking to release publicly
any updates or revisions to these forward-looking statements to reflect events
or circumstances that occur or arise or are anticipated to occur or arise after
the date hereof.
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RISK FACTORS
This Current Report on Form 8-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"). Actual results could differ materially from those projected
in the forward-looking statements as a result of certain factors and
uncertainties set forth below and elsewhere herein. See "Disclosure Regarding
Forward-Looking Statements".
RECENT AND ANTICIPATED OPERATING RESULTS
Zilog's operating results are affected by a wide variety of factors which
could have a material adverse effect on it including, but not limited to,
Zilog's ability to introduce new products and technologies on a timely basis,
changes in product mix or fluctuations in manufacturing yields which affect
Zilog's gross margins, market acceptance of Zilog's and its customers' products,
the level of orders that are received and can be shipped in a quarter, customer
order patterns and seasonality, cyclicality in the semiconductor industry,
increases in freight costs, gain or loss of a significant customer and whether
Zilog's customers buy from a distributor or directly from Zilog. Certain of the
Company's products have sustained decreases in average selling prices and the
Company has sustained product mix shifts that have caused average selling prices
of Zilog's products in the aggregate to decrease by 24% in 1997 and this trend
may continue. Significant reductions in selling prices may have a material
adverse effect on the Company. Zilog will likely experience substantial
period-to-period fluctuations in future operating results due to general
industry conditions including cyclical periods of diminished product demand,
accelerated erosion of average selling prices and production over-capacity or
events occurring in the United States economy or the economies of the worldwide
markets Zilog serves. A significant decline in demand for Zilog's products could
have a material adverse effect on the Company, and there can be no assurance
that any new products will receive or maintain substantial market acceptance.
Zilog's revenue and EBITDA have declined from $298.4 million and $92.0
million, respectively, for 1996 to $261.1 million and $75.7 million,
respectively, for 1997. Although the Company believes that it has developed a
business strategy that will improve its operating performance, it is anticipated
that revenue and EBITDA will decline significantly in 1998 while this business
strategy is being implemented. Many of the factors which affect the Company's
operating performance are outside the Company's control and there can be no
assurance that the Company's business strategy will be successful or that
results of operations will not continue to decline. Implementation of the
Company's business plan requires significant expenditures and there can be no
assurance that the Company will be in a position to implement it fully or that
such expenditures will be offset by any increase in revenue. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources". Continued significant declines
in operating performance could have a material adverse effect on the Company and
its ability to meet its debt service and other obligations.
THE SEMICONDUCTOR INDUSTRY
The semiconductor industry has been characterized by cyclicality. The
industry has experienced significant economic downturns at various times in the
last three decades, characterized by diminished product demand, accelerated
erosion of average selling prices and production over-capacity. During 1995, the
semiconductor industry in general, including Zilog, experienced a period of
increased demand. During 1996, the industry experienced a slowdown from the
growth levels of 1995. Zilog experienced this slowdown during the last two
quarters of 1996. Additionally, during 1997, Zilog's revenue and profit have
been lower than their respective levels in 1996 and there can be no assurance
that revenue and profit will return to historic levels. Zilog will likely
experience substantial period-to-period fluctuations in future operating results
due to general industry conditions or events occurring in the general economy.
The fluctuations are difficult to foresee and there can be no assurance that
future fluctuations will not be more severe or prolonged or otherwise would not
have a material adverse effect on the Company.
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Certain of Zilog's products are incorporated into printers, mouse-type
pointing devices, keyboards and modems. As a result, a slowdown in the demand
for personal computers and related peripherals could adversely affect Zilog's
operating results. A significant portion of Zilog sales are to the consumer
electronics markets for use in products such as television sets, infrared remote
controls and telephone answering machines. The consumer electronics markets are
volatile and rapid changes in customer preferences for electronics products
could have a material adverse effect on Zilog.
DEPENDENCE ON NEW PRODUCTS AND TECHNOLOGIES
Zilog's operating results will depend to a significant extent on its
ability to continue to introduce new products. The success of new product
introductions is dependent on several factors, including proper new product
selection, timely completion and introduction of new product designs, complexity
of the new products to be designed and manufactured, development of support
tools and collateral literature that make complex new products easy for
engineers to understand and use and market acceptance of customers' end
products. There can be no assurance that any new products will receive or
maintain substantial market acceptance. The Company's new business strategy
includes increased focus on design wins. However, there is a substantial delay
between a design win and sales of new products. Any such sales are subject to
the success or failure of the customer's product. There can be no assurance that
the Company will successfully identify new product opportunities and develop and
bring new products to market in a timely and cost-effective manner, or that
products or technologies developed by others will not render the Company's
products or technologies obsolete or noncompetitive. A fundamental shift in
technology in the Company's product markets could have a material adverse effect
on the Company.
NEW MANAGEMENT AND KEY PERSONNEL
Upon completion of the Recapitalization, Curtis J. Crawford will become
President and CEO of Zilog, replacing Dr. Edgar Sack, the current CEO. Although
Mr. Crawford has significant experience in the industry in which Zilog competes,
there can be no assurance that this management transition and the implementation
of a new management strategy will not adversely affect operating results. In
addition, the Company depends upon its ability to hire and retain qualified
technical, sales and management personnel. The competition for such personnel is
intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel.
CUSTOMER CONCENTRATION
In 1997, the Company's 10 largest customers accounted for approximately 44%
of the Company's total revenue, although no single customer accounted for more
than 8% of the Company's total revenue. Particular customers may change from
period to period but the Company expects that sales to a limited number of
customers will continue to account for a significant percentage of its revenue
in any particular period for the foreseeable future. The Company has no
long-term contracts with its customers and there can be no assurance that its
current customers will place additional orders, or that the Company will obtain
orders of similar magnitude from other customers. The loss of one or more major
customers or any reduction, delay or cancellation of orders by any such customer
or the failure of the Company to market successfully to new customers, could
have a material adverse effect on the Company. During 1997, purchases by a major
customer, which had accounted for approximately 13% of the Company's total
revenue in 1996, declined to approximately 6% of the Company's total revenue in
1997. This decline was primarily attributable to a technology shift at the
customer resulting in a product that did not require a controller. There can be
no assurance that sales to one or more significant customers will not decline in
the future or that any such decline will not have a material adverse effect on
the Company.
PRODUCTION YIELDS AND MANUFACTURING RISKS; NEW WAFER FABRICATION FACILITY
The manufacture of semiconductor products is highly complex and production
yields are sensitive to a wide variety of factors, including the level of
contaminants in the manufacturing environment, impurities in the materials used
and the performance of personnel and equipment. In addition, as is common in the
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semiconductor industry, Zilog has from time to time experienced difficulty in
beginning production at new facilities or in effecting transitions to new
manufacturing processes and, consequently, has suffered delays in product
deliveries or reduced yields. Zilog believes that an important competitive
factor will be its ability to continue to successfully increase production
capacity to meet customer demand and shorten delivery time. No assurance can be
given that Zilog or its outside wafer foundries will not experience production
yield problems in the future which could have a material adverse effect on the
Company. While the Company believes its manufacturing capacity to be sufficient,
the failure to increase production capacity through the successful and efficient
expansion of production at its new facility in Nampa or to obtain wafers from
outside suppliers as needed during periods of increased demand could have a
material adverse effect on the Company.
Zilog's future success is dependent upon its ability to develop and
implement new design and process technologies. Semiconductor design and process
methodologies are subject to rapid technological change, requiring large
expenditures for research and development. Most new products are extremely
complex in design and many use Zilog's 0.65 micron CMOS process. Zilog has
developed a 0.35 micron CMOS process, and the first test wafers in this process
were produced in January 1998. A failure to make a successful transition to the
0.35 micron CMOS process could have a material adverse effect on the Company.
Manufacture of large complex die involves a significant technological risk. The
failure to complete new product designs in time to meet market requirements and
achieve volume production of new products at acceptable yields using the new
manufacturing processes would have a material adverse effect on the Company. See
"Business -- Research and Development".
Zilog also uses outside contract assemblers for packaging a portion of its
production. Shortages in contract assembly capacity could adversely impact
Zilog's financial results. Should Zilog be unable to obtain additional assembly
capacity, Zilog's ability to achieve continued revenue growth may be restricted.
Shortage of product could also result in the loss of customers. See
"Business -- Manufacturing".
COMPETITION
The semiconductor industry is intensely competitive and is characterized by
price erosion, rapid technological change and heightened foreign competition in
many markets. The industry consists of major domestic and international
semiconductor companies, many of which have substantially greater financial and
other resources than Zilog with which to pursue engineering, manufacturing,
marketing and distribution of their products. Emerging companies are also
increasing their participation in the semiconductor market. The ability of Zilog
to compete successfully in its markets depends on factors both within and
outside of its control including, but not limited to, success in designing and
manufacturing new products that implement new technologies, protection of
Company products by effective utilization of intellectual property laws, product
quality, reliability, ease of use, price, diversity of product line, efficiency
of production, the pace at which customers incorporate Zilog's microprocessors,
microcontrollers and digital signal processors into their products, success of
competitors' products and general economic conditions. See
"Business -- Competition".
EXPORT SALES; INTERNATIONAL OPERATIONS
Approximately 59% of Zilog's sales in 1997 were to foreign customers and
Zilog expects that export sales will continue to represent a significant portion
of sales, although there can be no assurance that export sales, as a percentage
of net sales, will remain at current levels. Beginning in the fourth quarter of
1997, certain countries in Asia, which accounted for approximately 42% of
Zilog's 1997 revenue, experienced general market instability characterized by a
substantial decrease in demand that resulted in significant capital constraints
throughout the region. In many cases, these constraints were exacerbated by the
continuing need of businesses in the region to service indebtedness denominated
in dollars or other foreign currencies. As a result, many businesses in the
region have explored ways to preserve capital, including reducing capital
investment, reducing working capital, outsourcing manufacturing functions,
selling assets and discontinuing lines of business. In addition, substantial
devaluations of local currencies have significantly improved the competitive
position of certain competitors of the Company that operate in the affected
regions. Although the Company believes that this instability did not have a
material effect on the Company's revenue in 1997, there can be no assurance
that, as the instability continues, the Company's customers in these regions
will not significantly
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delay purchases of the Company's products, significantly reduce the production
of products which utilize the Company's ASSPs or purchase ASSPs from the
Company's competitors that operate in the affected regions. Consequently, there
can be no assurance that this instability will not have a material adverse
effect on the Company. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Recent Developments -- Asian Revenues".
Zilog purchases a substantial portion of its raw materials and equipment
from foreign suppliers. While Zilog's export sales are primarily United States
dollar denominated transactions, Zilog is subject to the risks of conducting
business internationally, including unexpected changes in, or impositions of,
legislative or regulatory requirements, fluctuations in the United States dollar
against foreign currencies, which could increase the sales price in local
currencies of Zilog's products in foreign markets or increase the cost of wafers
purchased by Zilog, delays resulting from difficulty in obtaining export
licenses for certain technology, tariffs and other barriers and restrictions,
potentially longer payment cycles, greater difficulty in accounts receivable
collection, potentially adverse taxes and the burdens of complying with a
variety of foreign laws. In addition, Zilog is subject to general geopolitical
risks, such as political and economic instability and changes in diplomatic and
trade relationships, which could affect, among other things, customers' ordering
patterns and inventory levels. Although Zilog has not to date experienced any
material adverse effect on its operations as a result of such regulatory,
geopolitical, economic and other factors, there can be no assurance that such
factors will not adversely impact Zilog in the future or require the Company to
modify its current business practices. In addition, the laws of certain foreign
countries may not protect Zilog's intellectual property rights to the same
extent as do the laws of the United States.
Zilog operates two primary assembly and test facilities in the Philippines
through two wholly owned subsidiaries. Zilog has a significant capital
investment at these facilities. Zilog's reliance on personnel and assets and its
maintenance of inventories at these facilities entails certain political and
economic risks, including political instability and expropriation, currency
controls and exchange fluctuations, as well as changes in tax laws, tariff and
freight rates. Political stability in the Philippines appears to have increased
markedly during the past three years, but no assurances of continued stability
can be given. Zilog has not experienced any significant interruptions in its
business operations in the Philippines to date. Nonetheless, any loss or
disruption of production in the Philippines could have a material adverse effect
on the Company, particularly if operations or air transportation from the
Philippines were disrupted for a substantial period of time.
INTELLECTUAL PROPERTY RIGHTS
Zilog's ability to compete will be affected by its ability to protect its
proprietary information. Zilog relies primarily on its trade secrets and
technological know-how in the conduct of its business. There can be no assurance
that the steps taken by Zilog to protect its intellectual property will be
adequate to prevent misappropriation of its technology or that Zilog's
competitors will not independently develop technologies that are substantially
equivalent or superior to Zilog's technology. The semiconductor industry is
characterized by frequent claims and related litigation regarding patent and
other intellectual property rights. There can be no assurance that third parties
will not assert additional claims or initiate litigation against Zilog, its
foundries or its customers with respect to existing or future products. In
addition, Zilog may initiate claims or litigation against third parties for
infringement of Zilog's proprietary rights or to determine the scope and
validity of the proprietary rights of Zilog or others. Litigation by or against
Zilog could result in significant expense to Zilog and divert the efforts of
Zilog's technical and management personnel, whether or not litigation is
determined in favor of Zilog. In the event of an adverse result in any such
litigation, Zilog could be required to pay substantial damages, cease the
manufacture, use, sale, offer for sale and importation of infringing products,
expend significant resources to develop or obtain non-infringing technology,
discontinue the use of certain processes, or obtain licenses to the technology
which is the subject of the litigation. There can be no assurance that Zilog
would be successful in such development or acquisition or that any such
licenses, if available, would be available on commercially reasonable terms, and
any such development or acquisition could require expenditures by Zilog of
substantial time and other resources. Any such litigation or adverse result
therefrom could have an adverse effect on Zilog.
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Zilog has been notified by three parties that it may be infringing certain
patent ownership and other intellectual property rights. In the event Zilog
determines that such notices may involve meritorious claims, Zilog may seek a
license. Based on industry practice, Zilog believes that in most cases any
necessary licenses or other rights could be obtained on commercially reasonable
terms. However, no assurance can be given that licenses could be obtained on
acceptable terms or that litigation will not occur. The failure to obtain
necessary licenses or other rights or the advent of litigation arising out of
such claims could have a material adverse effect on Zilog. See
"Business -- Patents and Licenses".
ENVIRONMENTAL REGULATION
Zilog is subject to a variety of government regulations related to the
discharge or disposal of hazardous materials used in its manufacturing process.
Although Zilog believes that it is in substantial compliance with all relevant
regulations and has all permits necessary to conduct its business, the failure
to comply with present or future regulations or the loss of any permit could
result in fines being imposed on Zilog, limitation or suspension of production
or cessation of operations. Compliance with any such future regulations could
require Zilog to acquire additional equipment or to incur substantial other
expenses. Any failure by Zilog to control the use of, or adequately restrict the
discharge of, hazardous materials could subject it to future liabilities.
In 1996, the U.S. District Court for the District of Idaho entered orders
approving a settlement in the lawsuit entitled Tsotung Ko, et al. v. Zilog, Inc.
In the suit, 31 plaintiffs alleged that the Company endangered their health and
safety by chemical exposures at one of the Company's Nampa, Idaho facilities. In
addition, the plaintiffs alleged that the Company discriminated against them
after they were injured by chemical exposures. Although the Company made
payments in connection with the settlement, the Company strongly denied these
allegations.
In January 1998, the newspaper USA Today published a series of articles
about environmental and employee health and safety conditions at semiconductor
manufacturing facilities. The Company's operations during 1993 and 1994 and the
Tsotung Ko lawsuit were the primary subject of one article and were mentioned in
other articles. Since 1993, the Company has constructed its MOD III facility,
expanded MOD II, closed MOD I and has upgraded the environmental monitoring and
control equipment at its MOD II facility. The Company believes it is in
substantial compliance with all applicable environmental and employee health and
safety regulations. However, this recent public attention focused on the
environmental and employee health and safety conditions at the Company's
facilities could increase the incidence of environmental or employee health and
safety complaints or governmental investigations into the Company's operations
and there can be no assurance that the Company will not incur significant
expense in connection therewith.
SECURITIES CLASS ACTION AND OTHER LEGAL MATTERS
The Company has been named as a defendant in a purported class action
lawsuit which was filed on January 23, 1998 in the United States District Court
for the Northern District of California. Certain executive officers of the
Company are also named as defendants. The plaintiff purports to represent a
class of all persons who purchased the Company's Common Stock between June 30,
1997 and November 20, 1997 (the "Class Period"). The complaint alleges that the
Company and certain of its executive officers made false and misleading
statements regarding the Company that caused the market price of its Common
Stock to be "artificially inflated" during the Class Period. The complaint does
not specify the amount of damages sought. The Company believes the lawsuit lacks
merit and intends to defend it vigorously. There can be no assurance that the
Company will prevail in its defense of the lawsuit or that any judgment against
the Company will not be material.
Zilog is participating in other litigation and responding to claims arising
in the ordinary course of business. Zilog intends to defend itself vigorously in
these matters. Zilog's management believes that it is unlikely that the outcome
of these matters will have a material adverse effect on the Company, although
there can be no assurance in this regard.
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THE RECAPITALIZATION
The Company was established in 1974 and became a wholly owned subsidiary of
Exxon Corporation in 1981. In 1989, Zilog was acquired in a leveraged buyout
transaction sponsored by Warburg Pincus Capital Company, L.P. In 1991, Zilog
became a publicly traded company; the Common Stock is listed on the NYSE and
trades under the symbol "ZLG".
Pursuant to the Merger Agreement by and among TPG Partners II, L.P. ("TPG
II"), TPG Zeus Acquisition Corporation ("Merger Sub") and Zilog dated as of July
20, 1997, as amended, Merger Sub will be merged with and into Zilog, and Zilog
will continue as the Surviving Corporation. By virtue of the Merger, shares of
Zilog common stock having an implied value of approximately $7.5 million held by
certain of Zilog's current stockholders (who are expected to remain investors of
Zilog following consummation of the Merger) will be converted into common stock
of the Surviving Corporation. All other shares of outstanding common stock will
be canceled and, except for shares of common stock held in Zilog's treasury,
owned by Zilog or any subsidiary of Zilog, or held by a stockholder of Zilog who
has properly exercised appraisal rights under Delaware law, will be converted
into the right to receive cash consideration, all as set forth in the Merger
Agreement. By virtue of the Merger, the common stock of Merger Sub will be
converted into new shares of common stock, non-voting common stock and preferred
stock of the Surviving Corporation. Also, in connection with the Merger, options
to purchase shares of common stock issued under Zilog's stock plans outstanding
immediately prior to the consummation of the Merger will be canceled and, in
certain instances, will be converted into the right to receive an amount in
cash, as set forth in the Merger Agreement. Zilog expects that it will pay
approximately $4.2 million to redeem outstanding options upon consummation of
the Merger. The Merger was approved by Zilog's stockholders on January 27, 1998.
Cash funding requirements for the Merger (assuming consummation on December
31, 1997) will be satisfied through the following: (i) an equity investment by
TPG II and certain other investors of $117.5 million in the stock of Merger Sub;
(ii) use of approximately $35.9 million of Zilog's cash and cash equivalents;
and (iii) $280.0 million of gross proceeds from an anticipated sale of senior
secured notes (the "Notes") through a private placement. The Notes will not be
and have not been registered under the Securities Act and may not be offered or
sold in the United States absent registration or an applicable exemption from
the registration requirements of the Act. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and "Description of Notes". Following consummation of the
Merger, it is also anticipated that Zilog will be able to borrow up to $25.0
million under a revolving credit facility (the "Revolving Credit Facility").
It is intended that the transactions contemplated by the Merger Agreement
will be accounted for as a recapitalization transaction for accounting purposes.
The following table sets forth the anticipated sources and uses of funds in
connection with the Recapitalization, assuming the Recapitalization occurred on
December 31, 1997. The actual amounts of sources and uses of funds may differ
from those shown.
<TABLE>
<S> <C>
Sources:
Notes........................................................... $280,000
New Equity Contribution......................................... 117,500
Continuing Equity Investment.................................... 7,500
--------
Total........................................................ $405,000
Excess Cash..................................................... 35,865
--------
Total........................................................ $440,865
========
Uses:
Continuing Equity Investment.................................... $ 7,500
Payment for Outstanding Shares.................................. 399,175
Payment for Outstanding Stock Options........................... 4,190
Estimated Fees and Expenses..................................... 30,000(1)
--------
Total........................................................ $440,865
========
</TABLE>
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(1) Includes approximately $12.8 million of debt issuance costs which will be
capitalized and amortized over the terms of the related debt, and
approximately $17.2 million of non-financing related transaction expenses
which will be netted against stockholder's equity.
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UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information has
been prepared to give effect to the Recapitalization. The pro forma adjustments
presented are based upon available information and certain assumptions that
Zilog's management believes are reasonable.
The Pro Forma Consolidated Statement of Operations Data and Other Data for
the year ended December 31, 1997 give effect to the Recapitalization as though
it had occurred on January 1, 1997. The Pro Forma Consolidated Balance Sheet
Data give effect to the Recapitalization as though it had occurred on December
31, 1997. The pro forma adjustments as applied to the respective historical
consolidated financial information of the Company reflect and account for the
Merger as a recapitalization. Accordingly, the historical basis of the Company's
assets and liabilities has not been impacted by the Merger.
The Pro Forma Financial Information should be read in conjunction with
Zilog's Consolidated Financial Statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere herein. The Pro Forma Financial Information and related notes
are provided for informational purposes only and are not necessarily indicative
of the results that actually would have occurred had the Recapitalization been
completed on the date indicated nor is such financial information necessarily
indicative of the results that may be expected to occur in the future.
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UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1997
------------------------------------------
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents........................... $ 92,184 $ (35,865)(1) $ 56,319(5)
Short-term investments.............................. 14,127 14,127(5)
Accounts receivable................................. 31,633 31,633
Inventories......................................... 32,968 32,968
Prepaid expenses, deferred income taxes and other
current assets................................... 19,769 19,769
---------- ----------- ---------
Total current assets............................. $ 190,681 $ (35,865) $ 154,816
Property, plant and equipment, at cost................ 415,458 415,458
Less: accumulated depreciation and amortization....... (191,881) (191,881)
---------- ----------- ---------
Net property, plant and equipment................... $ 223,577 $ 223,577
Other assets.......................................... 1,381 12,800(1) 14,181
---------- ----------- ---------
$ 415,639 $ (23,065) $ 392,574
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.................................... $ 24,733 $ 24,733
Accrued compensation and employee benefits.......... 18,284 5,000(2) 23,284
Other accrued liabilities........................... 5,287 5,287
Income taxes payable................................ 10,783 (1,676)(3) 9,107
---------- ----------- ---------
Total current liabilities........................ $ 59,087 $ 3,324 $ 62,411
Deferred income taxes................................. 16,070 16,070
The Notes............................................. -- 280,000(1) 280,000
---------- ----------- ---------
$ 16,070 $ 280,000 $ 296,070
Stockholders' equity:
Preferred Stock; Historical: Preferred Stock, $0.01
par value; 190,000 shares authorized; no shares
issued and outstanding. Pro Forma: Non-Voting 13.5%,
$100 stated value; 5,000,000 shares authorized;
250,000 shares issued and outstanding............... -- 25,000(1) 25,000
Common Stock, Historical: $0.01 par value; 75,000,000
shares authorized; 20,333,742 shares issued and
outstanding. Pro Forma: Common Stock, $0.01 par
value; 35,000,000 shares authorized; 3,750,000
shares issued and outstanding. Class A Non-Voting
Common Stock, $0.01 par value; 15,000,000 shares
authorized; 1,250,000 shares issued and
outstanding......................................... 165,153 92,500(1)
(257,603)(4) 50
Retained earnings................................... 175,236 (141,572)(4)
(17,200)(1)
(5,000)(2)
(2,514)(3) 8,950
Net unrealized gain on securities..................... 93 -- 93
---------- ----------- ---------
Total stockholders' equity....................... $ 340,482 $(306,389) $ 34,093
---------- ----------- ---------
$ 415,639 $ (23,065) $ 392,574
========= ========= =========
</TABLE>
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(1) Cash funding requirements for the Merger will be satisfied through the
following: (i) the Equity Investment of $117.5 million in Merger Sub
pursuant to which TPG II and certain other investors will receive 250,000
shares of Preferred Stock, 3,375,000 shares of Common Stock and 1,250,000
shares of Class A Non-Voting Common Stock; (ii) use of approximately $35.9
million of Zilog's cash and cash equivalents and (iii) $280.0 million of
gross proceeds from the Notes. Zilog estimates that it will incur
approximately $30.0 million of expenses to complete the Merger.
Approximately $12.8 million of the $30.0 million will relate to debt
issuance costs and will be capitalized as other assets. Approximately $17.2
million of the $30.0 million will be charged to retained earnings.
(2) Hiring and severance costs related to management change. This one time
charge is reflected in the Pro Forma Balance Sheet, but not in the Pro Forma
Statement of Operations due to its non-recurring nature.
(3) Zilog will make payments to cancel all outstanding stock options. At
December 31, 1997, options for 2,698,972 shares were outstanding with
exercise prices less than $20.00 per share. This one time charge of
approximately $4.2 million, net of taxes of approximately $1.7 million, is
reflected in the Pro Forma Balance Sheet but not in the Pro Forma Statement
of Operations due to its non-recurring nature.
(4) Zilog will repurchase and retire its outstanding Common Stock, less 375,000
shares, for $20.00 per share. This transaction will utilize approximately
$399.2 million of cash. As the carrying value of the Common Stock to be
retired (after the $117.5 million Equity Investment) is approximately $282.6
million after considering the par value of the post-Merger Preferred and
Common Stock of approximately $25.0 million, approximately $141.6 million
will be charged to retained earnings upon retirement.
(5) Cash, cash equivalents and short-term investments have not been reduced by
non-recurring expenses related to the Merger. See notes to "Unaudited Pro
Forma Consolidated Statement of Operations".
12
<PAGE> 13
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------------------
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
<S> <C> <C> <C>
Sales..................................................... $ 261,097 $ 261,097
Costs and expenses:
Cost of sales........................................... 171,722 171,722
Research and development................................ 30,467 30,467
Selling, general and administrative..................... 47,806 47,806
-------- --------
Total cost and expenses................................... 249,995 249,995
-------- --------
Operating income.......................................... 11,102 11,102
Other income (expense):
Interest expense........................................ (27,729)(2) (27,729)
Interest income......................................... 2,892 $ (1,296)(1) 1,596
Other................................................... 832 832
-------- -------- --------
Income (loss) before income taxes......................... 14,826 (29,025) (14,199)
Provision (benefit) for income taxes...................... 2,965 (10,159)(3) (7,194)
-------- -------- --------
Net income (loss)......................................... $ 11,861 $ (18,866) $ (7,005)
======== ======== ========
</TABLE>
- ---------------
(1) Represents reduction of interest income due to the reduction of cash and
cash equivalents as a result of the Merger.
(2) Represents interest expense and amortization of debt issuance costs as a
result of the Merger, using an assumed interest rate of 9.25%.
(3) Benefit provided at U.S. statutory rate.
Note: Not included in the Pro Forma Consolidated Balance Sheet and Pro Forma
Consolidated Statement of Operations are the following non-recurring
Merger related expenses: approximately $16.0 million in executive and
employee bonuses, severance payments and consulting fees and approximately
$4.2 million in payments in respect of employee stock options outstanding
prior to the Merger.
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<PAGE> 14
SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes certain selected consolidated financial data
of the Company and its subsidiaries. The selected consolidated financial data as
of December 31, 1997 and for each of the three years in the period ended
December 31, 1997 have been derived from, and should be read in conjunction
with, consolidated financial statements that have been audited by Ernst & Young
LLP, independent auditors, appearing elsewhere herein. The selected consolidated
financial data for each of the two years in the period ended December 31, 1994
have been derived from consolidated financial statements that have been audited
by Ernst & Young LLP, independent auditors, which are not included or
incorporated herein. The information presented below should be read in
conjunction with "Unaudited Pro Forma Consolidated Financial Information",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", and the Consolidated Financial Statements and Notes thereto and
other financial information included elsewhere herein. See also "Available
Information" and "Disclosure Regarding Forward-Looking Statements".
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT RATIO DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Sales...................................................... $202,727 $223,316 $265,122 $298,425 $261,097
Costs and expenses:
Cost of sales............................................ 105,727 111,288 135,066 175,319 171,722
Research and development................................. 20,833 23,048 24,546 30,548 30,467
Selling, general and administrative...................... 37,619 37,790 41,943 47,934 47,806
-------- -------- -------- -------- --------
Total costs and expenses................................... 164,179 172,126 201,555 253,801 249,995
-------- -------- -------- -------- --------
Operating income........................................... 38,548 51,190 63,567 44,624 11,102
Other income (expense):
Interest income.......................................... 2,463 2,496 2,676 2,443 2,892
Other.................................................... 813 860 (360) (911) 832
-------- -------- -------- -------- --------
Income before income taxes................................. 41,824 54,546 65,883 46,156 14,826
Provision for income taxes................................. 15,057 19,637 23,418 16,155 2,965
-------- -------- -------- -------- --------
Net income................................................. $ 26,767 $ 34,909 $ 42,465 $ 30,001 $ 11,861
======== ======== ======== ======== ========
OTHER DATA:
EBITDA(1).................................................. $ 55,489 $ 72,908 $ 90,421 $ 92,028 $ 75,684
Depreciation............................................... 16,128 20,858 27,214 48,315 63,750
Capital expenditures....................................... 39,658 60,708 79,346 117,065 38,437
Ratio of earnings to fixed charges(2)...................... 53.9x 79.7x 81.3x 56.4x 18.2x
CONSOLIDATED BALANCE SHEET DATA (AT END OF PERIOD):
Cash, cash equivalents and short-term investments........................................................... $106,311
Net property, plant and equipment........................................................................... 223,577
Total debt.................................................................................................. --
Stockholders' equity........................................................................................ 340,482
</TABLE>
- ---------------
(1) EBITDA represents earnings from operations before interest income and
expense (including amortization of deferred financing costs), income taxes,
depreciation, amortization of goodwill and non-cash stock option
compensation expenses. EBITDA is presented because it is a widely accepted
financial indicator of a leveraged company's ability to service and/or incur
indebtedness and because management believes that EBITDA is a relevant
measure of the Company's ability to generate cash without regard to the
Company's capital structure or working capital needs. EBITDA as presented
may not be comparable to similarly titled measures used by other companies,
depending upon the non-cash charges included. When evaluating EBITDA,
investors should consider that EBITDA (i) should not be considered in
isolation but together with other factors which may influence operating and
investing activities, such as changes in operating assets and liabilities
and purchases of property and equipment; (ii) is not a measure of
performance calculated in accordance with generally accepted accounting
principles; (iii) should not be construed as an alternative or substitute
for income from operations, net income or cash flows from operating
activities in analyzing the Company's operating performance, financial
position or cash flows; and (iv) should not be used as an indicator of the
Company's operating performance or as a measure of its liquidity.
(2) Earnings are defined as net income before income taxes and fixed charges,
except where capitalized. Fixed charges are defined as the estimated portion
of rental expense deemed by the Company to be representative of the interest
factor of rental payments under operating leases and interest expense
incurred. The pro forma ratio of earnings to fixed charges reflects the
interest expense on the Notes, including amortization of debt
expense, as if the Notes had been issued at the beginning of the respective
period. On a pro forma basis for the year ended December 31, 1997, earnings
would have been insufficient to cover fixed charges by approximately $14.2
million.
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<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of the financial
conditions and results of operations of the Company for the fiscal years ended
December 31, 1995, 1996 and 1997. This discussion and analysis should be read in
conjunction with, and is qualified in its entirety by, the sections entitled
"Selected Consolidated Financial Data," "Unaudited Pro Forma Consolidated
Financial Information" and the financial statements and notes thereto included
elsewhere herein. Management's discussion and analysis
provides information concerning the Company's business environment, consolidated
results of operations and liquidity and capital resources. In addition to
historical information, management's discussion and analysis includes certain
forward-looking statements regarding events and financial trends that may affect
the Company's future operating results and financial position. Readers are
cautioned not to place undue reliance on these forward-looking statements which
speak only as of the date hereof. Such statements are subject to risks and
uncertainties that could cause the Company's actual results and financial
position to differ materially. Such risks and uncertainties include, but are not
limited to, those specifically discussed below as well as those set forth in
"Risk Factors" and "Disclosure Regarding Forward-Looking Statements".
GENERAL
Zilog is a worldwide designer, manufacturer and marketer of ASSPs for use
in the consumer electronics, data communications, and computer peripherals end
markets. ASSPs are logic devices designed for a particular application but are
not proprietary to a specific customer. Zilog's products, many of which are
"designed in" to customers' end-products, demonstrate generally greater customer
acceptance, longer life cycles, and less obsolescence than general purpose
microprocessors.
Zilog, a pioneer in the semiconductor market, is headquartered in Campbell,
California, and operates two fabrication facilities in Nampa, Idaho and two test
and assembly centers in the Philippines. For the fiscal year ended December 31,
1997 the Company generated revenues and EBITDA of $261.1 million and $75.7
million, respectively.
RECENT DEVELOPMENTS -- ASIAN REVENUES
In 1997, the Company generated approximately $110.5 million, or 42.3% of
its total revenue, from sales to customers located in Korea, Singapore, Taiwan,
Hong Kong, Japan, and China. While economic activity in some of these countries,
most notably Korea, has been adversely affected by recent developments in local
currency and banking markets, the Company believes that the effect of these
developments on the Company's business is somewhat mitigated by the financial
condition of many of Zilog's customers in these markets, such as Samsung,
Hitachi, Logitech, and NMB. Many of these customers are leaders in their
respective industries and conduct their business on a multinational basis. In
addition, a substantial portion of the Company's total revenue generated from
the Asian region in 1997 was related to end-products subsequently exported to
non-Asian markets such as the United States and Europe and therefore represent
an important source of foreign currency for these customers. The Company does
not believe that economic conditions in Asia had a material effect on 1997
revenue. The Company believes that it will continue to benefit from the
geographic diversity of its customers and the diverse end-markets for its
customers' products. No assurance can be given that continued negative
developments in the Asian region will not have an adverse effect on Zilog's
future operating performance. See "Risk Factors -- Export Sales; International
Operations".
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Sales for 1997 were $261.1 million, compared to $298.4 million in 1996, a
decrease of $37.3 million, or 12.5%. The sales decline was primarily
attributable to (i) the loss of a significant design position with a data
communications equipment manufacturer and (ii) the decrease of microprocessor
sales to hard disk manufacturers. The data communications customer, which
generated approximately 12.8% of 1996 revenues, changed the technology of its
newest model(s) of its modem product, which resulted in a decrease to Zilog of
approximately $23 million in revenues versus the year-earlier period, although
this particular customer
15
<PAGE> 16
continues to purchase Zilog's products for other applications. No single
customer accounted for more than 8% of revenues in 1997. The discontinuation of
the development and marketing of the hard disk products, which resulted in a
decrease to Zilog of approximately $8.5 million in revenue versus the
year-earlier period, reflected the Company's strategic decision to refocus its
development efforts on other market opportunities.
Overall unit volume increased by 15.4% in 1997, largely driven by increased
demand for the Company's keyboard and pointing device ASSPs. Revenue growth,
however, was adversely affected by generally declining average selling prices as
a result of changes in sales mix described above and continuing over-capacity in
the industry.
Cost of Sales in 1997 was $171.7 million or 65.8% of sales, compared to
$175.3 million or 58.7% of sales in 1996, a decrease of $3.6 million or 2.1%.
The decrease in cost of sales was primarily attributable to the elimination in
1997 of outside wafer foundry cost offset by increased depreciation of $15.8
million and overhead associated with the new MOD III manufacturing facility in
Nampa, Idaho, which was completed in 1996. Excluding this increase in
depreciation expense associated with the new facility, 1997 cost of sales as a
percent of revenues was relatively unchanged at 59.7% compared to 58.7% in 1996.
Research and Development expenses for 1997 and 1996 were both $30.5
million. Research and Development expenses could increase in 1998 due to higher
depreciation charges associated with the Company's investments in its new
Research and Development Technology Center, which is located in the new MOD III
manufacturing facility.
Selling, General and Administrative expenses for 1997 were $47.8 million,
which is relatively unchanged from the $47.9 million recorded in 1996.
Administrative expenses were $1.5 million less in 1997 than in 1996 due to a
litigation settlement in 1996, partially offset by higher recruiting and
personnel costs in 1997 associated with increasing the sales force.
Operating Income for 1997 was $11.1 million, or 4.3% of sales, compared to
$44.6 million, or 15.0% of sales, for 1996. The reduction in operating income in
1997 was primarily due to a higher percentage of cost of goods sold as a result
of lower revenues and increased depreciation charges associated with the
Company's new MOD III manufacturing facility.
Provision for Taxes. The Company's effective tax rate was 20% for 1997
compared to 35% for 1996. The lower provision for income taxes for 1997 is
primarily attributable to a larger impact of tax exempt interest income, foreign
earnings taxed at a lower rate than the United States rate and the reinstatement
of the research and development tax credit on reduced pre-tax earnings. During
1997, the President signed new legislation into law retroactively reinstating
the research and development tax credit for 1997. In addition, through December
27, 1997, the Company was entitled to a partial tax holiday in the Philippines.
As of 1998, the Company's Philippines earnings will effectively be taxed at
higher rates.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Sales for 1996 were $298.4 million, compared to $265.1 million in 1995, an
increase of 12.6%. The growth in 1996 sales over 1995 was driven by increased
unit volumes of data communications and consumer electronics products with no
single customer accounting for more than 12.8% of sales. See "Risk Factors --
Key Customers".
Cost of Sales for 1996 was $175.3 million, compared to $135.1 million for
1995, an increase of 29.8%. As a percentage of sales, cost of sales increased to
58.7% in 1996 from 50.9% in 1995, primarily as a result of additional
depreciation expenses and production overhead costs related to Zilog's new MOD
III manufacturing facility.
Research and Development expenses for 1996 were $30.5 million, compared to
$24.5 million for 1995, an increase of 24.5%. The increase primarily reflects
continued investment in new product development.
Selling, General and Administrative expenses for 1996 were $47.9 million,
compared to $41.9 million for 1995, an increase of 14.3%. As a percentage of
sales, selling, general and administrative expenses increased to
16
<PAGE> 17
16.1% in 1996 from 15.8% in 1995. This increase in absolute dollars and as a
percentage of sales is primarily attributable to costs associated with a
litigation settlement. See "Risk Factors -- Environmental Regulation".
Operating Income for 1996 was $44.6 million, or 15.0% of sales, compared to
$63.6 million, or 24.0% of sales, for 1995. The decrease in operating income in
1996 was primarily due to a higher percentage of costs of goods sold as a result
of increased depreciation charges and production overhead associated with
Zilog's new MOD III manufacturing facility.
Provision for Taxes. The Company's effective tax rate was 35% for 1996
compared to 35.5% for 1995. The 1996 effective tax rate differs from the 1995
effective tax rate primarily because of the Company's increased investment in
tax exempt securities and state income tax credits.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash needs are working capital and capital
expenditures. The Company has financed these cash requirements primarily through
internally generated cash flow and cash received upon the exercise of stock
options. As of December 31, 1997, the Company had cash and short term
investments of approximately $106.3 million.
Cash provided by operating activities for fiscal 1997 was $72.6 million
compared to $91.6 million for fiscal 1996. The major component for both periods
was depreciation and amortization of $63.8 million and $48.3 million for 1997
and 1996, respectively, as well as a reduction in outstanding accounts
receivable and higher net income in 1996.
The Company generated cash from investing activities of $1.1 million in
1997 compared to using cash of $96.9 million in 1996 and $71.4 million in 1995,
primarily as a result of capital expenditures of $117.1 million and $79.3
million in 1996 and 1995, respectively. The Company has made approximately $38.4
million of capital expenditures through the end of fiscal 1997, principally for
equipment in the new research and development technology center for development
of 0.35 micron and mixed signal process.
Cash provided by financing activities was $3.0 million and $13.0 million
for 1997 and 1996, respectively, representing the proceeds from the exercise of
stock options and purchases under the Company's Stock Purchase Plan.
The Company expects its capital expenditures for 1998 to be approximately
$37.3 million, principally for equipment for the MOD III fabrication facility
and the technology center, computer networks and office productivity tools
(E-mail, voicemail and personal computers). The Company estimates that in 1998
following the Recapitalization it will spend approximately $20 million on
non-recurring expenses relating to the Recapitalization including executive and
employee bonuses and severance payments, payments in respect of outstanding
employee stock options and consulting fees. The Company also intends to move to
a larger headquarters building and to increase the number of its design
engineers, sales personnel, field application engineers and distribution
partners. See "Business -- Business Strategy". While the Company is unable to
estimate the annual cost of this increase, the Company anticipates that it may
be significant. The Company expects to fund these capital expenditures and other
costs from cash on hand and internally generated cash flows. As of December 31,
1997, on a pro forma basis giving effect to the Recapitalization, the Company
would have had $70.4 million of cash and short-term investments on hand. See
"Risk Factors -- Recent and Anticipated Operating Results".
As a result of the Recapitalization, the Company's capital structure will
change substantially. At the closing of the Recapitalization, the Company's
capital structure will consist of the Notes, a $25.0 million Revolving Credit
Facility (as to which no amount is anticipated to be drawn at closing) and
stockholders' equity of $34.1 million. Upon consummation of the Merger, the
Revolving Credit Facility will be available to fund the Company's working
capital needs. The Revolving Credit Facility will mature in 2003 and has no
scheduled interim amortization.
The Company's ability to make scheduled payments of the principal of, or to
pay the interest or premium, if any, on, or to refinance, its indebtedness
(including the Notes), or to fund planned capital and other
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<PAGE> 18
expenditures will depend on its future performance, which, to a certain extent,
is subject to general economic, financial, competitive, legislative, regulatory
and other factors that are beyond its control. Based upon the current level of
operations, management believes that cash flow from operations and available
cash, together with available borrowings under the Revolving Credit Facility,
will be adequate to meet the Company's anticipated future requirements for
working capital, budgeted capital and other expenditures and scheduled payments
of principal and interest on its indebtedness, including the Notes, for the next
several years. There can be no assurance that the Company's business will
generate sufficient cash flow from operations or that future borrowings will be
available under the Revolving Credit Facility in an amount sufficient to enable
the Company to service its indebtedness, including the Notes, or make
anticipated capital and other expenditures.
The Company currently recognizes revenue in respect of orders from
distributors at the time the products are shipped by the Company. The Company is
considering changing this practice to defer recognition of revenue until
products are shipped by distributors, which could adversely impact revenues.
As part of its business strategy, the Company plans to replace the majority
of its computer systems. Such systems will function properly with respect to
dates in the year 2000 and thereafter. The Company is investigating Year 2000
compliance by its vendors and customers. There can be no assurance that the
systems of such other companies will be converted in a timely manner and will
not have an adverse effect on the Company.
INFLATION
Zilog does not believe that inflation has had a material impact on its
results of operations.
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<PAGE> 19
BUSINESS
THE COMPANY
Zilog is a worldwide designer, manufacturer and marketer of ASSPs for use
in the high-growth consumer electronics, data communications and computer
peripherals end markets. Through proprietary design technology, the Company
works with customers to customize its ASSPs to control the basic function and
performance of electronic devices. ASSPs typically comprise some combination of
a microprocessor, digital signal processor, memory and input/output functions on
a single semiconductor. Examples of the Company's product applications include
chips in televisions that provide picture-in-picture display and in remote
control units that send instructions to televisions and video cassette
recorders, and chips that operate keyboards and mouse-type pointing devices.
Through its worldwide distribution network of more than 120 representatives and
distributors, the Company supplies over 800 customers with over 700 products.
The average life cycles of these products are over eight years.
The Company places significant emphasis on anticipating and meeting its
customers' needs as new electronic devices are designed. As customers "design
in" Zilog's products, the Company is able to gain a greater share of its
customers' purchases while maintaining its embedded position within its
customers' existing products. The Company believes that this design strategy is
at the core of its ability to achieve a high degree of customer acceptance
within specific applications. Reflecting the proprietary and often sole-source
nature of its products within its customers' applications, the Company's
relationships with its top 10 customers average seven years. In addition,
Zilog's customer base includes many leaders in their respective industries,
including Black & Decker, Cellnet, Cisco, DSC Communications, Fujitsu, General
Instrument, Hewlett-Packard, IBM, Logitech, Lucky Goldstar, Microsoft, NMB,
Samsung, Sharp and VeriFone.
Founded in 1974, Zilog is a pioneer in the semiconductor market. The
Company's Z-80 product, introduced in 1975, is the largest selling 8-bit
microprocessor in history and is still being sold today. In 1997, Zilog products
based on the Z-80 architecture accounted for approximately $75 million in
revenue, representing 29% of the Company's total revenue. Headquartered in
Campbell, California, the Company has two fabrication facilities in Nampa, Idaho
and two test and assembly centers in the Philippines. For the fiscal year ended
December 31, 1997, the Company had revenue of $261.1 million and EBITDA of $75.7
million.
THE INDUSTRY
According to trade statistics published by the SIA, revenue for the
worldwide semiconductor market was $137 billion in 1997. The overall
semiconductor market has expanded at a compound annual growth rate of 17% from
1991 to 1997. The semiconductor industry is comprised of three broad product
segments: logic devices, including microprocessors, microcontrollers and digital
signal processors, which process data (approximately 50% of total industry
sales); memory devices, which store data (approximately 22% of total industry
sales); and analog and discrete devices, which process electronic signals
(approximately 28% of total industry sales). Zilog develops, manufactures and
markets products in the logic device segment. The logic device segment further
consists of three distinct categories: (i) general purpose logic products, such
as the Intel Pentium(R) microprocessor, which are neither application nor
customer specific, are used for a wide array of logic-related functions and are
typically capable of more functions than are actually required for any given
application; (ii) ASICs, which are designed to meet particular application
requirements, are usually proprietary to one customer and are generally produced
in relatively small volumes; and (iii) ASSPs, which are designed for a
particular application, but are not proprietary to a single customer.
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<PAGE> 20
[Chart depicts the segments of, and Zilog's position within,
the semiconductor industry]
The Company's ASSPs typically comprise some combination of a
microprocessor, digital signal processor, memory and input/output functions on a
single semiconductor to control the basic function and performance of its
customers' products.
[Chart depicts ASSP]
Revenue for the ASSP segment of the semiconductor industry has grown from
$14.6 billion in 1994 to $27.8 billion in 1997, a compound annual growth rate of
approximately 24%, and is forecasted to grow to $44.6 billion by the year 2000.
The Company believes that the market for ASSPs is distinct from other logic and
memory markets in that it is less cyclical and that ASSPs typically have longer
product life cycles. Applications in the ASSP market generally do not demand the
processing power of general purpose microprocessors such as the Intel Pentium(R)
microprocessor, which operates personal computers; rather, Zilog's products
operate or perform specialized functions in everyday products such as
telephones, garage door openers and televisions, all of which exhibit growing
degrees of silicon content.
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<PAGE> 21
COMPANY STRENGTHS
As a pioneer in the industry, Zilog has established a well-recognized and
respected brand name in its markets and has developed strong, long-term
relationships with numerous customers who are leaders in their respective
markets. The Company's franchise is built upon several specific strengths,
including the following:
LEADING MARKET POSITION WITH HIGH QUALITY CUSTOMER BASE. The Company
believes it maintains a leading market position in several niches, including
television remote controls, keyboards and mouse-type pointing devices.
Approximately 70% of its revenue is derived from proprietary relationships with
customers for a particular product design. The Company believes that these
relationships provide a significant recurring revenue stream and represent a
strong competitive advantage for Zilog as a redesign of the customer's hardware
and software to use a competitor's ASSP would often involve substantial costs to
the customer. In addition, Zilog believes that it has established strong,
long-term relationships by partnering with customers throughout the iterative
product design and manufacturing process. Currently, the Company sells to more
than 800 customers worldwide, and its relationships with its top 10 customers
average seven years. In consumer electronics, Zilog sells to customers that
include Black & Decker, Samsung, SGS-Thomson, Sony and Zenith. In data
communications, Zilog's customers include Lucent, Cisco, IBM, Motorola and
VeriFone. Zilog's computer peripheral customers include Hewlett-Packard,
Microsoft and NMB, the largest keyboard manufacturer in the world.
DIVERSIFIED PRODUCTS AND MARKETS. Within the consumer electronics, data
communications and computer peripherals end markets, Zilog sells and markets
over 700 products to more than 800 customers worldwide. The Company sells either
directly through its 29 sales offices or indirectly through its more than 120
sales representatives and distributors located throughout the world. In 1997, no
single product or single customer accounted for more than 8% of total revenue.
The Company believes that its product and market diversity, its independence
from reliance on any one customer and its numerous sales personnel and locations
around the world help to insulate the Company from some of the volatility that
affects other companies in the semiconductor industry. The Company also believes
no competitor addresses exactly the same diverse set of markets.
COMPREHENSIVE PROPRIETARY DESIGN LIBRARY. Based upon over 20 years of
design expertise, Zilog's proprietary design library allows customers to select
or modify proven components that can be combined and assembled to create new
products or new applications. Zilog's customers that have designed their
products using one or more of the Company's devices can redesign and upgrade to
new Zilog ASSPs, often without the loss of hardware or software compatibility.
This methodology allows customers to leverage Zilog's vast component library to
advance their own product development processes. Because of extensive
customization, Zilog's customers depend upon Zilog's expertise for much of their
end-product functionality. A Zilog customer switching to a non-Zilog design
could incur significant learning, design, software and manufacturing costs.
OWNERSHIP OF STATE-OF-THE-ART MANUFACTURING FACILITIES. Over the last three
years, Zilog has spent $235 million to increase capacity and improve efficiency
by building a new wafer fabrication facility, renovating an existing facility
and equipping both facilities with state-of-the-art equipment. These facilities
contain fabrication modules equipped to manufacture products with competitive
submicron dimensions. Overall, the Company estimates that it is operating its
fabrication facilities at 60% capacity, enabling Zilog to capitalize on future
upswings in industry demand. The present building also has sufficient space and
infrastructure to accommodate the additional machinery for a 50% increase in
total capacity. The Company believes that its manufacturing facilities will
remain highly competitive in the current market environment without additional
significant capital expenditures, and that the Company's manufacturing, assembly
and test facilities are among the most efficient in the industry.
BUSINESS STRATEGY
Under the leadership of Curtis J. Crawford, formerly Group President of the
Microelectronics Group and President of the Intellectual Property Division of
Lucent, who will join Zilog as President and CEO upon the
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<PAGE> 22
closing of the Offering, the Company intends to capitalize on its core strengths
with the following business strategies:
INCREASE CUSTOMER FOCUS. The Company intends to increase the number of
field application engineers, sales personnel, design engineers and distribution
partners to respond more effectively to its customers' changing product needs.
As competition occurs primarily at the design stage, Zilog believes that once a
customer commits to a design (a "design win"), it typically results in a
proprietary supplier relationship. Zilog believes a strong focus on design wins
through an increase in field application engineers and improvements in design
tools should lead to an increased base of recurring revenues from its customers.
The Company increased its design wins from 180 in 1995 to over 220 in each of
1996 and 1997.
BROADEN APPLICATIONS. Utilizing its library of proprietary designs, the
Company has introduced an average of 39 new products annually since 1993,
including 36 new products in 1997. The Company's strategy is to upgrade its
existing product lines to meet the changing requirements of evolving
applications and to design new products in new markets. In addition to releasing
new or upgraded products in its historic market applications (e.g., keyboards,
mouse-type pointing devices and television remote controls), Zilog expects to
introduce products in several new areas in 1998, including transaction
processing (credit card) modems, internet-access devices for televisions and
telephones and enhanced USB keyboard and pointing device microcontrollers for
personal computers.
EXPAND PRODUCT CAPABILITIES. The Company's position within its markets
depends in part upon the strength and capabilities of its library of proprietary
designs. Zilog intends to expand its existing library by recruiting additional
engineers, investing in computer-aided development tools to assist the Company's
design engineers and acquiring additional design technology from third parties.
By investing in its design library, Zilog will be able to offer more products
with broader functionalities and enhance its competitive position with new and
existing customers.
STRENGTHEN INTERNAL SYSTEMS AND CUSTOMER SUPPORT TOOLS. The Company intends
to increase the efficiency of its experienced employee workforce by investing in
appropriate productivity tools and upgrading office workspace. For example, the
Company intends to invest over $8 million in 1998 in improved internal systems
such as E-mail, computer networks and voicemail. In addition, the Company
intends to move its headquarters to a nearby facility providing approximately
30,000 additional square feet of office space. Zilog also intends to improve its
offering of customer support tools such as compilers, emulators and debuggers,
which facilitate customer adoption of Zilog products. With these tools, Zilog
believes the value of its existing product portfolio to its customers, as well
as from its ability to create new products, should be significantly enhanced.
LEVERAGE MANUFACTURING CAPABILITIES. The Company's ownership of a
substantial portion of its manufacturing resources provides an important
strategic advantage. Direct control over fabrication, assembly and test
operations allows Zilog to offer its customers continuous supply, shortens the
Company's design and production cycles and allows Zilog to capture the
manufacturing margin. Having spent $235 million over the last three years in
order to increase capacity and improve efficiency in its manufacturing
facilities, Zilog believes it is well positioned to increase revenue and margins
in the future.
MARKETS AND PRODUCTS
Zilog relies upon its knowledge, experience, customer relationships and
proprietary core and cell designs to target products in the rapidly growing
consumer electronics, data communications and computer peripheral end markets.
Because Zilog creates ASSPs which have a high degree of integration and which
are designed for a particular application, but which are not proprietary to a
single customer, Zilog's ASSPs typically address larger aggregate markets and
generally have higher production volumes than ASICs. Zilog works closely with
industry leaders in its selected markets to design innovative products. Through
its customer relationships, Zilog has been able to establish and maintain
technological leadership, attract multiple customers in the same market and
create industry standards. The Company believes that it is well-positioned with
respect to the trends in its target market areas, which trends include the
increase in the complexity and sophistication of
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<PAGE> 23
consumer electronics products and the networking of, and increased demand for,
personal computers and peripherals.
Zilog's ASSP products are primarily based upon 8-bit and 16-bit
microprocessor, microcontroller or digital signal processors. Applications in
the ASSP market generally do not demand the processing power of microprocessors
such as the Intel Pentium(R) microprocessor, which operates personal computers.
Rather, Zilog's products operate or perform specialized functions in everyday
products such as telephones, garage door openers and televisions, all of which
exhibit growing degrees of silicon content.
Zilog currently offers over 700 products (independent of ROM codes), sold
in a wide selection of package, speed grade and other configurations to more
than 800 customers worldwide. Zilog's customers include Black & Decker, Cisco,
Cellnet, DSC Communication, Fujitsu, General Instrument, Hewlett-Packard,
Hitachi, IBM, Logitech, Lucent, Lucky Goldstar, Microsoft, NMB, Motorola,
Northern Telecom, Samsung, Sharp, Sony, Texas Instruments, VeriFone and Zenith
Electronics. The Company believes its product portfolio, with an average product
life cycle of over eight years, has relatively less obsolescence risk than those
of other semiconductor companies.
Zilog's three target markets are consumer electronics, data communications
and computer peripherals:
Consumer Electronics. The increase in the use of ASSPs in consumer
electronics has created a significant market opportunity for Zilog.
Sophisticated ASSPs are increasingly found in consumer electronics such as
spread spectrum cordless telephones, audiovisual equipment, telephone answering
machines and household appliances. Other consumer electronics applications that
use Zilog's products are television controllers, infrared remote controls,
internet appliances, battery chargers, garage door openers, home security
systems, cable television systems, video cassette recorders and automotive
controllers such as airbags.
Data Communications. The data communications market is growing in response
to the need to connect computer systems at remote locations and the need for
multiple users to share peripherals such as printers and facsimile machines. By
networking computers and peripherals, it is possible to share information files,
distribute computer loads more efficiently and facilitate communications between
terminals, computers and peripherals, thereby maximizing the benefit from an
organization's investment in its installed base of computer equipment. Zilog
sells microprocessors optimized for use in the following data communications
applications: ethernet routers, bridges, data switches, modems, terminals,
printers, workstations, local area networks and wide area networks.
Computer Peripherals. Strong unit demand for personal computers and
peripherals has driven growth for ASSPs. The typical computer system may have up
to six or seven peripherals which facilitate the human interface, provide memory
functions, or service the communications link with other computers. Among the
most common peripherals are the printer, keyboard, monitor, mouse-type pointing
device, facsimile and modem. Zilog ASSPs are used in each of these applications.
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<PAGE> 24
The following table summarizes selected applications of the Company's
products in the consumer electronics, data communications and computer
peripherals markets.
<TABLE>
<S> <C> <C> <C>
- ----------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
END MARKET: CONSUMER ELECTRONICS DATA COMMUNICATIONS COMPUTER PERIPHERALS
- ----------------------------------------------------------------------------------------------
PERCENTAGE OF REVENUE
FOR
1997 36% 37% 27%
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Applications: Cordless phones ISDN Mouse-type pointing
Television controllers WAN device
Infrared remote XDSL Keyboard
controls Modems Fax/Printer/Scanner
Battery chargers ATM/frame relay PCMCIA
Household appliances
Meter reader
Automotive
Card reader/smart
cards
Security systems
- ----------------------------------------------------------------------------------------------
Customers: Black & Decker Cisco Acer
Samsung Lucent Hewlett-Packard
SGS-Thomson Motorola Logitech
Sharp VeriFone Microsoft
Sony NMB
Zenith
- ----------------------------------------------------------------------------------------------
Example of Product Television Modem Mouse
Application:
- ----------------------------------------------------------------------------------------------
Example of Zilog ASSP Picture-in-Picture Transmits and receives Causes cursor to move
Function: data
- ----------------------------------------------------------------------------------------------
- ----------------------
</TABLE>
RESEARCH AND DEVELOPMENT
Zilog believes that the continued introduction of new ASSPs in its target
markets and application support tools for these products are essential to its
growth. As of December 31, 1997, Zilog employed 140 people in research and
development. Expenditures for research and development in 1995, 1996 and 1997
were approximately $24.5 million, $30.5 million and $30.5 million, respectively,
representing approximately 9%, 10% and 12%, respectively, of sales.
Most of Zilog's new products are created by design engineers through the
use of its proprietary design library. All of the designs in Zilog's library are
produced by a subset of Zilog's standard manufacturing process. The design rules
employed ensure that the need to adjust the library is minimal as manufacturing
technology advances to smaller dimensions. Zilog employs the concept of
"concurrent engineering." Designers and process engineers work side by side in
the product definition and design stages to manufacture a new product that will
maximize efficiencies and yields when the design cycle and fabrication processes
are completed.
Zilog has three design centers with different specialties. The Campbell,
California, design center specializes in consumer electronics, while the Nampa,
Idaho, design center focuses primarily on Zilog's memory libraries. The Austin,
Texas, design center concentrates its efforts mainly on digital signal processor
products and applications. While cross-fertilization occurs, by concentrating
design efforts in these centers, engineers develop valuable expertise in their
respective areas.
MANUFACTURING
Zilog owns a substantial portion of its manufacturing resources and
believes this is an important part of its strategy. The Company has made
significant capital expenditures of $235 million over the last three years to
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<PAGE> 25
increase capacity and improve efficiency at its facilities. Direct control over
wafer fabrication, assembly and test operations allows Zilog to provide
customers with continuous supply, shorten Zilog's design and production cycles,
and capture manufacturing margins.
By operating two semiconductor fabrication facilities in Nampa, Idaho,
Zilog enjoys significant manufacturing flexibility. These facilities contain
fabrication modules equipped to produce products with submicron dimensions. The
Company can manufacture certain ASSPs using low volume, low cost production runs
from its MOD II facility built in 1984, as well as more tightly integrated,
newly developed ASSPs from its MOD III facility built in 1996. Additionally, the
Company's facilities enable Zilog to produce mixed-signal (analog-digital
conversion) ASSPs. Zilog's MOD III facility is currently producing ASSPs at 0.65
micron dimensions and produced its first test wafers at 0.35 micron dimensions
in January 1998. Overall, the Company estimates its facilities are operating at
60% capacity which should enable the Company to capitalize on future upswings in
industry demand. The Company further believes that its manufacturing facilities
provide cost and quality competitive advantages. In addition, the Company
conducts high volume assembly and test operations in two facilities in the
Philippines. Zilog also uses outside contract assemblers for packaging a portion
of its products. The Company believes that its manufacturing facilities will
remain competitive in the current market environment without additional
significant capital expenditures, and that the Company's manufacturing, assembly
and test facilities are among the most efficient in the industry.
The Idaho and Philippines plants operate 24 hours per day, seven days a
week. Automated data collection and analysis systems are used to maintain
efficient manufacturing line loading and to assure that the production mix is in
accord with the Company's sales order forecast. A skilled workforce is very
important to high productivity in semiconductor manufacturing. Zilog maintains
an extensive personnel training and certification program in its plants and
believes that this leads to lower turnover and higher worker involvement. All of
Zilog's operations are managed through the use of statistical process control
techniques.
SALES AND MARKETING
In 1997, Zilog shipped its products to over 800 customers through its
direct sales force and through manufacturers' sales representatives and
distributors. The Company's products are sold to manufacturers in the consumer
electronics, data communications and computer peripherals markets as well as the
military and aerospace industries. Zilog's worldwide headquarters are in
Campbell, California. The Company has sales offices located in the metropolitan
areas of Atlanta, Austin, Boston, Boulder, Chicago, Cleveland, Dallas,
Minneapolis, Orange County, Philadelphia, Portland, San Diego, Beijing, Erfurt,
Hong Kong, Kuala Lumpur, London, Munich, Seoul, Shanghai, Shenzhen, Singapore,
Taipei, Tokyo, Toronto and Vancouver. Each of these offices has a direct sales
force who calls on large accounts and manages the activities of Zilog's 31 sales
representative organizations. The Company frequently holds technical sales
conferences and training sessions for its direct sales and sales representative
personnel.
Zilog's direct marketing force consists of technical specialists and field
application engineers. Zilog's technical specialists are based at corporate
headquarters and focus exclusively on one of consumer electronics, data
communications or computer peripherals applications. Field application engineers
are located in Zilog's sales offices around the world and work directly with
local customers in close consultation with the Company's technical specialists.
Field application engineers typically develop technology expertise in the market
segment which is most prominent in their geographic area. The Company intends to
hire additional field application engineers as part of its business strategy.
Zilog also markets and sells its products through four North American
distributors and 32 international distributors. As is common in the
semiconductor industry, Zilog grants price protection and limited rights of
return to distributors. In certain circumstances, distributors are granted a
credit for the difference between the price they were originally charged for
products in inventory at the time of a price reduction and the reduced price
which Zilog subsequently charges. In 1997, the aggregate amount of this credit
was $67,000.
For the years ended December 31, 1995, 1996 and 1997, sales to customers
located outside of the United States aggregated approximately 57%, 56% and 59%,
respectively, of sales for these periods. Total sales to
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<PAGE> 26
these international customers in each of such periods were approximately $150.4
million, $166.9 million and $154.3 million, respectively. See "Risk
Factors -- Export Sales; International Operations".
During the year ended December 31, 1997, no single customer represented
more than 8% of Zilog's sales and no distributor accounted for more than 7% of
Zilog's sales. Zilog believes that its customer and geographic balance help it
to reduce volatility in operating results.
COMPETITION
The principal competitive factors in Zilog's markets include design and
end-market applications expertise, product features and performance, including
the ability to preserve the customers' software, price, time to market and
manufacturing. Zilog believes its competitive strengths include its expertise in
the technology of a broad range of applications in the consumer electronics,
data communications and computer peripherals markets, its design methodology
which includes its design system with its extensive library of customer familiar
cores and cells and its manufacturing facilities and capabilities.
The semiconductor industry is intensely competitive and is characterized by
price erosion, rapid technological change and heightened foreign competition in
many markets. The industry consists of major domestic and international
semiconductor companies, many of which have substantially greater financial and
other resources than Zilog with which to pursue engineering, manufacturing,
marketing and distribution of their products. Emerging companies are also
expected to increase their participation in the semiconductor market. The
ability of Zilog to compete successfully in its markets depends on factors both
within and outside of its control, including, but not limited to, success in
designing and manufacturing new products that implement new technologies,
protection of Company products by effective utilization of intellectual property
laws, product quality, reliability, ease of use, price, diversity of product
line, efficiency of production, the pace at which customers incorporate Zilog's
microcontrollers, microprocessors and digital signal processors into their
products, success of competitors' products and general economic conditions.
Zilog competes with its licensees on certain products. With respect to
certain products, Zilog competes with other ASSP manufacturers which target the
same specific market segment. However, no single competitor addresses exactly
the same set of products or markets as Zilog.
PATENTS AND LICENSES
Zilog holds 91 United States patents and has 12 United States patent
applications pending, as well as 16 pending foreign patent applications. Zilog
has also filed and received one patent outside of the United States. Zilog has
more than 75 United States mask work registrations on its products. Copyright
registrations are held by Zilog to protect proprietary software employed in over
100 of its products. The Company has claimed more than 40 trademarks or
servicemarks.
Zilog's ability to compete may be enhanced by its ability to protect its
proprietary information, including the issuance of patents, copyrights, mask
work registrations and trademarks. Only a few of these intellectual property
rights have been litigated. While no intellectual property right of Zilog has
been invalidated or declared unenforceable, there can be no assurance that such
rights will be upheld in the future. Accordingly, management believes that, in
view of the rapid pace of technological change in the semiconductor industry,
the technical experience and creative skills of the Company's engineers and
other personnel will be extremely important in determining Zilog's future
technological success.
Zilog has more than 100 active licenses for product or technology exchange.
The purpose of these licenses has, in general, been to provide second sources
for standard products or to convey or receive rights to certain proprietary or
patented cores, cells or other technology.
As is typical in the semiconductor industry, Zilog has from time to time
received, and may in the future receive, communications from third parties
asserting patent rights, mask work rights, copyrights or trademark rights
covering certain of Zilog's products, technologies or information. See "Risk
Factors -- Intellectual Property Rights".
26
<PAGE> 27
PROPERTIES
Zilog's headquarters and research and development facilities are located at
210 East Hacienda Avenue, Campbell, California, in an 80,000 square foot
facility leased through June 1998. Zilog has entered into a letter of intent
relating to a six-year lease on a new 108,000 square foot headquarters and
research and development facility commencing May 1, 1998. Zilog performs wafer
fabrication at its 77,000 square foot and 128,000 square foot buildings located
on a 65-acre site in Nampa, Idaho. Zilog owns these Idaho facilities.
Assembly and test operations are performed at Zilog's two facilities in
Manila, the Philippines, which are 54,000 square feet and 34,000 square feet,
respectively. Zilog owns the larger facility subject to a ground lease which
expires in 2004, and leases the second Manila facility. This lease expires in
July 1998, but has an option for Zilog to renew for a term of five years. Zilog
has leased a 4,000 square foot engineering design center in Austin, Texas. This
lease expires in March 1998, prior to which time the Company plans to move this
facility to a new location. In addition, Zilog has short-term leases for its
sales offices located around the world in the United States, Canada, England,
Germany, Hong Kong, Japan, Korea, Malaysia, the Peoples Republic of China,
Singapore and Taiwan.
EMPLOYEES
As of December 31, 1997, Zilog employed 1,702 full-time persons, including
1,335 in manufacturing, 120 in research and development, 179 in sales and
marketing and 68 in finance and administration. Approximately one-half of
Zilog's employees work at its assembly and test facilities located in Manila,
the Philippines. Zilog considers its relations with its employees to be good.
ENVIRONMENTAL
Zilog is subject to a variety of government regulations related to the
discharge or disposal of toxic, volatile or otherwise hazardous chemicals used
in its manufacturing process, including the Resource Conservation and Recovery
Act, the Comprehensive Environmental Response, Compensation and Liability Act,
the Superfund Amendment and Reauthorization Act, the Clean Air Act and the Water
Pollution Control Act. Zilog believes it has also obtained all necessary
environmental permits to conduct its business, which generally relate to the
discharge of hazardous wastes. Nevertheless, the failure to comply with present
or future regulations could result in fines being imposed on Zilog, suspension
of production or cessation of operations. Such regulations could require the
Company to acquire significant equipment or to incur substantial other expenses
to comply with environmental regulations. Any failure by Zilog to control the
use of, or adequately restrict the discharge of, hazardous substances could
subject it to future liabilities.
In 1996, the U.S. District Court for the District of Idaho entered orders
approving a settlement in the lawsuit entitled Tsotung Ko, et al. v. Zilog, Inc.
In the suit, 31 plaintiffs alleged that the Company endangered their health and
safety by chemical exposures at one of the Company's Nampa, Idaho facilities. In
addition, the plaintiffs alleged that the Company discriminated against them
after they were injured by chemical exposures. Although the Company made
payments in connection with the settlement, the Company strongly denied these
allegations.
In January 1998, the newspaper USA Today published a series of articles
about environmental and employee health and safety conditions at semiconductor
manufacturing facilities. The Company's operations during 1993 and 1994 and the
Tsotung Ko lawsuit were the primary subject of one article and were mentioned in
several other articles. Since 1993, the Company has constructed its MOD III
facility, expanded MOD II, closed MOD I and has upgraded the environmental
monitoring and control equipment at its MOD II facility. The Company believes it
is in substantial compliance with all applicable environmental and employee
health and safety regulations. However, this recent public attention focused on
the environmental and employee health and safety conditions at the Company's
facilities could increase the incidence of environmental or employee health and
safety complaints or governmental investigations into the Company's operations
and there can be no assurance that the Company will not incur significant
expense in connection therewith.
27
<PAGE> 28
LEGAL MATTERS
The Company has been named as a defendant in a purported class action
lawsuit which was filed on January 23, 1998 in the United States District Court
for the Northern District of California. Certain executive officers of the
Company are also named as defendants. The plaintiff purports to represent a
class of all persons who purchased the Company's Common Stock during the Class
Period. The complaint alleges that the Company and certain of its executive
officers made false and misleading statements regarding the Company that caused
the market price of its Common Stock to be "artificially inflated" during the
Class Period. The complaint does not specify the amount of damages sought. The
Company believes the lawsuit lacks merit and intends to defend it vigorously.
There can be no assurance that the Company will prevail in its defense of the
lawsuit or that any judgment against the Company will not be material.
Zilog is participating in other litigation and responding to claims arising
in the ordinary course of business. Zilog intends to defend itself vigorously in
these matters. Zilog's management believes that it is unlikely that the outcome
of these matters will have a material adverse effect on the Company, although
there can be no assurance in this regard.
RETENTION OF NEW CHIEF EXECUTIVE OFFICER
The Company expects to enter into an employment agreement with Mr.
Crawford, which will provide that, for a period of five years commencing on the
date the Recapitalization is consummated, Mr. Crawford will serve as President
and CEO of the Company and as a member of its Board of Directors. The employment
agreement is expected to provide for an annual base salary of $800,000, and to
provide an annual target bonus of at least $600,000 provided the Company
achieves certain performance objectives to be determined each year, except that,
with respect to calendar year 1998, a minimum bonus of $600,000 will be paid.
It is expected that, upon commencement of employment with the Company, Mr.
Crawford will receive a $1.0 million bonus and the Company will establish a
deferred compensation account of $8.0 million, which will earn interest of 8%
per annum, compounded annually. The $8.0 million plus earnings will be paid to
Mr. Crawford on January 2, 2002 or earlier, if Mr. Crawford elects, upon the
occurrence of (i) a change in control of the Company (as defined in the
employment agreement), (ii) a public offering (as defined in the employment
agreement) of any class of stock of the Company or (iii) the termination of Mr.
Crawford's employment with the Company, provided that, if Mr. Crawford
voluntarily resigns his employment with the Company prior to January 1, 1999, he
shall forfeit all rights to the $8.0 million payment.
It is also anticipated that the Company will grant Mr. Crawford 50,000
shares of Common Stock on each of May 1, 1998, 1999, 2000 and 2001 (all share
and share price information in this paragraph give effect to a 4-for-1 stock
split anticipated to be declared after consummation of the Recapitalization).
Such shares shall become fully deliverable prior to such dates on the earlier to
occur of a change in control, a public offering or if Mr. Crawford ceases to be
employed with the Company for any reason, provided that, if Mr. Crawford
voluntarily resigns his employment prior to January 1, 1999, he shall return any
shares granted and shall forfeit any shares that have not yet been granted.
Finally, it is anticipated that the employment agreement will provide that the
Company will grant Mr. Crawford the option to purchase 500,000 shares of Common
Stock at an exercise price of $5.00 per share (the "$5 Option") and 500,000
shares of Common Stock at an exercise price of $10.00 per share (the "$10
Option"). The $5 Option and the $10 Option will each become exercisable as
follows: (i) 62,500 shares on the date the Recapitalization is consummated, (ii)
62,500 shares on December 31, 1998 and (iii) 31,250 shares at the end of each
calendar quarter in each of calendar years 1999, 2000 and 2001. The options will
also become immediately exercisable in full upon the occurrence of any of the
following events: (i) change in control of the Company, (ii) a public offering
or (iii) the termination of Mr. Crawford's employment by the Company without
cause (as defined in the employment agreement), by Mr. Crawford for good reason
(as defined in the employment agreement) or on account of Mr. Crawford's death
or permanent disability. Mr. Crawford will have the right to require the Company
to register his shares of Common Stock acquired pursuant to such option on May
1, 2001, or, at the Company's option in lieu of registering such shares, to
purchase such shares from Mr. Crawford at an appraised fair market value on such
date.
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<PAGE> 29
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL
ARRANGEMENTS
Dr. Sack has notified the Company that he will step down as CEO following
consummation of the Recapitalization. Pursuant to Dr. Sack's employment
agreement, upon such resignation, Dr. Sack will be entitled to receive the
following payments in a cash lump sum: (A) the current base salary for the
period remaining under his employment agreement, (B) payouts under Zilog's
Employee Performance Incentive Plan for awards granted prior to the effective
date of termination of employment, and (C) payouts under Zilog's Executive Bonus
Plan for awards granted prior to the effective date of termination of
employment. In addition, Dr. Sack will be entitled to continue his participation
in group insurance plans, including basic and supplemental life insurance and
disability insurance and health insurance and the flexible spending plan for the
health insurance and dependent care coverage, maintained by Zilog for an
additional 24 months. In addition, upon consummation of the Recapitalization,
all of Dr. Sack's outstanding stock options will fully vest, be canceled and Dr.
Sack will receive cash for the difference, if any, between the exercise price
and $20.00. See 'The Recapitalization".
Pursuant to the employment agreements between Zilog and each of Michael J.
Bradshaw, Richard L. Moore, Robert E. Collins, Richard R. Pickard, Sally M.
Baumwell, J. James Magill, Alan Secor and Thomas C. Carson, upon consummation of
the Recapitalization, the term of each such executive officer's employment will
be automatically extended for 24 months from the earlier of the Effective Time
or the expiration date of each respective employment agreement. If any of such
executive officers terminates employment with Zilog after the Effective Time,
either voluntarily for Good Reason (as defined in each respective employment
agreement) or involuntarily for reasons other than for Cause or Detrimental
Activity (as defined in each respective employment agreement): (i) the executive
officer will be entitled to receive the following payments in a cash lump sum:
(A) the then current base salary for the period remaining under the employment
agreement, (B) payouts under Zilog's Employee Performance Incentive Plan for
awards granted prior to the effective date of termination of employment, and (C)
payouts under Zilog's Executive Bonus Plan for awards granted prior to the
effective date of termination of employment; (ii) the executive officer's
unvested stock options granted after the Effective Time and outstanding as of
the date of such termination will continue to vest for the period of time
remaining under the employment agreement; and (iii) the executive officer will
be entitled to continue participation in group insurance plans, including basic
and supplemental life insurance and disability insurance and health insurance
and the flexible spending plan for the health insurance and dependent care
coverage, maintained by Zilog through the expiration of the term of the
employment agreement. In addition, upon consummation of the Recapitalization,
all of the above executives' outstanding stock options will fully vest, be
canceled and they will receive cash for the difference, if any, between the
exercise price and $20.00. See 'The Recapitalization".
The employment agreements for each of Dr. Sack, Messrs. Bradshaw, Moore,
Collins, Pickard, Magill, Secor and Carson and Ms. Baumwell provide for: (i)
awards and payouts under Zilog's Employee Performance Incentive Plan and
Executive Bonus Plan for the year in which the termination of employment occurs
and (ii) excise tax restoration bonuses to the extent any of such individuals
are subject to any excise tax imposed by Section 4999 of the United States
Internal Revenue Code of 1986, as amended (the "Code"). The amount of payouts
will be calculated in accordance with the respective terms of the Employee
Performance Incentive Plan and Executive Bonus Plan as if such individual's
termination date was the last day of Zilog's fiscal year and based on Zilog's
financial performance for the portion of the fiscal year that ends on the last
day of the month prior to the termination date.
PRINCIPAL STOCKHOLDER
Following consummation of the Recapitalization, 3,375,000 shares of Common
Stock, 1,250,000 shares of Class A Non-Voting Common Stock and 250,000 shares of
Preferred Stock, which in the aggregate will represent approximately 94% of
total equity capital and 90% of the voting interests of Zilog, will be owned by
TPG II and certain related investors.
29
<PAGE> 30
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst and Young LLP, Independent Auditors................................... 31
Consolidated Balance Sheets as of December 31, 1996 and 1997.......................... 32
Consolidated Statements of Income for the Years Ended December 31, 1995, 1996 and
1997................................................................................ 33
Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1996 and
1997................................................................................ 34
Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1995,
1996 and 1997....................................................................... 35
Notes to Consolidated Financial Statements............................................ 36
</TABLE>
30
<PAGE> 31
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders of Zilog, Inc.
We have audited the accompanying consolidated balance sheets of Zilog, Inc.
as of December 31, 1997 and 1996, and the related consolidated statements of
income, shareholders' equity and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Zilog, Inc. at
December 31, 1997 and 1996, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
San Jose, California
February 6, 1998
31
<PAGE> 32
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
-------- --------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Current Assets:
Cash and cash equivalents............................................ $ 92,184 $ 15,511
Short-term investments............................................... 14,127 53,412
Accounts receivable, less allowance for doubtful accounts of $250 in
1997 and 1996..................................................... 31,633 29,395
Inventories.......................................................... 32,968 34,469
Prepaid expenses, deferred income taxes and other current assets..... 19,769 15,516
-------- --------
Total current assets......................................... 190,681 148,303
Property, plant and equipment, at cost:
Land, buildings and leasehold improvements........................... 34,314 34,061
Machinery and equipment.............................................. 381,144 345,867
-------- --------
415,458 379,928
Less accumulated depreciation and amortization....................... (191,881) (131,217)
-------- --------
Net property, plant and equipment............................ 223,577 248,711
Other assets........................................................... 1,381 4,052
-------- --------
$415,639 $401,066
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable..................................................... $ 24,733 $ 28,786
Accrued compensation and employee benefits........................... 18,284 17,545
Other accrued liabilities............................................ 5,287 5,116
Income taxes payable................................................. 10,783 8,289
-------- --------
Total current liabilities.................................... 59,087 59,736
Deferred income taxes.................................................. 16,070 16,050
Commitments and contingencies
Shareholders' Equity:
Preferred Stock, $0.01 par value; 190,000 shares authorized, no
shares outstanding................................................ -- --
Common Stock, $0.01 par value; 75,000,000 shares authorized,
20,333,742 shares issued and outstanding in 1997 and 20,127,976
shares in 1996.................................................... 203 201
Additional paid-in capital........................................... 164,950 161,599
Retained earnings.................................................... 175,236 163,375
Net unrealized gains on securities (Net of tax effect)............... 93 105
-------- --------
Total shareholders' equity................................... 340,482 325,280
-------- --------
$415,639 $401,066
======== ========
</TABLE>
See Accompanying Notes.
32
<PAGE> 33
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C> <C>
Sales.............................................. $261,097.. $298,425 $265,122
Costs and expenses:
Cost of sales.................................... 171,722 175,319 135,066
Research and development......................... 30,467 30,548 24,546
Selling, general and administrative.............. 47,806 47,934 41,943
-------- -------- --------
249,995 253,801 201,555
Operating income................................... 11,102 44,624 63,567
Other income (expense):
Interest income.................................. 2,892 2,443 2,676
Other, net, including license and royalty income
and expense................................... 832 (911) (360)
-------- -------- --------
Income before income taxes......................... 14,826 46,156 65,883
Provision for income taxes......................... 2,965 16,155 23,418
-------- -------- --------
Net income......................................... $ 11,861 $ 30,001 $ 42,465
======== ======== ========
Earnings per common share.......................... $ 0.59 $ 1.51 $ 2.21
======== ======== ========
Earnings per common share, assuming dilution....... $ 0.57 $ 1.47 $ 2.09
======== ======== ========
</TABLE>
See Accompanying Notes.
33
<PAGE> 34
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
--------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................... $ 11,861 $ 30,001 $ 42,465
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation........................................... 63,750 48,315 27,214
Loss from disposition of equipment..................... 50 100 386
Deferred income taxes.................................. (2,229) 3,811 4,794
Changes in assets and liabilities:
Accounts receivable................................. (2,238) 13,666 (5,640)
Inventories......................................... 1,501 (6,317) (7,171)
Prepaid expenses, and other assets.................. 201 5,000 (9,956)
Accounts payable.................................... (4,053) (7,421) (2,620)
Accrued compensation and employee benefits.......... 739 2,798 2,068
Other accrued liabilities and income taxes
payable........................................... 3,062 1,683 3,322
--------- -------- ---------
Cash provided by operating activities.......... 72,644 91,636 54,862
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures..................................... (38,437) (117,065) (79,346)
Short-term investments:
Purchases.............................................. (229,730) (55,006) (112,240)
Proceeds from sales.................................... 141,936 45,035 87,121
Proceeds from maturities............................... 127,304 30,095 33,076
--------- -------- ---------
Cash provided by (used for) investing
activities................................... 1,073 (96,941) (71,389)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of stock.......................... 2,956 13,032 16,276
--------- -------- ---------
Cash provided by financing activities.......... 2,956 13,032 16,276
--------- -------- ---------
Increase (decrease) in cash and cash equivalents......... 76,673 7,727 (251)
Cash and cash equivalents -- beginning of period......... 15,511 7,784 8,035
--------- -------- ---------
Cash and cash equivalents -- end of period............... $ 92,184 $ 15,511 $ 7,784
========= ======== =========
Supplemental disclosures of cash flow information --
Cash paid for:
Income taxes........................................... $ 1,905 $ 9,249 $ 12,754
========= ======== =========
</TABLE>
See Accompanying Notes.
34
<PAGE> 35
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
NET
UNREALIZED
COMMON STOCK ADDITIONAL GAIN (LOSS) TOTAL
---------------------- PAID-IN RETAINED ON SHAREHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS SECURITIES EQUITY
---------- --------- ---------- -------- ----------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995........... 18,499,965 $ 185 $122,327 $ 90,909 $ (826) $ 212,595
Issuance of Common Stock under stock
option and stock purchase plans,
including tax benefit of $6,525.... 955,662 10 22,791 -- -- 22,801
Adjustments to unrealized gains
(losses) on available-for-sale
securities, net of tax............. -- -- -- -- 1,003 1,003
Net income........................... -- -- 42,465 -- 42,465
---------- -------- -------- -------- ----- --------
Balance at December 31, 1995......... 19,455,627 195 145,118 133,374 177 278,864
Issuance of Common Stock under stock
option and stock purchase plans,
including tax benefit of $3,455.... 672,349 6 16,481 -- -- 16,487
Adjustments to unrealized gains
(losses) on available-for-sale
securities, net of tax............. -- -- -- -- (72) (72)
Net income........................... -- -- -- -- -- 30,001
---------- -------- -------- -------- ----- --------
Balance at December 31, 1996......... 20,127,976 201 161,599 163,375 105 325,280
Issuance of Common Stock under stock
option and stock purchase plans,
including tax benefit of $397...... 205,766 2 3,351 -- -- 3,353
Adjustments to unrealized gains
(losses) on available-for-sale
securities, net of tax............. -- -- -- -- (12) (12)
Net income........................... -- -- -- 11,861 -- 11,861
---------- -------- -------- -------- ----- --------
Balance at December 31, 1997......... 20,333,742 $ 203 $164,950 $175,236 $ 93 $ 340,482
========== ======== ======== ======== ===== ========
</TABLE>
See Accompanying Notes.
35
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of business
Zilog designs, develops, manufactures and markets application specific
standard products (ASSPs) for the data communications, consumer product
controller and intelligent peripheral controller markets.
Principles of consolidation
The consolidated financial statements include the accounts of Zilog, Inc.
and its subsidiaries. All significant transactions and accounts between the
Company and these subsidiaries have been eliminated in consolidation.
Revenue recognition
Certain of the Company's sales are made through distributors under
agreements allowing limited right of return and price protection on merchandise
unsold by the distributors. Revenue is recognized at the time of shipment with
appropriate reserves provided for returns and price allowances. Royalty income
is recognized on a quarterly basis when the income is earned and received from
the licensees.
Foreign currency translation
All of the Company's subsidiaries use the U.S. dollar as the functional
currency. Accordingly, monetary accounts and transactions are remeasured at
current exchange rates, and nonmonetary accounts are remeasured at historical
rates. Revenues and expenses are remeasured at the average exchange rates for
each period, except for depreciation expense which is remeasured at historical
rates. Foreign currency exchange gains and (losses) were included in determining
results of operations and aggregated $940,000, $(540,000), and $(508,000) for
the years ended December 31, 1997, 1996 and 1995, respectively.
Fair values of financial instruments
The Company's short-term investments consist primarily of various State and
Municipal bonds. Cash and cash equivalents consist primarily of cash in bank
accounts and overnight investments in commercial paper. The following methods
and assumptions were used by the Company in estimating its fair value
disclosures for financial instruments:
Cash and cash equivalents: The carrying amount (at cost), in the balance
sheet for cash and cash equivalents at December 31, 1997 and 1996 were
$92,184,000 and $15,511,000 respectively, which approximates fair value, due to
their short maturities.
Short-term investments: The fair values for marketable debt securities are
based on quoted market prices. Investments consist primarily of marketable debt
securities which are classified as available-for-sale and are carried at fair
value. Unrealized gains and losses, net of tax, are reported in shareholders'
equity. The cost basis of investments is adjusted for amortization of premiums
and accretion of discounts to maturity, which is included in interest income.
Realized gains and losses are included in other income. The cost of securities
sold is based on the specific identification method.
36
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following is a summary of available-for-sale securities as of December
31, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
--------- ---------
MUNICIPAL MUNICIPAL
BONDS BONDS
--------- ---------
<S> <C> <C>
Cost.................................................... $14,011 $53,250
Gross Unrealized Gains.................................. 116 173
Gross Unrealized (Losses)............................... -- (11)
------- -------
Estimated Fair Value.................................... $14,127 $53,412
======= =======
</TABLE>
The gross realized gains and losses on sales for the year ended December
31, 1997, 1996 and 1995 were not significant.
The maturities for the marketable debt securities at December 31, 1997 and
1996 are shown below (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------------- ----------------------
ESTIMATED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
------- ---------- ------- ----------
<S> <C> <C> <C> <C>
Due in 1 year or less............... $14,011 $ 14,127 $30,831 $ 30,921
Due after 1 year through 3 years.... -- -- 22,419 22,491
------- ------- ------- -------
$14,011 $ 14,127 $53,250 $ 53,412
======= ======= ======= =======
</TABLE>
Inventories
Inventories are stated at the lower of standard cost (which approximates
actual cost on a first-in, first-out basis) or market and consist of the
following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Raw materials...................................... $ 4,171 $ 5,385
Work-in-process.................................... 23,543 23,412
Finished goods..................................... 5,254 5,672
------- -------
$ 32,968 $ 34,469
======= =======
</TABLE>
Property, plant and equipment
Depreciation is computed using the straight-line method over the estimated
economic lives of the assets which are generally five years for machinery and
equipment and thirty years for buildings. Amortization of leasehold improvements
is computed using the shorter of the remaining terms of the leases or the
estimated economic lives of the improvements.
Use of estimates
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 financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
37
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Concentration of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, short-term
investments and trade accounts receivable. By policy, the Company places its
investments only with high credit quality financial institutions. Almost all of
the Company's trade accounts receivable are derived from sales to electronics
distributors and to manufacturers of consumer products, intelligent computer
peripherals and products which network computers and peripherals. The Company
performs ongoing credit evaluations of its customers' financial condition and
limits its exposure to accounting losses by limiting the amount of credit
extended whenever deemed necessary and generally does not require collateral.
Stock Awards
The Company accounts for employee stock awards in accordance with APB
Opinion No. 25, Accounting for Stock Issued to Employees. As stock option grants
are issued with an exercise price equal to the fair value of the stock, the
Company recognizes no compensation expense for stock option grants.
Additionally, as the Stock Purchase Plan qualifies as an "Employee Stock
Purchase Plan" under Section 423 of the Code, no compensation expense is
recorded. Pro forma information required by FASB Statement No. 123, Accounting
for Stock Based Compensation is presented in Note 5, below.
Earnings per share
Earnings per common share and earnings per common share, assuming dilution,
have been calculated in accordance with FASB Statement No. 128, Earnings per
Share. The table below summarizes these calculations as of December 31, 1997,
1996, and 1995 (in thousands except per share amount):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
1997 1996 1995
---------------------------- ---------------------------- ----------------------------
PER-SHARE PER-SHARE PER-SHARE
INCOME SHARES AMOUNTS INCOME SHARES AMOUNTS INCOME SHARES AMOUNTS
------- ------ --------- ------- ------ --------- ------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net income......................... $11,861 $30,001 $42,465
======= ======= =======
Earnings per Common Share:
Income available to common
stockholders................... $11,861 20,233 $0.59 $30,001 19,896 $1.51 $42,465 19,172 $2.21
===== =====
Effect of Dilutive Securities:
Stock options.................... 443 558 1,113
------ ------ ------
Earnings per Common Share, assuming
dilution:
Income available to common
stockholders and assumed option
exercises........................ $11,861 20,676 $0.57 $30,001 20,454 $1.47 $42,465 20,285 $2.09
======= ====== ===== ======= ====== ======= ====== =====
</TABLE>
Options outstanding to purchase approximately 897,000, 2,389,000 and
396,000 shares of common stock for the years ended December 31, 1997, 1996, and
1995, respectively, were not included in the computation of earnings per common
share assuming dilution, because the options' exercise price was greater than
the average market price of the common shares, and, therefore, the effect would
be antidilutive.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, Reporting Comprehensive Income (FAS No. 130) and Statement No. 131.
Disclosures About Segments of An Enterprise and Related Information (FAS No.
131). FAS No. 130 establishes rules for reporting and displaying comprehensive
income. FAS No. 131 will require the Company to use the "management approach" in
disclosing segment information. Both statements are effective for the Company
during 1998.
38
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2. PROPOSED MERGER
On July 20, 1997 the Company announced that it would be purchased by TPG
Partners II, L.P., subject to the satisfaction of certain conditions prior to
closing. The transaction is to be accounted for as a recapitalization, which
would result in TPG owning 90.0% of the voting shares. At a Special Meeting of
the stockholders held on January 27, 1998, the Agreement and Plan of Merger as
amended by Amendments Number One and Number Two, dated November 18, 1997 and
December 10, 1997, respectively, was approved. The Merger, subject to completion
of the contemplated financing, is expected to be completed by the end of
February, 1998. It is not expected that the Company will have publicly-listed
shares following the Merger.
Zilog will utilize approximately $433.4 million of cash to complete the
Merger. The sources and uses of funds to consummate the Merger are expected to
be as follows (in thousands):
<TABLE>
<S> <C>
Sources:
Senior Secured Notes.................................................... $280,000
New Equity Contribution................................................. 117,500
Cash of Zilog........................................................... 35,865
--------
Total........................................................... $433,365
========
Uses:
Payment for Outstanding Shares.......................................... $399,175
Estimated Payment for Outstanding Stock Options......................... 4,190
Estimated Fees and Expenses............................................. 30,000
--------
Total........................................................... $433,365
========
</TABLE>
NOTE 3. STATE OF INCORPORATION
The Company changed the state of incorporation from California to Delaware
in May 1997. As a result of that change, no par Common Stock became $.01 par
Common Stock under the State of Delaware Corporation laws. All share information
has been retroactively adjusted to reflect the $.01 par value.
NOTE 4. EMPLOYEE BENEFIT PLANS
Employee Performance Incentive Plan
Under the amended 1987 Employee Performance Incentive Plan (the Incentive
Plan), domestic exempt employees not included in any other Company incentive
program are eligible to participate in incentive awards. The Incentive Plan
provided for awards of up to 7.5% of pretax profit (as defined) for the periods
1997, 1996 and 1995 dependent upon the attainment of certain operating results.
Results of operations were charged approximately $2,421,000, $2,141,000, and
$3,893,000 in the years ended December 31, 1997, 1996 and 1995, respectively,
under this plan. The Incentive Plan may be continued, discontinued or amended by
the Company's Board of Directors.
Savings Plan
The Company has an employee savings plan that qualifies as a deferred
salary arrangement under Section 401(k) of the Internal Revenue Code. Under the
plan, participating U.S. employees may defer a portion of their pretax earnings,
up to the Internal Revenue Service annual contribution limit ($9,500 for
calendar year 1997). The Company may make matching contributions on behalf of
each participating employee in an amount equal to 100% of the participant's
deferral contribution, up to 1 1/2% of the participant's compensation on a
quarterly basis. The Company may also make additional discretionary
contributions to the 401(k) Plan up to a limit set by federal tax law. Matching
contributions to the savings plan were approximately $583,000,
39
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
$589,000, and $549,000 in 1997, 1996 and 1995, respectively. The discretionary
contributions for 1997, 1996 and 1995 were approximately $1,820,000, $2,354,000,
and $1,308,000, respectively.
NOTE 5. SHAREHOLDERS' EQUITY
Stock purchase plan
During 1990, the Company adopted an employee stock purchase plan (the
"Stock Purchase Plan") allowing eligible employees to purchase shares of the
Company's Common Stock. The total number of shares of Common Stock authorized
for issuance under the plan is 600,000. All full-time employees of the Company
are eligible to participate, subject to certain limited exceptions. The Stock
Purchase Plan provides a means for the Company's employees to purchase stock
through payroll deductions of up to 10% of their gross compensation. The
purchase price for shares offered under the Stock Purchase Plan is equal to 85%
of the lower of the closing price of the Common Stock on the first day of the
six month offer period, or the last day of the six month offer period. Shares
purchased under the Plan were 92,898, 65,087 and 47,875 in 1997, 1996 and 1995,
respectively. Subscriptions of the Stock Purchase Plan were suspended after the
expiration in October, 1997 of the six month offer period. Upon completion of
the Merger, the Plan will be terminated.
Stock Option Plans
The Zilog New Employee and Employee Promotion Common Share Option Plan (the
"1989 Option Plan") and The Zilog Employee Common Share Option Plan (the "1990
Option Plan") expired during 1995, and no further stock options may be granted
under these plans. In April 1994, the 1994 Long-Term Stock Incentive Plan (the
"1994 Option Plan") was adopted, effective January 1, 1994.
Under the 1994 Option Plan, the Company may grant to eligible employees:
restricted shares, stock units, incentive stock options, nonqualified stock
options or stock appreciation rights, to purchase up to a total of 3,542,208
shares as of December 31, 1997. The exercise price for incentive stock options,
nonqualified stock options and stock appreciation rights will be determined by
the Board of Directors. Under the terms of the plan, restricted shares and stock
units may be awarded to eligible employees at no cost. No options have been
granted since July 1997. Upon completion of the Merger, the 1994 Option Plan
will be terminated.
Options under the plans generally vest 25% at the end of one year from the
date of grant and 25% on each anniversary of the grant date thereafter. Eligible
employees under the option plans are new employees and employees at certain
position classification levels within the Company. Effective January 1, 1995 and
on each January 1 thereafter for the remaining term of the Plan, an additional
1,000,000 Common Shares shall be reserved for award as Restricted Shares, Stock
Units, Options and SARs. Any Common Shares that have been reserved but not
awarded as Restricted Shares, Stock Units, Options and SARs during any calendar
year shall not remain available for award in any subsequent calendar year. All
options granted have 10 year terms.
Shares granted and cancelled for 1996, include a Stock Option Replacement
offered by the Company to existing grant holders of unexercised shares of the
1994 plan which were granted prior to October 18, 1996. Under the terms of the
Stock Option Replacement offer, 2,494,352 shares were cancelled and re-granted
at the market value of the common stock, at the election of the grant holder.
These new grants are not otherwise exercisable for one year from the date of the
stock option replacement on November 6, 1996, but with the same vesting schedule
and expiration date of the original grants.
40
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The following table summarizes activity under the 1989, 1990 and 1994
Option Plans:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
SHARES ------------------------------
AVAILABLE PRICE PER
FOR GRANT SHARES SHARE
---------- --------- ----------------
<S> <C> <C> <C>
Balance at December 31, 1994............... 433,182 4,662,860 $ 0.13 - $35.25
Shares reserved............................ 1,000,000 -- --
Granted.................................... (1,644,600) 1,644,600 $29.75 - $47.75
Exercised.................................. -- (907,787) $ 0.13 - $35.25
Cancelled.................................. 248,913 (549,149) $ 2.67 - $47.75
---------- ---------
Balance at December 31, 1995............... 37,495 4,850,524 $ 0.13 - $47.75
========== =========
</TABLE>
A summary of the Company's stock option activity, and related information
for the year ended December 31, 1997 and 1996 follows:
<TABLE>
<CAPTION>
SHARES OPTIONS
AVAILABLE SHARES WEIGHTED-AVERAGE
FOR GRANT OUTSTANDING EXERCISE PRICE
---------- ----------- ----------------
<S> <C> <C> <C>
Balance at January 1, 1996................. 37,495 4,850,524 $27.12
Shares reserved............................ 1,000,000 -- --
Granted.................................... (3,598,502) 3,598,502 $25.56
Exercised.................................. -- (607,262) $19.12
Cancelled.................................. 2,561,007 (3,171,491) $33.16
---------- ---------- -------
Balance at December 31, 1996............... -- 4,670,273 $20.67
Shares reserved............................ 1,000,000 -- --
Granted.................................... (916,800) 916,800 $22.84
Exercised.................................. -- (112,868) $12.89
Cancelled.................................. (83,200) (330,872) $21.79
---------- ---------- -------
Balance at December 31, 1997............... -- 5,143,333 $21.11
========== ========== =======
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISABLE PRICES OUTSTANDING CONTRACTURAL LIFE EXERCISABLE PRICE EXERCISABLE EXERCISE PRICE
----------- ----------------- ----------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
At December, 1997:
$ 0.1333 - $10.00 180,543 2.93 $ 5.68 180,543 $ 5.68
$10.6666 - $20.00 2,531,803 7.80 $ 19.36 1,359,443 $ 18.83
$20.1666 - $30.00 2,163,289 7.26 $ 22.91 1,092,026 $ 22.44
$30.1250 - $47.75 267,698 7.42 $ 33.53 168,609 $ 32.55
--------- -------- --------- --------
$ 0.1333 - $47.75 5,143,333 7.38 $ 21.11 2,800,621 $ 20.22
========= ======== ========= ========
</TABLE>
The weighted average fair value of options granted in 1997, 1996 and 1995
were $8.52, $9.23 and $12.26 per share, respectively.
Pro forma Stock Based Compensation
Pro forma information regarding net income and earnings per share is
required by FASB Statement 123, which also requires that the information be
determined as if the Company has accounted for its employee options granted
subsequent to December 31,1994 under the fair value method of that statement.
The fair value for these options was estimated at the date of grant utilizing a
Black-Scholes option pricing model with a multiple option approach. The
following weighted-average assumptions for 1995, 1996, and 1997, respectively,
41
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
were used: risk-free interest rates (annual average) of 6.4%, 5.5%, and 6.1%;
dividend yields of zero; volatility factors of the expected market price of the
Company's common stock of .40, .67, and .47; and a weighted-average expected
life of the option of 4.5 years.
To comply with the pro forma reporting requirements of FAS No. 123 for
stock awards granted under the employee stock purchase plan, compensation cost
is estimated for the fair value of the employees' purchase rights using the
Black-Scholes model with the following assumptions for those rights granted in
1995, 1996, and 1997; dividend yield of 0.0%; an expected life ranging up to .5
years; expected volatility factor of .42, .61, and .48; and a risk free interest
rate of 6.1%, 5.4%, and 6.0%. The weighted average fair value of those purchase
rights granted in March 1995, September 1995, March 1996, September 1996 and
March 1997 were $3.75, $3.59, $3.54, $5.62 and $5.93, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in managements opinion, the existing models do not
necessarily provide a reliable, single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosure, the expense amortization of the
options' fair value is allocated over the options' vesting period (4 years). The
Company's pro forma information follows (in thousands except for earnings per
share information):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
------ ------- -------
<S> <C> <C> <C>
Pro forma net income................................... $2,012 $10,413 $36,957
Pro forma earnings per common share.................... $ 0.10 $ 0.52 $ 1.93
Pro forma earnings per common share, assuming
dilution............................................. $ 0.10 $ 0.52 $ 1.86
</TABLE>
For pro forma disclosure in accordance with FAS No. 123, the 1996 Stock
Option Replacement offer options were treated as a modification of an award. Any
additional compensation arising from the modification is recognized over the
remaining vesting period of the new grant. FAS No. 123 is effective for options
granted by the Company commencing January 1, 1995. All options granted before
January 1, 1995 have not been valued and no pro forma compensation expense has
been recognized. However any option granted before January 1, 1995 that was
repriced in 1996 is treated as a new grant within 1996 and valued accordingly.
In addition, as compensation expense is recognized over the vesting period of
the option, which is typically four years, and pro forma disclosure is only
required commencing with 1995, the initial impact on pro forma income may not be
representative of pro forma compensation expense in future years. However, upon
completion of the Merger, all options will be cancelled and all existing option
plans terminated.
42
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 6. INCOME TAXES
The provision for income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Federal:
Current............................................. $ 3,036 $10,076 $15,998
Deferred............................................ (1,949) 3,360 4,074
------- ------- -------
1,087 13,436 20,072
State:
Current............................................. 565 966 1,478
Deferred............................................ 55 636 684
------- ------- -------
620 1,602 2,162
Foreign:
Current............................................. 1,593 1,302 1,148
Deferred............................................ (335) (185) 36
------- ------- -------
1,258 1,117 1,184
------- ------- -------
Provision for income taxes.......................... $ 2,965 $16,155 $23,418
======= ======= =======
</TABLE>
The tax benefits associated with the exercise of stock options reduce taxes
currently payable as shown above by $397,000, $3,455,000, and $6,525,000 in
1997, 1996 and 1995 respectively. Such benefits are credited to additional
paid-in-capital when realized.
Pretax income from foreign operations was $5,309,000, $4,678,000, and
$3,901,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Unremitted foreign earnings to be indefinitely reinvested outside the United
States and on which no deferred taxes have been provided, amounted to
approximately $17,500,000 at December 31, 1997. If such amounts were remitted,
the residual U.S. tax liability (net of foreign tax credits), would be
approximately $3,000,000.
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before taxes. The sources and
tax effects of the differences are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
------ ------- -------
<S> <C> <C> <C>
Computed expected provision............................ $5,189 $16,155 $23,059
State tax, net of federal benefit...................... 403 1,042 1,405
Tax exempt interest income............................. (721) (745) (710)
Foreign rates less than the federal rate............... (838) (791) (206)
Research and development credits....................... (921) (572) (682)
Other.................................................. (147) 1,066 552
------ ------- -------
$2,965 $16,155 $23,418
====== ======= =======
</TABLE>
43
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
---------------------
1997 1996
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation................................... $(18,599) $(16,046)
Valuation of investment portfolio............................ (59) (57)
-------- --------
(18,658) (16,103)
Deferred tax assets:
Inventory valuation adjustment and reserves.................. 4,105 4,106
Accruals not currently deductible............................ 1,975 2,297
Alternative minimum tax credits.............................. 3,186 --
Prepaid expenses and other................................... 2,183 537
-------- --------
11,449 6,940
-------- --------
Net deferred tax liabilities................................. $ (7,209) $ (9,163)
======== ========
</TABLE>
At December 31, 1997 the Company had alternative minimum tax credit
carryforwards of approximately $3,186,000 which may be carried forward
indefinitely.
NOTE 7. COMMITMENTS AND CONTINGENCIES
The Company leases certain of its facilities under noncancelable operating
leases which expire in 1998 through 2004. The Company is currently negotiating a
new office lease which will start May 1, 1998 for Campbell headquarters and
expects to have the lease signed by the end of February, 1998. The facilities
lease agreements generally provide for base rental rates which increase at
various times during the terms of the leases and also provide for renewal
options at fair market rental value.
Minimum future payments under these noncancelable operating leases at
December 31, 1997 are as follows (in thousands):
<TABLE>
<S> <C>
1998........................................................ $1,390
1999........................................................ 534
2000........................................................ 418
2001........................................................ 340
2002........................................................ 280
Thereafter.................................................. 296
------
$3,258
======
</TABLE>
Total rental expense, including month-to-month rentals, was $2,875,000,
$2,778,000, and $2,732,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
The Company has been named as a defendant in a purported class action
lawsuit which was filed on January 23, 1998 in the United States District Court
for the Northern District of California. Certain executive officers of the
Company are also named as defendants. The plaintiff purports to represent a
class of all persons who purchased the Company's Common Stock between June 30,
1997 and November 20, 1997 (the "Class Period"). The complaint alleges that the
Company and certain of its executive officers made false and misleading
statements regarding the Company that caused the market price of its Common
Stock to be "artificially inflated" during the Class Period. The complaint does
not specify the amount of damages sought. The Company believes the lawsuit lacks
merit and intends to defend it vigorously. There can be no assurance
44
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
that the Company will prevail in its defense of the lawsuit or that any judgment
against the Company will not be material.
The Company is participating in other litigation and responding to claims
arising in the ordinary course of business. The Company intends to defend itself
vigorously. The Company believes that it is unlikely that the outcome of these
matters will have a material adverse effect on the Company, although there can
be no assurance in this regard.
NOTE 8. GEOGRAPHIC INFORMATION
The Company operates in one industry segment and is primarily engaged in
the design, development, manufacturing and marketing of application specific
standard semiconductor products. The Company sells its products to system
manufacturers in a broad range of industries. During the period ending December
31, 1996 one customer, Lucent Technologies, represented 12.8% of sales or
approximately $38,000,000. No single customer accounted for more than 8.5% of
sales during the years ended December 31,1997 and 1995.
Export sales to unaffiliated customers located outside the United States,
expressed as a percentage of consolidated sales, consist of the following:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Far East................................................ 42% 42% 40%
Europe.................................................. 10 9 10
Other................................................... 7 5 7
-- - -- -
---
59% 56% 57%
=== === ===
</TABLE>
The Company's operating results are subject to the risks inherent in
international sales and purchases, including, but not limited to various
regulatory requirements, political and economic changes and disruptions,
transportation delays, foreign currency fluctuations, export/import controls,
tariff regulations, higher freight rates, difficulties in staffing and managing
foreign sales operations, greater difficulty in accounts receivable collection,
and potentially adverse tax consequences. Duty, tariff and freight costs can
materially increase the cost of crucial components for the Company's products.
Foreign exchange fluctuations may render the Company's products less competitive
relative to locally manufactured product offerings, or could result in foreign
exchange losses. The Company remains subject to the transaction exposures that
arise from foreign exchange movements between the dates foreign currency export
sales or purchase transactions are recorded and the dates cash is received or
payments are made in foreign currencies. There can be no assurance that the
Company's current or any future currency exchange strategy will be successful in
avoiding exchange related losses or that any of the factors listed above will
not have a material adverse effect on the Company's business, financial
condition and results of operations.
45
<PAGE> 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
The Company's operations outside the United States consist of two assembly
plants in the Philippines and sales offices in certain foreign countries.
Domestic operations are responsible for the design, development and wafer
fabrication of all products, as well as the coordination of production planning
and shipping to meet world-wide customer commitments. The Philippine assembly
plants are reimbursed in relation to value added during assembly, and the
foreign sales offices receive a commission on export sales within their
territory. Accordingly, for financial statement purposes, it is not meaningful
to segregate revenues or operating profits for the assembly and foreign sales
operations. Identifiable assets by geographic area are as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
-------- --------
<S> <C> <C>
United States (including corporate assets)............. $353,224 $329,304
Philippines............................................ 60,061 70,388
Other.................................................. 2,354 1,374
-------- --------
Total assets........................................... $415,639 $401,066
======== ========
</TABLE>
Item 7. FINANCIAL STATEMENTS AND EXHIBITS.
(c) Exhibits.
23.1 Consent of Ernst & Young LLP
46
<PAGE> 47
SIGNATURE
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 hereunto duly authorized.
Dated: February 10, 1998
Zilog, Inc.
By /s/ Richard R. Pickard
--------------------------------
Richard R. Pickard
Vice President, General Counsel
and Secretary
47
<PAGE> 48
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
23.1 Consent of Ernst & Young LLP
<PAGE> 1
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Selected Consolidated
Financial Data" included in the Zilog, Inc. Current Report on Form 8-K dated
February 11, 1998, filed with the Securities and Exchange Commission and to the
incorporation by reference of our report dated February 6, 1998, with respect
to the consolidated financial statements of Zilog, Inc. for the year ended
December 31, 1997 in the Registration Statements Form S-4 (No. 333-42123) and
related Proxy Statement/Prospectus of Zilog, Inc. for the registration of
375,000 shares of its common stock and Form S-8 (Nos. 33-67938 and 33-95110)
pertaining to the 1990 Zilog Employee Common Share Option Plan and 1990 Zilog
Employee Stock Purchase Plan, and the 1994 Long-Term Stock Incentive Plan and
in the related Prospectuses.
/s/ Ernst & Young LLP
San Jose, California
February 6, 1998
