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 July 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 August 2, 1999, there were 30,198,736 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 Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales............................. $61,039 $48,568 $115,248 $98,107
--------- --------- ---------- ----------
Costs and expenses:
Cost of sales....................... 41,794 40,874 80,204 81,641
Research and development............ 8,258 6,916 15,521 15,020
Selling, general and administrative. 14,598 12,911 29,104 26,852
Special charges .................... 4,686 12,383 4,686 25,687
--------- --------- ---------- ----------
69,336 73,084 129,515 149,200
--------- --------- ---------- ----------
Operating loss........................ (8,297) (24,516) (14,267) (51,093)
Other income (expense):
Interest income..................... 565 761 1,175 1,920
Interest expense.................... (7,216) (7,052) (14,445) (10,030)
Other, net.......................... (143) (163) (228) (251)
--------- --------- ---------- ----------
Loss before income taxes..... (15,091) (30,970) (27,765) (59,454)
Provision (benefit) for income taxes.. 250 (2,157) 500 (10,702)
--------- --------- ---------- ----------
Net loss.............................. (15,341) (28,813) (28,265) (48,752)
Other comprehensive loss,
net of tax......................... -- -- -- (93)
--------- --------- ---------- ----------
Comprehensive loss.................... ($15,341) ($28,813) ($28,265) ($48,845)
========= ========= ========== ==========
</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>
July 4, December 31,
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $54,689 $50,856
Accounts receivable, less allowance for doubtful
accounts of $323 in 1999 and $366 in 1998.......... 26,438 25,151
Inventories........................................... 27,812 22,232
Prepaid expenses and other current assets ............ 9,455 7,521
----------- -----------
Total current assets.......................... 118,394 105,760
----------- -----------
Property, plant and equipment, at cost.................. 415,839 424,401
Less: accumulated depreciation and amortization......... (263,155) (242,653)
----------- -----------
Net property, plant and equipment.................... 152,684 181,748
Other assets............................................ 13,866 9,563
----------- -----------
$284,944 $297,071
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable...................................... $22,461 $16,381
Accrued compensation and employee benefits............ 24,573 24,595
Other accrued liabilities............................. 20,762 17,977
----------- -----------
Total current liabilities..................... 67,796 58,953
Notes Payable........................................... 280,000 280,000
Other non-current liabilities .......................... 15,561 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 July 4, 1999 and December 31, 1998; aggregate
liquidation preference $29,002 ...................... 25,000 25,000
Common Stock, $0.01 par value; 70,000,000 shares
authorized; 30,198,736 shares issued and outstanding
at July 4, 1999 and 30,098,736 shares at 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 July 4, 1999 and December
31, 1998 ............................................ 402 401
Additional paid-in capital............................. 798 799
Accumulated deficit.................................... (104,613) (74,431)
----------- -----------
Total stockholders'deficiency ................ (78,413) (48,231)
----------- -----------
$284,944 $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>
Six Months Ended
----------------------
July 4, July 5,
1999 1998
---------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss .............................................. ($28,265) ($48,752)
Adjustments to reconcile net loss to cash
provided (used) by operating activities:
Depreciation and amortization....................... 31,228 32,125
Write-down of assets held for disposal.............. 3,677 --
Write-off of in-process research and development ... 1,009 --
Changes in certain assets and liabilities:
Accounts receivable................................. (1,287) 3,420
Inventories......................................... (5,580) 1,778
Prepaid expenses and other assets .................. (393) (1,783)
Accounts payable.................................... 6,080 (4,304)
Accrued compensation and employee benefits.......... (22) 11,062
Other accrued and non-current liabilities .......... 10,080 (2,315)
---------- -----------
Cash provided (used) by operating activities.. 16,527 (8,769)
---------- -----------
Cash flows from investing activities:
Capital expenditures................................... (6,763) (13,912)
Acquisition of Seattle Silicon, net of cash acquired .. (5,931) --
Proceeds from sales of short-term investments ......... -- 14,127
---------- -----------
Cash provided (used) by investing activities... (12,694) 215
---------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock................. -- 208
Purchase of outstanding shares......................... -- (399,475)
Merger costs charged to retained earnings.............. -- (17,421)
Net proceeds from issuance of notes payable ........... -- 270,204
Investment by Texas Pacific Group...................... -- 117,500
---------- -----------
Cash used by financing activities............. -- (28,984)
---------- -----------
Increase (decrease) in cash and cash equivalents......... 3,833 (37,538)
Cash and cash equivalents at beginning of period......... 50,856 92,184
---------- -----------
Cash and cash equivalents at end of period............... $54,689 $54,646
========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
ZILOG, INC.
NOTES TO CONDENSED 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, but does not include all of the information and
footnotes required by generally accepted accounting principles for
complete financial statements.
Pursuant to the Agreement and Plan of Merger by and among TPG Partners
II, L.P. ("TPG"), 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 continues as the surviving
corporation (the "Merger"). The Merger was accounted for as a
recapitalization (the "Recapitalization") which resulted in TPG
Partners, II, L.P. owning approximately 90 percent of the voting shares
and the pre-Merger shareholders owning approximately 10 percent of the
voting shares.
2) INVENTORIES
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
July 4, December 31,
1999 1998
---------- -----------
<S> <C> <C>
Raw materials.............. $763 $2,439
Work-in-process............. 22,279 17,844
Finished goods.............. 4,770 1,949
---------- -----------
$27,812 $22,232
========== ===========
</TABLE>
3) ACQUISITION
On April 20, 1999, ZiLOG acquired substantially all of the assets and
assumed the operating liabilities of Seattle Silicon Corporation
("Seattle Silicon") a fabless semiconductor company based in Bellevue,
Washington that offers a customized design capability for analog devices
and mixed signal system-on-a-chip (SOC) technology. The purchase price
of approximately $6.1 million, including acquisition costs of
approximately $0.4 million, was allocated based on fair values as
follows: tangible net assets of $0.1 million; goodwill of $5.0 million
(three-year amortization period); and in-process research and
development of $1.0 million. For financial statement purposes, this
acquisition was accounted for as a purchase, and accordingly, the
results of operations of Seattle Silicon subsequent to April 20, 1999,
are included in the Company's condensed consolidated statements of
operations.
In-process research and development was expensed in the current period
because the projects related to the acquired research and development
(partially developed semiconductor product designs), had not reached
technological feasibility and have no alternative future use. The nature
of efforts required to develop the purchased in-process technology into
commercially viable products primarily relates to completion of design,
prototyping and testing to ensure the products can be produced to meet
customer design specifications, including functions, features and
performance requirements. However, there can be no assurance that these
products will ever achieve commercial viability.
Factors considered in valuing in-process research and development,
included the stage of development of each project, target markets and
associated risks of achieving technological feasibility and market
acceptance of the products. The value of the purchased in-process
technology was determined by estimating the projected net cash flows
relating to such products, including costs to complete the technology
and product development and the future expected income upon
commercialization of the products over periods ranging from one to four
years. These cash flows were then discounted to their net present value
using a discount rate of 25 percent.
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 market. 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 market.
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.
The Company manages its operations on the enterprise level and
accordingly, it does not have any reportable operating segments.
Segment financial data: Net sales to external customers for the three
month and six month periods ended July 4, 1999 and July 5, 1998 for each
of the Company's business units are presented as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
---------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Communications ................... $22,536 $15,789 $43,841 $33,541
Integrated Controls............... 23,524 19,700 44,880 39,650
Home Entertainment................ 14,979 13,079 26,527 24,916
---------- ----------- ---------- ----------
Net sales $61,039 $48,568 $115,248 $98,107
========== =========== ========== ==========
</TABLE>
Major customers: During the three month and six month periods ended
July 4, 1999 one distributor accounted for approximately 13% and 12% of
net sales, respectively. During the three month and six month periods
ended July 5, 1998 the same distributor accounted for approximately 10%
and 11% of net sales, respectively.
5) SPECIAL CHARGES
During the second quarter of 1999 ZiLOG incurred Special Charges of $4.7
million. Approximately $1.0 million was purchased in-process research
and development expense in the second quarter of 1999 relating to
several partially developed semiconductor product designs that were
acquired through the acquisition of Seattle Silicon Corporation in April
1999. (See Note 3) In addition, ZiLOG recognized a $3.7 million charge
for underutilized test equipment, which is being held for sale. Also,
as a result of the Merger and Recapitalization in February 1998, special
charges were incurred, which consisted of expenses directly related to
the change in control and repositioning of the Company. Special Charges
for the three and six month periods ended July 4, 1999 and July 5, 1998
are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
---------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Write-down of assets held for
disposal ..................... $3,677 $ -- $3,677 $ --
In-process research and
development .................. 1,009 -- 1,009 --
Merger and Recapitalization:
Executive severance pay and
new executive bonuses......... -- 7,452 -- 9,813
Stock option buyout............. -- -- -- 4,195
Bridge loan fees................ -- -- -- 3,360
Employee retention bonus........ -- 4,000 -- 7,333
Consultants, other.............. -- 931 -- 986
---------- ----------- ---------- ----------
$4,686 $12,383 $4,686 $25,687
========== =========== ========== ==========
</TABLE>
6) 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.
The Company is a party to an insurance coverage lawsuit in the Superior
Court of the State of California in and for Santa Clara County filed on
July 29, 1996, in which its former insurers, Pacific Indemnity Company,
Federal Insurance Company and Chubb & Son, Inc., claim that insurance
coverage did not exist for allegations made in an underlying lawsuit
brought by employees of the Company and their families who claimed that
they suffered personal injuries and discrimination because of alleged
exposure to chemicals at Zilog's manufacturing plant in Nampa, Idaho in
1993 and 1994. The insurers seek a declaration that insurance coverage
under the applicable policies did not exist, and they seek reimbursement
of attorneys' fees, costs and settlement funds expended on the Company's
behalf. A total of approximately six million, three hundred thousand
dollars plus interest is sought by the insurers. Both the insurers and
the Company have each brought separate motions for summary judgment or,
in the alternative, motions for summary adjudication. All such motions
were denied by the Superior Court, and the Court of Appeals denied each
party's respective petition for review of each denial of their summary
judgment motions. The Company is petitioning the California Supreme
Court for review of the denial of its motion for summary judgment. No
trial date has been set.
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>
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 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. Sales comparisons are 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 Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales............................. $61,039 $48,568 $115,248 $98,107
Operating loss........................ ($8,297) ($24,516) ($14,267) ($51,093)
Net loss.............................. ($15,341) ($28,813) ($28,265) ($48,752)
EBITDA ............................... $12,043 $3,466 $21,354 $5,980
</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
compensation expenses and 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>
Three Months Ended Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Communications ....................... $22,536 $15,789 $43,841 $33,541
Integrated Controls .................. 23,524 19,700 44,880 39,650
Home Entertainment ................... 14,979 13,079 26,527 24,916
--------- --------- ---------- ----------
Total ................................ $61,039 $48,568 $115,248 $98,107
========= ========= ========== ==========
</TABLE>
Overall, net sales for the second quarter of 1999 increased 25.7% from
the comparable period of 1998, and increased 17.5% for the first half of
1999, compared to the similar period of 1998. The increase in current
year net sales was primarily attributable to higher unit shipments for
communications products as a result of improving market conditions.
During the three and six month periods ended July 4, 1999, the Company's
communications business unit experienced sales growth of 42.7% and
30.7%, rspectively, compared to the same periods in 1998. The growth in
sales of communications products relates primarily to higher unit
shipments and selling prices of embedded control and serial
communications products as a result of improving market conditions.
During the current quarter, the Company's integrated controls business
unit experienced a 19.4% increase in net sales over second quarter 1998
as a result of higher unit shipments, particularly of one-time-
programmable microcontrollers ("OTP"). The improvement in integrated
controls net sales during the first half of 1999 is also attributable
primarily to higher
OTP shipments in the second quarter. Net sales in the home
entertainment business unit improved slightly in the three and six month
periods ended July 4, 1999 as compared to the year ago period, as a
result of higher unit shipments of TV products, offset partially by
price declines in the television and remote control business lines.
Domestic and international sales (sales attributable to the ship-to
locations of ZiLOG's customers) in the second quarter of 1999 were
45.8% and 54.2%, respectively, compared to 51.1% and 48.9%,
respectively, in the second quarter of 1998. International sales
represented 55.0% of the Company's net sales for the first six months of
1999, compared to 50.3% in the similar period of 1998. The increase in
international sales as a percentage of total sales in 1999 was due to
higher unit shipments in all business units in both the Asia and
European regions.
Cost of Sales
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Cost of sales....................... $41,794 $40,874 $80,204 $81,641
Gross profit ....................... $19,245 $7,694 $35,044 $16,466
Gross profit percentage............. 31.5% 15.8% 30.4% 16.8%
</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 periods in
1998, the improvement in gross profit margin for both the second quarter
and the first half of 1999 was primarily attributable to higher net
sales, ZiLOG's cost reduction programs and increased factory
utilization, particularly in the Company's 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, coupled with higher
production levels, contributed to increased gross profit in 1999 for all
periods presented.
Based on recent qualification of a .35 micron manufacturing process in
ZiLOG's eight inch wafer fab and the Company's current product roadmap,
ZiLOG expects that certain machinery and equipment will have extended
useful lives. Accordingly, the Company expects to change the remaining
depreciable lives of these assets and expects depreciation charges to
decline, impacting both gross profit and inventory valuation in future
periods.
Research and Development
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Research and development............ $8,258 $6,916 $15,521 $15,020
Percentage of sales................. 13.5% 14.2% 13.5% 15.3%
</TABLE>
When compared to the similar period of 1998, research and development
expenditures increased $1.3 million in the second quarter of 1999,
primarily due to higher spending in the Company's new and existing
design centers in Seattle, Washington and Austin, Texas. When compared
to the similar period of 1998, research and development spending
increased slightly in the first half of 1999, as increases in design
center spending were largely offset by decreased spending on .35 micron
CMOS wafer fabrication process development which was qualified for
commercial production in the fourth quarter of 1998. ZiLOG has focused
its research and development efforts largely on new and enhanced product
development and new customer development tools in the first half of
1999.
Selling, General and Administrative
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Selling, general and administrative. $14,598 $12,911 $29,104 $26,852
Percentage of sales................. 23.9% 26.6% 25.3% 27.4%
</TABLE>
Selling, general and administrative expenses increased in dollars in
both the second quarter and first half of 1999, compared to the 1998
similar periods, primarily due to higher payroll costs including
commissions and marketing expenses in connection with increased sales
levels. During the first half of 1999, ZiLOG also recognized
approximately $0.5 million of selling, general and administrative
expense 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 both the second quarter and first half of 1999 when compared
to the similar periods of 1998, primarily as a result of higher sales.
Special Charges
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Special charges .................... $4,686 $12,383 $4,686 $25,687
Percentage of sales................. 7.7% 25.5% 4.1% 26.2%
</TABLE>
ZiLOG recognized Special Charges of $4.7 million in the second quarter
and first half of 1999, consisting of $3.7 million for write-downs of
equipment held for sale and $1.0 million of purchased in-process
research projects in connection with the acquisition of assets from
Seattle Silicon. The $3.7 million of equipment charge relates to
semiconductor test equipment that is being held for sale. The Company
expects manufacturing depreciation expense to decrease by approximately
$0.6 million per quarter for the remainder of 1999 as a result of
decommissioning this test equipment.
The $1.0 million of purchased in-process research and development
expense recognized in the second quarter of 1999 relates to several
partially developed semiconductor product designs that were acquired
from Seattle Silicon in April 1999. The nature of efforts required to
develop the purchased in-process technology into commercially viable
products primarily relates to completion of design, prototyping and
testing to ensure the products can be produced to meet device design
specifications, including functions, features and performance
requirements, but there can be no assurance that these products will
achieve commercial viability. The value of the purchased in-process
technology was determined by estimating the projected net cash flows
relating to such products, including costs to complete the technology
and product development and the future revenues and expenses upon
commercialization of the products over periods ranging from one to four
years. These cash flows were then discounted to their net present value
using a rate of 25 percent.
The Company was recapitalized in February 1998, and in connection with
the Recapitalization incurred special charges. The special charges
recognized in the three and six month periods of 1998 represent
recapitalization-related expenses. See Note 5 to the Condensed
Consolidated Financial Statements.
Other Income/(Expense), Net
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- ---------------------
July 4, July 5, July 4, July 5,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Other income (expense), net......... ($6,794) ($6,454) ($13,498) ($8,361)
Percentage of sales................. -11.1% -13.3% -11.7% -8.5%
</TABLE>
Other expenses, net of interest income, increased to $6.8 million in the
second quarter of 1999 from $6.5 million for the similar period in 1998
due to lower interest income relating to lower cash and investments in
the current year period. For the first half of 1999, other expenses,
net were $13.5 million, compared to $8.4 million in the same period of
1998. This increase relates to higher 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
Provisions for income taxes were $0.25 million and $0.5 million for the
three and six month periods ended July 4, 1999, respectively, compared
to benefit provisions of $2.2 million and $10.7 million for the similar
periods of 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 second quarter ended July 4, 1999 EBITDA was $12.0 million as
compared to $3.5 million for the corresponding period in 1998. For the
six month periods ended July 4, 1999 and July 5, 1998, EBITDA was $21.4
million and $6.0 million, respectively. The increase in EBITDA for both
the three and six month periods ended July 4, 1999 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>
July 4, December 31,
1999 1998
---------- -----------
<S> <C> <C>
Cash and cash equivalents ............................... $54,689 $50,856
Working capital.......................................... $50,598 $46,807
</TABLE>
ZiLOG's planned capital expenditures for 1999 are approximately $12.0
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's semi-annual interest payment on the Notes
of approximately $13.3 million are payable each March 1 and September 1.
Additionally, ZiLOG has a senior secured credit facility (the
"Facility") from a commercial lender (the "Lender") that provides
for total borrowings of up to $40 million, which consist of 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 July 4, 1999. The calculated availability
on the Facility at July 4, 1999 was $37.7 million. The Facility has
certain financial covenants that apply depending on the level of
borrowings under the Facility.
Cash provided by operating activities was $16.5 million for the six
months ended July 4, 1999 as compared to cash used by operations of $8.8
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 mainly because of lower net
sales and from recapitalization related expenses.
Cash used by investing activities was $12.7 million for the six months
ended July 4, 1999 and cash provided by investing activities was
$215,000 for the comparable 1998 period. Cash used by investing
activities in 1999 was for capital expenditures and the acquisition of
the net assets of Seattle Silicon, 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 largely offset by capital expenditures of $13.9 million.
No cash was used or provided by financing activities for the three
months ended July 4, 1999 and $29.0 million was used for the six months
ended July 5, 1998. The use of cash by investing activities in 1998 was
primarily for cash transactions related to the recapitalization of the
Company.
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
for this acquisition will approximate $6.0 million in 1999. 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
recapitalization of the Company. 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
July 5, 1999, completed the remediation phase of the Y2K program. 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.
On July 5, 1999 the Company implemented the last significant changes to
its internal applications and embedded systems. The company continues to
monitor new fixes released by vendors and any reported problems to
ensure that any newly discovered problems are resolved. This monitoring
will continue until the beginning of 2000.
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 July 4, 1999 was approximately
$4.0 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 will be
substantially completed in August 1999. While ZiLOG believes that these
information systems were installed properly, there can be no assurance
that unforeseen circumstances concerning the installation or operation
of these systems will not have a material adverse effect on the Company.
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 amounts already expended. 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 of the Company, which became effective February 27,
1998. At July 4, 1999, ZiLOG had $280 million of consolidated long-term
indebtedness and a capital deficiency of $78.4 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 slightly in the first half of
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.
Beginning in early July 1999, the Company is implementing a new
Enterprise Resource Planning ("ERP") system that is intended to
improve order entry, supply chain management and financial reporting.
While ZiLOG believes that the ERP system can be properly installed
without material adverse effect on the Company, there can be no
assurance that unforeseen circumstances concerning activation of the ERP
system will not have a material adverse effect on the Company.
RISKS OF ACQUISITIONS. ZiLOG acquired substantially all of the assets
and assumed the operating liabilities of Seattle Silicon Corporation on
April 20, 1999 for approximately $6.1 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
further 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. For the year ended December 31, 1998, the
Company's 10 largest customers accounted for approximately 46% of the
Company's net sales, although no single customer accounted for more than
10.5% of net sales. For the first half of 1999, the Company's 10
largest customers accounted for approximately 47% of the Company's net
sales, with one distributor customer accounting for approximately 12% 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 55% of the Company's net sales
in the first six months of 1999 were to foreign customers as compared to
50% 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.
INTELLECTUAL 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.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The Company's exposure to market risk for changes in interest rates
relates primarily to the Company's investment portfolio and long-term
debt obligations. The Company does not use derivative financial
investments in its investment portfolio. The Company's primary
investment objectives are to preserve capital and maintain liquidity.
These objectives are met by investing in high quality credit issuances
and limiting the amount of credit exposure to any one company. The
Company mitigates default risk by investing in only the highest quality
securities and monitoring the credit ratings of such investments. The
Company has no cash flow exposure due to rate changes for its cash
equivalents or the Notes as these instruments have fixed interest rates.
The Notes were issued to finance the Merger.
The table below presents principal amounts and related average interest
rates by year of maturity for the Company's cash equivalents and debt
obligations (in thousands):
<TABLE>
<CAPTION>
1999 2005 Total Fair Value
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Cash Equivalents:
Fixed rate $47,600 $ -- $47,600 $47,600
Average rate 4.50% -- 4.50% --
Long-Term Debt:
Fixed rate -- $280,000 $280,000 $243,600
Average rate -- 9.50% 9.50% --
</TABLE>
<PAGE>
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.
The Company is a party to an insurance coverage lawsuit in the Superior
Court of the State of California in and for Santa Clara County filed on
July 29, 1996, in which its former insurers, Pacific Indemnity Company,
Federal Insurance Company and Chubb & Son, Inc., claim that insurance
coverage did not exist for allegations made in an underlying lawsuit
brought by employees of the Company and their families who claimed that
they suffered personal injuries and discrimination because of alleged
exposure to chemicals at Zilog's manufacturing plant in Nampa, Idaho in
1993 and 1994. The insurers seek a declaration that insurance coverage
under the applicable policies did not exist, and they seek reimbursement
of attorneys' fees, costs and settlement funds expended on the Company's
behalf. A total of approximately six million, three hundred thousand
dollars plus interest is sought by the insurers. Both the insurers and
the Company have each brought separate motions for summary judgment or,
in the alternative, motions for summary adjudication. All such motions
were denied by the Superior Court, and the Court of Appeals denied each
party's respective petition for review of each denial of their summary
judgment motions. The Company is petitioning the California Supreme
Court for review of the denial of its motion for summary judgment. No
trial date has been set.
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.
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: August 17, 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>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM CONDENSED CONSOLIDATED BALANCE SHEETS, CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUL-04-1999
<CASH> 54,689
<SECURITIES> 0
<RECEIVABLES> 26,761
<ALLOWANCES> 323
<INVENTORY> 27,812
<CURRENT-ASSETS> 118,394
<PP&E> 415,839
<DEPRECIATION> 263,155
<TOTAL-ASSETS> 284,944
<CURRENT-LIABILITIES> 67,796
<BONDS> 280,000
0
25,000
<COMMON> 402
<OTHER-SE> (103,815)
<TOTAL-LIABILITY-AND-EQUITY> 284,944
<SALES> 115,248
<TOTAL-REVENUES> 115,248
<CGS> 80,204
<TOTAL-COSTS> 80,204
<OTHER-EXPENSES> 15,521
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 14,445
<INCOME-PRETAX> (27,765)
<INCOME-TAX> 500
<INCOME-CONTINUING> (28,265)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (28,265)
<EPS-BASIC> 0.00
<EPS-DILUTED> 0.00
</TABLE>
