UNITED STATES
SECURITIES & EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
- ---- Exchange Act of 1934. For the quarterly period ended April 4, 1999.
Transition report pursuant to Section 13 or 15(d) of the Securities
- ---- Exchange Act of 1934. For the transition period from _____________
to _____________.
Commission File Number: 001-13748
---------
ZILOG, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3092996
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
910 East Hamilton Avenue, Campbell, California, 95008
-----------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 558-8500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------- -------
As of May 3, 1999, there were 30,098,736 shares of the Company's Voting
Common Stock, $.01 par value and 10,000,000 shares of the Company's Non-Voting
Common Stock, $.01 par value outstanding.
<PAGE>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
ZILOG, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
-------------------
April 4, April 5,
1999 1998
--------- ---------
<S> <C> <C>
Net sales............................. $54,209 $49,539
--------- ---------
Costs and expenses:
Cost of sales....................... 38,410 40,767
Research and development............ 7,263 8,104
Selling, general and administrative. 14,506 13,941
Special charges:
Recapitalization.................... -- 13,304
--------- ---------
60,179 76,116
--------- ---------
Operating loss........................ (5,970) (26,577)
Other income (expense):
Interest income..................... 610 1,159
Interest expense.................... (7,229) (2,978)
Other, net.......................... (85) (88)
--------- ---------
Loss before income taxes.............. (12,674) (28,484)
Provision (benefit) for income taxes.. 250 (8,545)
--------- ---------
Net loss.............................. (12,924) (19,939)
Other comprehensive loss,
net of tax......................... -- (93)
--------- ---------
Comprehensive loss.................... ($12,924) ($20,032)
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
ZILOG, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)
(dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
April 4, December 31,
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $46,540 $50,856
Accounts receivable, less allowance for doubtful
accounts of $340 in 1999 and $366 in 1998.......... 27,177 25,151
Inventories........................................... 25,797 22,232
Prepaid expenses and other current assets............. 9,831 7,521
----------- -----------
Total current assets.......................... 109,345 105,760
----------- -----------
Property, plant and equipment, at cost.................. 428,298 424,401
Less: accumulated depreciation and amortization......... (257,146) (242,653)
----------- -----------
Net property, plant and equipment.................... 171,152 181,748
Other assets............................................ 8,926 9,563
----------- -----------
$289,423 $297,071
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable...................................... $21,207 $16,381
Accrued compensation and employee benefits............ 22,658 24,595
Other accrued liabilities............................. 11,851 17,977
----------- -----------
Total current liabilities..................... 55,716 58,953
Notes Payable........................................... 280,000 280,000
Other non-current liabilities........................... 15,804 6,349
Stockholders' deficiency:
Preferred Stock, $100.00 par value; 5,000,000 shares
authorized; 1,500,000 shares designated as Series A
Cumulative Preferred Stock; 250,000 shares of Series
A Cumulative Preferred Stock issued and outstanding
at April 4, 1999 and December 31, 1998; aggregate
liquidation preference $28,027....................... 25,000 25,000
Common Stock, $0.01 par value; 70,000,000 shares
authorized; 30,098,736 shares issued and
outstanding at April 4, 1999 and December 31, 1998.
Class A Non-voting Common Stock, $0.01 par value;
30,000,000 shares authorized; 10,000,000 shares
issued and outstanding at April 4, 1999 and December
31, 1998............................................. 401 401
Additional paid-in capital............................. 799 799
Accumulated deficit.................................... (88,297) (74,431)
----------- -----------
Total stockholders' deficiency................ (62,097) (48,231)
----------- -----------
$289,423 $297,071
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
ZILOG, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Increase (decrease) in cash and cash equivalents
(dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
----------------------
April 4, April 5,
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................. ($12,924) ($19,939)
Adjustments to reconcile net loss to cash provided
(used) by operating activities:
Depreciation ....................................... 15,380 16,015
Changes in assets and liabilities:
Accounts receivable................................. (2,026) 3,526
Inventories......................................... (3,565) 457
Prepaid expenses and other assets .................. (1,673) (452)
Accounts payable.................................... 4,826 (740)
Accrued compensation and employee benefits.......... (1,937) 1,173
Other accrued and non-current liabilities........... 2,387 (5,966)
---------- ----------
Cash provided (used) by operating activities.. 468 (5,926)
---------- ----------
Cash flows from investing activities:
Capital expenditures.................................. (4,784) (7,260)
Proceeds from sales of short-term investments......... -- 14,127
---------- ----------
Cash provided (used) by investing activities... (4,784) 6,867
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock................. -- 208
Purchase of outstanding shares......................... -- (399,475)
Merger costs charged to retained earnings.............. -- (15,202)
Net proceeds from issuance of notes payable............ -- 270,734
Investment by Texas Pacific Group...................... -- 117,500
---------- ----------
Cash provided (used) by financing activities.. -- (26,235)
---------- ----------
Decrease in cash and cash equivalents.................... (4,316) (25,294)
Cash and cash equivalents at beginning of period......... 50,856 92,184
---------- ----------
Cash and cash equivalents at end of period............... $46,540 $66,890
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
ZILOG, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1) BASIS OF PRESENTATION
The accompanying interim financial information is unaudited. In the
opinion of ZiLOG, Inc.'s ("ZiLOG" or the "Company") management, all
adjustments (consisting only of normal recurring adjustments),
necessary for a fair presentation of interim results have been
included. The results for interim periods are not necessarily
indicative of results to be expected for the entire year. These
financial statements and notes should be read in conjunction with the
Company's annual consolidated financial statements and notes thereto
contained in the Company's 1998 Form 10-K filed on March 31, 1999. The
condensed consolidated balance sheet at December 31, 1998 has been
derived from audited financial statements at that date.
2) INVENTORIES
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
April 4, December 31,
1999 1998
----------- -----------
<S> <C> <C>
Raw materials............... $1,228 $2,439
Work-in-process............. 21,003 17,844
Finished goods.............. 3,566 1,949
----------- -----------
$25,797 $22,232
=========== ===========
</TABLE>
3) ACQUISITION
ZiLOG, Inc. and Seattle Silicon Corporation executed an Asset Purchase
Agreement (the "Agreement") which closed on April 20, 1999. By the
terms of the Agreement, ZiLOG acquired substantially all of the assets
and assumed the operating liabilities of Seattle Silicon Corporation
for up to approximately $6.0 million, including transaction expenses
and contingent consideration based on future sales levels. The
acquisition has been accounted for as a purchase. Substantially all of
the former employees of Seattle Silicon Corporation were hired,
establishing ZiLOG's fourth design center. Their activities will
principally support ZiLOG's Integrated Controls business unit.
4) SEGMENT REPORTING
The Company has three business units that all sell application specific
standard products to original equipment manufacturers and distributors.
The Communications business unit markets semiconductor components
primarily in the communications end markets. The Integrated Controls
business unit markets semiconductor components primarily in the
consumer and computer peripherals end market. The Home Entertainment
business unit markets semiconductor components primarily in the
television and TV remote controller end markets.
Segment accounting: There are no sales or transfers between the
business units. The Company does not assign specific assets to each
business unit because all business units use the same fabrication,
assembly and test equipment as well as the same building facilities.
Accordingly, the Company does not have any reportable operating
segments.
Segment financial data: Net sales to external customers for the three
month periods ended April 4, 1999 and April 5, 1998 for each of the
Company's business units are presented as follows (in thousands):
<TABLE>
<CAPTION>
April 4, April 5,
1999 1998
----------- -----------
<S> <C> <C>
Communications ................... $21,223 $17,752
Integrated Controls............... 21,469 19,950
Home Entertainment................ 11,517 11,837
----------- -----------
Net Sales $54,209 $49,539
=========== ===========
</TABLE>
Major customers: During both of the three month periods ended April 4,
1999 and April 5, 1998 one distributor accounted for approximately 11%
of net sales.
<PAGE>
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
This Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities
Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), regarding future events and the Company's
plans and expectations that involve risks and uncertainties. When used
in this Report, the words "estimate," "project," "intend," "expect,"
"anticipate" and similar expressions are intended to identify such
forward-looking statements. Such statements are subject to certain
risks and uncertainties, including those discussed below, which could
cause actual results to differ materially from those projected.
Factors that may cause or contribute to such differences include, but
are not limited to, those discussed below under "Factors That May
Affect Future Results," as well as those discussed elsewhere in this
Report. In light of the important factors that can materially affect
results, including those set forth in this paragraph and below, the
inclusion of forward-looking information herein should not be regarded
as a representation by the Company or any other person that the
objectives or plans for the Company will be achieved. The reader is
therefore cautioned not to place undue reliance on the forward-looking
statements contained herein, which speak only as of the date hereof.
ZiLOG, Inc. undertakes no obligation to publicly release updates or
revisions to these statements.
The following tables present unaudited results. The Company believes
that all necessary adjustments, consisting only of normal recurring
adjustments, have been included in the amounts shown below to state
fairly the selected quarterly information when read in conjunction with
the Condensed Consolidated Financial Statements included elsewhere
herein. Interim results are based on fiscal quarters of thirteen weeks
in duration ending on the last Sunday of each quarter. The operating
results for any quarter are not necessarily indicative of results for
any subsequent quarter or the full fiscal year. All tabular
information is provided in thousands, except percentages.
Results of Operations
The Company's quarterly operating results have and will vary because of
a number of factors, including the timing and success of new product
introductions, the success of cost reduction programs, changes in
product mix, volume, timing and shipment of orders and fluctuations in
manufacturing productivity. Quarter-to-quarter sales comparisons are
<PAGE>
also subject to customer order patterns and seasonality. Because the
Company's products are available from both the Company and
distributors, the customer's decision to buy from a distributor or
directly from the Company can affect ZiLOG's quarterly sales and
profitability.
<TABLE>
<CAPTION>
Three Months Ended
-------------------
April 4, April 5,
1999 1998
--------- ---------
<S> <C> <C>
Net sales............................. $54,209 $49,539
Operating loss........................ ($5,970) ($26,577)
Net loss.............................. ($12,924) ($19,939)
EBITDA................................ $9,311 $2,514
</TABLE>
EBITDA represents earnings (losses) from operations before interest
income and expense (including amortization of deferred financing
costs), income taxes, depreciation, amortization of goodwill, non-cash
stock option compensation expenses and recapitalization and
restructuring expenses ("Special Charges"). 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 its capital structure or
working capital needs. EBITDA as presented should not be used as an
alternative to operating income or net cash provided/(used) for
operating activities, each as measured under generally accepted
accounting principles, and may not be comparable to similarly titled
measures presented by other companies.
Net Sales
<TABLE>
<CAPTION>
April 4, April 5,
1999 1998
----------- -----------
<S> <C> <C>
Communications ................... $21,223 $17,752
Integrated Controls............... 21,469 19,950
Home Entertainment................ 11,517 11,837
----------- -----------
Net Sales $54,209 $49,539
=========== ===========
</TABLE>
Overall, net sales for the first quarter of 1999 increased $4.7 million
or 9.4% from the comparable period of 1998. The increase in current
year net sales was primarily attributable to higher unit shipments and
increased selling prices for communications products. During the
current quarter, the Company's integrated controls business unit
experienced a $1.5 million increase in net sales over first quarter
1998 as a result of higher unit shipments, offset partially by
decreased selling prices for personal computer peripheral products.
Net sales in the home entertainment business unit declined slightly in
the first quarter of 1999 as compared to the year ago period as a
result of price declines in the television and remote control business
lines.
Cost of Sales
<TABLE>
<CAPTION>
Three Months Ended
-------------------
April 4, April 5,
1999 1998
--------- ---------
<S> <C> <C>
Cost of sales....................... $38,410 $40,767
Gross profit ....................... $15,799 $8,772
Gross profit percentage............. 29.1% 17.7%
</TABLE>
The Company's cost of sales represents the cost of its wafer
fabrication, assembly and test operations. Cost of sales fluctuates,
depending on manufacturing productivity, product mix, equipment
utilization and depreciation. When compared to the similar period in
1998, ZiLOG's increase in gross profit margin in the first quarter of
1999 was primarily a result of the Company's cost reduction programs
and increased utilization of its eight-inch wafer fabrication facility.
Late in the third quarter of 1998, ZiLOG took two actions to reduce the
cost structure of its wafer fabrication facilities in Nampa, Idaho.
The actions taken reduced the workforce by 20% and changed the shift
structure to accommodate the transfer of more wafer manufacturing into
the Company's more efficient, eight-inch semiconductor fabrication
facility from its five-inch facility. Additionally, the Company was
able to negotiate significant price reductions in raw materials prices
during the third quarter of 1998. The Company also completed the
outsourcing of its assembly operations to subcontractors in the first
quarter of 1999. The results of these actions contributed to a higher
gross profit in the first quarter of 1999 as compared to the similar
period in 1998.
Research and Development
<TABLE>
<CAPTION>
Three Months Ended
-------------------
April 4, April 5,
1999 1998
--------- ---------
<S> <C> <C>
Research and development............ $7,263 $8,104
Percentage of sales................. 13.4% 16.4%
</TABLE>
When compared to the similar period of 1998, research and development
expenditures decreased $0.8 million, or 10.4% in the first quarter of
1999 as the Company finalized the development of its .35 micron CMOS
wafer fabrication process in the fourth quarter of 1998 and transferred
the process to manufacturing. ZiLOG focussed on new and enhanced
product development and new customer development tools in the first
quarter of 1999. The first quarter of 1999 decrease as a percentage of
sales, when compared to the same period of 1998 was primarily
attributable to higher sales in 1999.
Selling, General and Administrative
<TABLE>
<CAPTION>
Three Months Ended
-------------------
April 4, April 5,
1999 1998
--------- ---------
<S> <C> <C>
Selling, general and administrative. $14,506 $13,941
Percentage of sales................. 26.8% 28.1%
</TABLE>
Selling, general and administrative expenses increased slightly in
dollars in the first quarter of 1999 when compared to the 1998 similar
period, mainly attributable to higher employee related expenses,
including severance costs in connection with a reorganization of the
Company's sales force. The board of directors approved changes to the
Company's incentive bonus plan that will provide for increased bonus
payments to executive officers and other employees over 1998 levels based
on substantial improvement in 1999 financial performance. If Zilog
attains certain financial targets, the Company anticipates that selling,
general and administrative expenses could increase in 1999 as a result of
higher bonus expense. Selling, general and administrative expenses
decreased as a percentage of sales in the first quarter of 1999 when
compared to the similar period of 1998, primarily as a result of higher
sales.
Special Charges
ZiLOG had no Special Charges in the first quarter of 1999. Pursuant to
the Agreement and Plan of Merger by and among TPG Partners II, L.P.,
TPG Zeus Acquisition Corporation ("Merger Sub") and ZiLOG dated as of
July 20, 1997, as amended, Merger Sub merged with and into ZiLOG on
February 27, 1998, and ZiLOG continued as the surviving corporation
(the "Merger"). In connection with the Merger, ZiLOG recorded $13.3
million of recapitalization-related expenses during the first quarter
of 1998.
<PAGE>
Other Income/(Expense), Net
<TABLE>
<CAPTION>
Three Months Ended
-------------------
April 4, April 5,
1999 1998
--------- ---------
<S> <C> <C>
Other income (expense), net......... ($6,704) ($1,907)
Percentage of sales................. -12.4% -3.8%
</TABLE>
Other expenses, net of interest income, increased to $6.7 million in
the first quarter of 1999 from $1.9 million for the similar period in
1998. The primary reason for the increase was interest expense
(including amortization of debt issuance costs) on the Company's 9.5%
Senior Secured Notes Payable issued February 27, 1998 and due February
27, 2005 (the "Notes"). The Company will incur approximately $26.6
million in interest coupon payments annually on the Notes.
Taxes
The provision for income taxes was $0.25 million for the three months
ended April 4, 1999 compared to a benefit provision of $8.5 million for
the three months ended April 5, 1998. The 1999 provision for income
taxes primarily reflects foreign income taxes for certain profitable
jurisdictions as well as foreign withholding taxes. Due to the
Company's overall loss position, a full valuation allowance has been
established for the current year losses and, therefore, no benefit is
realized in the 1999 tax rate. The 1998 rate reflected the benefit of
refundable taxes related to the Company's overall loss position and the
realization of deferred tax assets based on the reversal of taxable
temporary differences, offset by foreign taxes.
Under Statement of Financial Accounting Standards No. 109 (FAS 109),
deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and
are measured using the enacted tax rates and laws that will be in
effect when the differences are expected to reverse. FAS 109 provides
for the recognition of deferred tax assets if realization of such
assets is more likely than not. Based on the weight of available
evidence, the Company has provided a valuation allowance against
certain deferred tax assets for 1999. The Company will continue to
evaluate the realizability of the deferred tax assets on a quarterly
basis.
EBITDA
For the first quarter ended April 4, 1999 EBITDA was $9.3 million as
compared to $2.5 million for the year-ago period. The increase in
EBITDA was primarily the result of improved gross profit.
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 its capital
structure or working capital needs. EBITDA as presented should not be
used as an alternative to operating income or net cash provided/(used)
for operating activities, each as measured under generally accepted
accounting principles, and may not be comparable to similarly titled
measures presented by other companies.
Liquidity and Capital Resources
<TABLE>
<CAPTION>
Three Months Ended
----------------------
April 4, April 5,
1999 1998
---------- ----------
<S> <C> <C>
Cash and cash equivalents................................ $46,540 $66,890
Working capital.......................................... $53,629 $93,791
Cash provided (used) by operating activities............. $468 ($5,926)
Cash provided (used) by investing activities............. ($4,784) $6,867
Cash used by financing activities........................ $ -- ($26,235)
</TABLE>
ZiLOG's planned capital expenditures for 1999 are approximately $10.0
million, which are primarily for test equipment, design tools and
computer system upgrades.
The Company's primary cash needs are debt service, working capital and
capital expenditures. ZiLOG made its semi-annual interest payment on
the Notes of approximately $13.4 million on March 1, 1999.
Additionally, ZiLOG has a senior secured credit facility (the "
Facility") from a commercial lender (the "Lender") that provides for
a total of up to $40 million, which includes a three-year revolving
credit facility of up to $25 million and a five-year capital
expenditure line of up to $15 million and expires on December 30, 2001
and 2003, respectively. Borrowings under the Facility bear interest at
a rate per annum equal (at ZiLOG's option) to the Lender's stated prime
rate or the London Interbank Overnight Rate ("LIBOR") plus 2% for the
revolving credit facility and the Lender's prime rate plus 1% or LIBOR
plus 3% for the capital expenditure line. There were no borrowings
under either facility as of April 4, 1999. The calculated availability
on the Facility at April 4, 1999 was $36.4 million.
Cash provided by operating activities was $0.5 million for the three
months ended April 4, 1999 as compared to cash used by operations of
$5.9 million for the similar period of 1998. This improvement was
primarily attributable to increased sales and improved gross profit in
1999, as well as changes in certain operating assets and liabilities.
The use of cash by operating activities in 1998 was incurred mainly
because of lower net sales and from recapitalization related expenses.
Cash used by investing activities was $4.8 million for the three months
ended April 4, 1999 and cash provided by investing activities was $6.9
million for the comparable 1998 period. Cash used by investing
activities in 1999 was due to capital expenditures while cash provided
by investing activities in 1998 was primarily because of the receipt of
cash from the maturity and sale of short- term investments of $14.1
million, which were partially offset by capital expenditures of $7.2
million.
No cash was used or provided by financing activities for the three
months ended April 4, 1999 and $26.2 million was used for the three
months ended April 5, 1998. The use of cash by investing activities in
1998 was primarily for cash transactions related to the Merger.
On April 20, 1999 (the "Closing Date"), ZiLOG acquired substantially
all of the assets and assumed the operating liabilities of Seattle
Silicon Corporation (the "Seattle Design Center"). Cash expenditures
anticipated from this acquisition will approximate up to $6.0 million
in 1999, of which $4.5 million was expended on the Closing Date. The
on-going operations of the Seattle Design Center are not expected to
have a material impact on the Company's cash flows during 1999.
The Company has incurred substantial indebtedness in connection with
the Merger. ZiLOG's ability to make scheduled principal payments, or
to pay the interest, or premium if any, or to refinance its
indebtedness (including the Notes), or to fund capital and other
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 available cash, cash flow from
operations and its credit facility will be adequate to meet ZiLOG's
future requirements for working capital, budgeted capital and other
expenditures and scheduled payments of principal and interest on its
indebtedness, including the Notes, for at least the next twelve months.
However, there can be no assurance that ZiLOG's business will generate
sufficient cash to enable the Company to service its indebtedness,
including the Notes, or make anticipated capital and other
expenditures.
Year 2000 Compliance
ZiLOG has an active year 2000 ("Y2K") readiness program and has, as of
April 4, 1999, made a substantial effort to reasonably evaluate its
operations to prevent any material adverse Y2K-related impact. This
program began with a survey of potential sources of Y2K exposures in
both information technology ("IT") Company resources and non-IT
resources, which could potentially affect the Company's business. This
initial source identification phase was completed by December 31, 1998.
For potential sources of Y2K risk which are external to the Company,
such as with the Company's external vendors and suppliers, the Company
typically relies upon written assurances of Y2K compliance from those
various parties in lieu of physical testing by the Company's employees.
To date, the Company has not identified any Y2K issues inherent in its
products.
The next step in the Company's Y2K remediation program is to
systematically analyze each identified potential internal IT and non-IT
Y2K exposures to determine its likelihood of material effect on the
Company's operation and the range of available remediation actions by
performing physical tests which simulated performances of the systems
with post-year 2000 dates. The Company's products, for the most part,
involve hardware ICs, which, at the time of sale to customers, have no
inherent date sensitive features. The analysis phase of the Y2K
readiness program was substantially completed by December 31, 1998 and
the Company expects to complete its internal and external Y2K readiness
programs in July 1999.
The total cost associated with required modifications to become Y2K
compliant is not expected to be material to the Company's financial
position. The amount expended through April 4, 1999 was approximately
$3.6 million, primarily associated with the total replacement of the
information systems related to the Company's sales order process,
planning, physical distribution and finance functions which are
expected to be completed in July 1999. The Company had intended to
replace such systems in the ordinary course of its business and the
implementation was not substantially accelerated due to Y2K. The
Company believes that the cost of its Y2K readiness program, as well as
currently anticipated costs to be incurred with respect to Y2K issues
of third parties, will not exceed $5 million, inclusive of the cost
described above. It is anticipated that all such expenditures will be
funded from operating cash flows and absorbed as part of the Company's
ongoing operations.
Having reasonably determined that the Company's own hardware and
software systems will be substantially Y2K compliant and that its
products inherently have no date-related issues, management believes
that the worst case scenarios would most likely involve massive,
simultaneous Y2K-related disruptions from the Company's key external
raw material suppliers and/or service providers. For these worst case
scenarios to have maximum adverse impact on the Company, the vendors in
question would either need to be sole-source providers, or their peer
companies, who would otherwise be potential second-source suppliers,
would also need to undergo similar Y2K-related disruption. Examples on
the material supplier side include extended and substantial disruptions
of the Company's key raw material suppliers of silicon wafers, piece
parts, specialty chemicals and gasses. Examples on the service
provider side would include, extended substantial disruptions of the
Company's third party semiconductor assembly firms, telecommunications
and data communications services, airfreight and delivery services, or
the worldwide banking system. The Company believes that such massive
and simultaneous disruptions of the supply of basic goods and services
as a result of Y2K-related issues are unlikely to occur. However, no
assurance can be given that unforeseen disruptions in the supply of
basic goods or services will not have a material adverse effect on the
Company.
The Company has made no contingency plans for handling Y2K issues
because it believes that the steps it has taken to assess its own
hardware and software systems and those of its key vendors and
suppliers are adequate to prevent all but minimal disruptions to its
business processes. In the third quarter of 1999, the Company plans to
conduct a review of then current advice from government agencies,
transportation suppliers and major customers to determine what actions,
if any, should be taken to mitigate loss of supply to customers through
failures in customs clearances or transportation services. In the
event of random, unforeseen Y2K problems (such as failures of specific
pieces of process equipment or the temporary inability of certain
vendors to provide materials or services), the Company believes that
these types of issues will be resolved in the normal course of
business, including the potential use of alternate suppliers.
FACTORS THAT MAY AFFECT FUTURE RESULTS
This Form 10-Q contains certain forward-looking statements within the
meaning of various provisions of the Securities Act of 1933, as amended
and the Securities Exchange Act of 1934 as amended. 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 in this Form 10-Q.
SUBSTANTIAL LEVERAGE AND ABILITY TO SERVICE INDEBTEDNESS. ZiLOG has
incurred substantial indebtedness in connection with the
Recapitalization, which became effective February 27, 1998. At April
4, 1999, ZiLOG had $280 million of consolidated long-term indebtedness
and a capital deficiency of $62.1 million.
The high degree to which the Company is leveraged may have important
consequences to the Company, including the following: (i) the
Company's ability to obtain additional financing for working capital,
capital expenditures, product development, future acquisitions (if
any), or other purposes may be impaired or any such financing may not
be available on terms favorable to the Company; (ii) a substantial
portion of the Company's cash flow available from operations after
satisfying certain liabilities arising in the ordinary course of
business will be dedicated to the payment of debt service, thereby
reducing funds that would otherwise be available to the Company; (iii)
a decrease in net operating cash flows or an increase in expenses could
make it difficult for the Company to meet its debt service requirements
or force it to modify its operations; and (iv) high leverage may place
the Company at a competitive disadvantage, limit its flexibility in
reacting to changes in its operating environment and make it vulnerable
to a downturn in its business or the economy generally.
In order to satisfy the Company's obligations under the Notes, the
Company will be required to generate substantial operating cash flow.
The ability of the Company to meet debt service and other obligations
or to refinance any such obligation will depend on the future
performance of the Company, which will be subject to prevailing
economic conditions and to financial, business and other factors,
certain of which may be beyond the control of the Company. While the
Company believes that, based on current levels of operations and its
business plan, it will be able to meet its debt service and other
obligations or to refinance its indebtedness, there can be no
assurances with respect thereto.
RECENT AND ANTICIPATED OPERATING RESULTS. The Company'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, the
Company's ability to introduce and sell new products and technologies
on a timely basis, execute on cost reduction programs, changes in
product mix or fluctuations in manufacturing yields which affect the
Company's gross profit, market acceptance of the Company'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 the Company's
customers buy from a distributor or directly from the Company. Certain
of the Company's products sustained decreases in average selling prices
and the Company sustained product mix shifts that caused its overall
average selling prices to decrease by approximately 15% in the quarter
ended April 4, 1999, when compared to the similar period of 1998, and
this trend may continue. Significant reductions in selling prices may
have a material adverse effect on the Company. The Company will likely
experience substantial period-to-period fluctuations in future
operating results due to general industry conditions including cyclical
periods of diminished product demand, product mix, 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 the Company serves. A significant decline in demand
for the Company'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.
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. 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. Similar to other semiconductor
companies, the Company has implemented and is considering implementing
additional cost-cutting measures which may include, but are not limited
to, the following: refocusing of business priorities; renegotiations
with vendors and service providers to lower the costs of materials and
services; reallocation of personnel and responsibilities to better
utilize human resources; partnering to better utilize assets;
reductions in workforce; changes of manufacturing mix; increased use of
subcontractors or foundry for greater efficiency and lower short term
costs; changes in shift structures; and temporary plant shutdowns. In
addition, the Company has realigned capital expenditures to be
consistent with its current level of business. There can be no
assurance that such cost-cutting measures will be successful in
repositioning the Company or result in increased efficiency or
profitability.
RISKS OF ACQUISITIONS. ZiLOG acquired substantially all of the assets
and assumed the operating liabilities of Seattle Silicon Corporation on
April 20, 1999 for up to approximately $6.0 million. The Company
intends to consider acquisitions from time to time of other companies
and businesses, and to pursue attractive acquisition opportunities.
However, no assurance can be given that ZiLOG will consummate any
acquisitions. Acquisitions involve a number of risks that could
adversely affect ZiLOG. ZiLOG may not have had any experience with
technologies and markets involved with the acquired business and
accordingly may not have the experience necessary to successfully
operate and integrate the business. The successful operation of an
acquired business will require communication and cooperation in product
development and marketing among senior executives and key technical
personnel. This cooperation may not occur. In addition, ZiLOG may not
be able to successfully integrate its operations with those of the
acquired businesses and acquisitions may disrupt the acquired business
and ZiLOG's existing business. There can be no assurance that ZiLOG
will retain key technical, management, sales and other personnel, or
that the Company will realize any of the other anticipated benefits of
the acquisition. Furthermore, acquisitions would require investment of
financial resources, and may require debt or equity financing.
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. The Company will
likely experience substantial period-to-period fluctuations in future
operating results that are attributable 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.
Certain of the Company'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
or industry pressure to reduce prices could adversely affect the
Company's operating results. A significant portion of the Company's
sales are to the consumer electronics markets for use in products such
as television sets, infrared remote controls and garage door openers.
The consumer electronics markets are volatile and rapid changes in
customer preferences for electronics products could have a material
adverse effect on the Company.
DEPENDENCE ON NEW PRODUCTS AND TECHNOLOGIES. The Company's operating
results will depend to a significant extent on its ability to continue
to introduce and sell 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
ZiLOG's product markets could have a material adverse effect on the
Company.
CUSTOMER CONCENTRATION. In 1998, the Company's 10 largest customers
accounted for approximately 45% of the Company's net sales, although no
single customer accounted for more than 10.5% of net sales. For the
first three months of 1999, the Company's 10 largest customers
accounted for approximately 49% of the Company's net sales, with one
distributor customer accounting for approximately 11% of net sales.
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. 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 semiconductor industry,
the Company has from time to time experienced difficulty in beginning
production at new facilities or in effecting transitions to new
manufacturing processes, delays in product deliveries or reduced
yields. As an example, operating results could be adversely affected
if any problems occur that make it difficult to produce quantities of
commercial product that the Company anticipates producing at its newer,
0.35 and 0.65 micron CMOS process facility ("MOD III") in Nampa,
Idaho. Such difficulties can include, but are not limited to (i)
equipment being delivered later than or not performing as expected;
(ii) process technology changes not operating as expected and (iii)
engineers not operating equipment as expected. The Company 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 the Company 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 MOD III
facility or to obtain wafers from outside suppliers as needed during
periods of increased demand could have a material adverse effect on the
Company.
The Company's future success is dependent upon its ability to develop
and implement new design and process technologies. Semiconductor
design and process methodologies are extremely complex and subject to
rapid technological change, requiring large expenditures for research
and development. Most new products are extremely complex in design and
many use the Company's 0.65 micron and 0.35 CMOS processes. A failure
to successfully transition eligible products to either the 0.35 micron
or 0.65 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.
The Company also uses outside contract assemblers for packaging a
portion of its production. Shortages in contract assembly capacity
could adversely impact the Company's financial results. Should the
Company be unable to obtain additional assembly capacity, the Company's
ability to achieve continued revenue growth might be restricted.
Shortage of product could also result in the loss of customers.
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 the
Company 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 the
Company 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 the Company's 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 the Company's
microprocessors, microcontrollers and digital signal processors into
their products, success of competitors' products and general economic
conditions.
INTERNATIONAL OPERATIONS. Approximately 63% of the Company's net sales
in the first three months of 1999 were to foreign customers as compared
to 53% in the similar period of 1998. The Company expects that
international sales will continue to represent a significant portion of
sales, although there can be no assurance that international sales, as a
percentage of net sales, will remain at current levels.
The Company purchases a substantial portion of its raw materials and
equipment from foreign suppliers. While the Company's export sales are
primarily United States dollar denominated transactions, the Company 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
the Company's products in foreign markets or increase the cost of
wafers purchased by the Company, 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, the Company 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. There can be no assurance that
such regulatory, geopolitical, economic and other factors will not
adversely impact the Company in the future or require ZiLOG to modify
its current business practices. In addition, the laws of certain
foreign countries may not protect the Company's intellectual property
rights to the same extent as do the laws of the United States.
The Company operates a test facility in the Philippines through two
wholly owned subsidiaries. ZiLOG has a significant capital investment
at this facility. The Company's reliance on personnel and assets and
its maintenance of inventories at this facility 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.
The Company 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.
INTELLECUTAL PROPERTY RIGHTS. The Company's ability to compete will be
affected by its ability to protect its proprietary information. The
Company 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 the Company to protect its intellectual property will be
adequate to prevent misappropriation of its technology or that the
Company's competitors will not independently develop technologies that
are substantially equivalent or superior to the Company'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 the Company, its
foundries or its customers with respect to existing or future products.
In addition, the Company may initiate claims or litigation against
third parties for infringement of the Company's proprietary rights or
to determine the scope and validity of the proprietary rights of the
Company or others. Litigation by or against the Company could result
in significant expense to the Company and divert the efforts of the
Company's technical and management personnel, whether or not litigation
is determined in favor of the Company. In the event of an adverse
result in any such litigation, the Company 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 the Company
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 the Company of substantial time and other resources.
Any such litigation or adverse result therefrom could have an adverse
effect on the Company.
ENVIRONMENTAL REGULATION. The Company is subject to a variety of
government regulations related to the discharge or disposal of
hazardous materials used in its manufacturing process. Although the
Company 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 the Company, limitation
or suspension of production or cessation of operations. Compliance
with any such future regulations could require the Company to acquire
additional equipment or to incur substantial other expenses. Any
failure by the Company to control the use of, or adequately restrict
the discharge of, hazardous materials could subject it to future
liabilities. Further there can be no assurance that the Company will
not in the future incur significant expense in connection with
governmental investigations and/or environmental or employee health and
safety matters.
RESTRICTIVE DEBT COVENANTS. The terms of the Notes and the Facility
contain a number of significant covenants that, among other things,
restrict the ability of the Company to dispose of assets, incur
additional indebtedness, prepay other indebtedness or amend certain
debt instruments, pay dividends, create liens on assets, enter into
sale and leaseback transactions, make investments, loans or advances,
make acquisitions, engage in mergers or consolidations, change the
business conducted by the Company or its subsidiaries, make capital
expenditures or engage in certain transactions with affiliates and
otherwise restrict certain corporate activities.
The Company's ability to comply with such agreements may be affected by
events beyond its control, including prevailing economic, financial and
industry conditions. The breach of any of such covenants or
restrictions could result in a default, which would permit the holders
of the Notes or the Lender on the Facility, to declare all amounts
borrowed thereunder to be due and payable, together with accrued and
unpaid interest.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company has been named as a defendant in a purported class
action lawsuit that was filed on January 23, 1998 in the U.S.
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. On
March 24, 1999, the district court granted ZiLOG's motion to dismiss
and entered judgment in favor of all defendants. On April 16, 1999,
the plaintiffs filed their notice of appeal to the Ninth Circuit
Court of Appeals.
One party has notified ZiLOG that it may be infringing certain
patents and other intellectual property rights. In the event ZiLOG
determines that such notice 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.
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.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
a) The following exhibits are filed herewith:
Exhibit 27 Financial Data Schedule
b) Reports on Form 8-K:
None.
<PAGE>
ZILOG, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
Date: May 18, 1999
ZiLOG, INC.
/s/ James M. Thorburn
------------------------------
James M. Thorburn
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer
and Duly Authorized Officer)
<PAGE>
ZILOG, INC.
Article 5 of Regulation S-X
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CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
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<CGS> 38,410
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<INTEREST-EXPENSE> (7,229)
<INCOME-PRETAX> (12,674)
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