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 October 3, 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 November 1, 1999, there were 30,415,786 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 Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales............................. $64,528 $52,530 $179,776 $150,637
--------- --------- ---------- ----------
Costs and expenses:
Cost of sales....................... 39,488 42,070 119,692 123,711
Research and development............ 8,476 7,135 23,997 22,155
Selling, general and administrative. 14,786 13,656 43,890 40,508
Special charges .................... -- 7,128 4,686 32,815
--------- --------- ---------- ----------
62,750 69,989 192,265 219,189
--------- --------- ---------- ----------
Operating income (loss)............... 1,778 (17,459) (12,489) (68,552)
Other income (expense):
Interest income..................... 638 733 1,813 2,653
Interest expense.................... (7,282) (7,293) (21,727) (17,323)
Other, net.......................... 180 51 (48) (200)
--------- --------- ---------- ----------
Loss before income taxes..... (4,686) (23,968) (32,451) (83,422)
Provision (benefit) for income taxes.. 250 (2,314) 750 (13,016)
--------- --------- ---------- ----------
Net loss.............................. (4,936) (21,654) (33,201) (70,406)
Other comprehensive loss,
net of tax......................... -- -- -- (93)
--------- --------- ---------- ----------
Comprehensive loss.................... ($4,936) ($21,654) ($33,201) ($70,499)
========= ========= ========== ==========
</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>
October 3, December 31,
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $47,598 $50,856
Accounts receivable, less allowance for doubtful
accounts of $323 in 1999 and $366 in 1998.......... 32,596 25,151
Inventories........................................... 28,751 22,232
Prepaid expenses and other current assets ............ 9,891 7,521
----------- -----------
Total current assets.......................... 118,836 105,760
----------- -----------
Property, plant and equipment, at cost.................. 417,858 424,401
Less: accumulated depreciation and amortization......... (272,829) (242,653)
----------- -----------
Net property, plant and equipment.................... 145,029 181,748
Other assets............................................ 13,651 9,563
----------- -----------
$277,516 $297,071
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable...................................... $23,210 $16,381
Accrued compensation and employee benefits............ 28,448 24,595
Other accrued liabilities............................. 14,959 17,977
----------- -----------
Total current liabilities..................... 66,617 58,953
Notes Payable........................................... 280,000 280,000
Other noncurrent liabilities ........................... 15,217 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 October 3, 1999 and December 31, 1998; aggregate
liquidation preference $30,009 ...................... 25,000 25,000
Common Stock, $0.01 par value; 70,000,000 shares
authorized; 30,414,161 shares issued and outstanding
at October 3, 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 October 3, 1999 and December
31, 1998 ............................................ 404 401
Additional paid-in capital............................. 834 799
Accumulated deficit.................................... (110,556) (74,431)
----------- -----------
Total stockholders'deficiency ................ (84,318) (48,231)
----------- -----------
$277,516 $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>
Nine Months Ended
----------------------
October 3, October 4,
1999 1998
---------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss .............................................. ($33,201) ($70,406)
Adjustments to reconcile net loss to cash
provided (used) by operating activities:
Depreciation and amortization....................... 41,855 47,996
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................................. (7,445) 7,418
Inventories......................................... (6,519) 6,699
Prepaid expenses and other assets .................. (1,115) 484
Accounts payable.................................... 6,829 (6,521)
Accrued compensation and employee benefits.......... 3,853 4,393
Other accrued and noncurrent liabilities .......... 2,926 (9,155)
---------- -----------
Cash provided (used) by operating activities.. 11,869 (19,092)
---------- -----------
Cash flows from investing activities:
Capital expenditures................................... (9,234) (18,635)
Acquisition of Seattle Silicon, net of cash acquired .. (5,931) --
Proceeds from sales of short-term investments ......... -- 14,127
---------- -----------
Cash used by investing activities............. (15,165) (4,508)
---------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock................. 38 208
Purchase of outstanding shares......................... -- (399,475)
Merger costs charged to retained earnings.............. -- (17,401)
Net proceeds from issuance of notes payable ........... -- 270,198
Investment by Texas Pacific Group...................... -- 117,500
---------- -----------
Cash provided (used) by financing activities.. 38 (28,970)
---------- -----------
Decrease in cash and cash equivalents.................... (3,258) (52,570)
Cash and cash equivalents at beginning of period......... 50,856 92,184
---------- -----------
Cash and cash equivalents at end of period............... $47,598 $39,614
========== ===========
</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 of normal recurring adjustments and the change
in depreciable lives of certain assets described below), 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 condensed consolidated 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.
Effective July 5, 1999, the Company changed the estimated useful lives
of certain machinery and equipment located in its eight-inch wafer fab
in Nampa, Idaho from five to seven years. This change in accounting
estimate resulted in a $4.6 million reduction of depreciation expense in
the third quarter of 1999, as compared to depreciation expense, which
would have been recorded under the previous useful life estimates. The
decision to change the estimated service period for these assets was
based on the Company's recent qualification of a new .35 micron wafer
manufacturing process in its eight-inch wafer fab and the transfer of
many of ZiLOG's products into volume production in this facility.
Accordingly, the Company believes that extending the service period on
these assets is consistent with its current production plans.
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.
As described in Note 9, Stockholders' Equity, to the Consolidated
Financial Statements of the Company's 1998 Annual Report on Form 10-K,
ZiLOG's Series A Cumulative Preferred Stock (Series A Stock) accumulates
dividends at a rate of 13.5% per annum, with dividends payable quarterly
at the election of the Board of Directors. Unpaid dividends are
recognized as a charge to accumulated deficit and as an increase in the
liquidation preference of the Series A Stock. As of October 3, 1999,
the Company has not paid any dividends on the Series A Stock and the
corresponding accrued dividends are $5.9 million. During the nine month
period ended October 3, 1999, $2.9 million of dividends on Series A
Stock were accrued and charged to accumulated deficit.
2) 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; in-process research and
development of $1.0 million; and intangible assets of $5.0 million
(three-year amortization period). 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 April 1999 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.
3) INVENTORIES
The components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
October 3, December 31,
1999 1998
---------- -----------
<S> <C> <C>
Raw materials.............. $912 $2,439
Work-in-process............. 21,186 17,844
Finished goods.............. 6,653 1,949
---------- -----------
$28,751 $22,232
========== ===========
</TABLE>
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 nine month periods ended October 3, 1999 and October 4, 1998
for each of the Company's business units are presented as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------- ---------------------
October 3, October 4, October 3, October 4
1999 1998 1999 1998
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Communications ................... $20,968 $17,429 $64,809 $50,970
Integrated Controls............... 26,777 22,270 71,657 61,920
Home Entertainment................ 16,783 12,831 43,310 37,747
---------- ----------- ---------- ----------
Net sales $64,528 $52,530 $179,776 $150,637
========== =========== ========== ==========
</TABLE>
Major customers: During the three and nine month periods ended October
3, 1999, one distributor accounted for approximately 13.2% and 12.3% of
net sales, respectively. During the three and nine month periods ended
October 4, 1998 the same distributor accounted for approximately 9.9%
and 10.5% 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 related to several partially developed
semiconductor product designs that were acquired through the acquisition
of Seattle Silicon Corporation in April 1999 (see Note 2).
ZiLOG also recognized a $3.7 million charge for under-utilized test
equipment during the second quarter of 1999, 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 nine month periods ended
October 3, 1999 and October 4, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
---------------------- ---------------------
October 3, October 4, October 3, October 4
1999 1998 1999 1998
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Write-down of assets held for
disposal ..................... $ -- $ -- $3,677 $ --
In-process research and
development .................. -- -- 1,009 --
Employee severance and termination
benefits ..................... -- 1,641 -- 1,641
Recapitalization:
Executive severance pay and new
executive bonuses......... -- 2,236 -- 12,049
Stock option buyout............. -- -- -- 4,195
Bridge loan fees................ -- -- -- 3,360
Employee retention bonus........ -- 2,178 -- 9,511
Consultants, other.............. -- 1,073 -- 2,059
---------- ----------- ---------- ----------
$ -- $7,128 $4,686 $32,815
========== =========== ========== ==========
</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 petitioned the California Supreme Court
for review of the denial of its motion for summary judgment. The
California Supreme Court denied the Company's petition for review
without making a decision on the merits of the dispute. 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, customer design wins and losses, 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
its 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 Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales............................. $64,528 $52,530 $179,776 $150,637
Operating income (loss)............... $1,778 ($17,459) ($12,489) ($68,552)
Net loss.............................. ($4,936) ($21,654) ($33,201) ($70,406)
EBITDA ............................... $12,585 $5,268 $33,939 $11,248
</TABLE>
EBITDA represents earnings (losses) from operations before interest
income and expense (including amortization of deferred financing costs),
income taxes, depreciation, amortization of intangible assets, 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, which are measured under generally accepted
accounting principles, and EBITDA may not be comparable to similarly
titled measures presented by other companies.
Net Sales
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Communications ....................... $20,968 $17,429 $64,809 $50,970
Integrated Controls .................. 26,777 22,270 71,657 61,920
Home Entertainment ................... 16,783 12,831 43,310 37,747
--------- --------- ---------- ----------
Total ................................ $64,528 $52,530 $179,776 $150,637
========= ========= ========== ==========
</TABLE>
Overall, net sales for the third quarter of 1999 increased 22.8% from
the comparable period of 1998, and increased 19.3% for the first nine
months of 1999, compared to the similar period of 1998. The increase in
current year net sales was primarily attributable to higher unit
shipments for all of the Company's business units as a result of
improving market conditions.
During the three and nine month periods ended October 3, 1999, the
Company's communications business unit experienced sales growth of 20.3%
and 27.2%, respectively, compared to the same periods in 1998. The
growth in sales of communications products relates primarily to higher
unit shipments of embedded control, serial communications and modem
products as a result of improving market conditions. For the three and
nine months ended October 3, 1999, the Company's integrated controls
business unit experienced an increase in net sales of 20.2% and 15.7%,
respectively, over the comparable periods of 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 nine months
of 1999 is also attributable to higher OTP shipments in the third quarter.
The Company has learned that its products are being designed out of mouse-type
pointing device applications at certain of its customers. As a result,
the bookings rate for peripheral products decreased substantially in the
third quarter of 1999 to approximately $4.5 million from a prior run
rate of approximately $8.0 to $9.0 million per quarter. This bookings
trend is expected to result in lower sales in peripheral products in the
fourth quarter of 1999 and in the foreseeable future. The foregoing is
a forward-looking statement. Results could differ materially. Net
sales in the home entertainment business unit improved 30.8% and 14.7%,
respectively, for the three and nine months ended October 3, 1999 as
compared to similar periods in 1998, as a result of higher unit
shipments of both TV products and infrared remote control products.
Domestic and international sales (sales attributable to the ship-to
locations of ZiLOG's customers) in the third quarter of 1999 were 45.5%
and 54.5%, respectively, compared to 50.0% for both domestic and
international sales in the third quarter of 1998. International sales
represented 55.0% of the Company's net sales for the first nine months
of 1999, compared to 49.2% 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 Asian and
European regions.
Cost of Sales
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Cost of sales....................... $39,488 $42,070 $119,692 $123,711
Gross profit ....................... $25,040 $10,460 $60,084 $26,926
Gross profit percentage............. 38.8% 19.9% 33.4% 17.9%
</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 for both the third quarter and the
year-to-date period of 1999 was primarily attributable to higher net
sales, ZiLOG's cost reduction programs, increased factory utilization
and reduced depreciation expense, particularly in the Company's eight-
inch wafer fabrication facility. During the second quarter of 1999, the
Company recorded a special charge of approximately $3.7 million for a
write-down of test equipment which is being held for sale. As a result
of decommissioning this test equipment, ZiLOG's manufacturing
depreciation expense was reduced by approximately $0.6 million in the
third quarter of 1999, when compared to manufacturing depreciation
expense reported in prior quarters.
Effective July 5, 1999, the Company changed the estimated useful lives
of certain machinery and equipment located in its eight-inch wafer fab
in Nampa, Idaho from five to seven years. This change in accounting
estimate resulted in a $4.6 million reduction of depreciation expense in
the third quarter of 1999 as compared to depreciation expense, which
would have been recorded under the previous useful life estimates.
The decision to change the estimated service period for these assets was
based on the Company's recent qualification of a new .35 micron wafer
manufacturing process in its eight-inch wafer fab and the transfer of
many of ZiLOG's products into volume production in this facility.
Accordingly, the Company believes that extending the service period on
these assets is consistent with its current production plans.
The Company completed the outsourcing of its assembly operations
to subcontractors in the first quarter of 1999. Late in the
third quarter of 1998, ZiLOG implemented 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 reductions in raw materials prices.
The results of these actions, coupled with higher production levels,
contributed to increased gross profit in 1999 for all periods presented.
Research and Development
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Research and development............ $8,476 $7,135 $23,997 $22,155
Percentage of sales................. 13.1% 13.6% 13.3% 14.7%
</TABLE>
When compared to the similar period of 1998, research and development
expenditures increased by 18.8% in the third 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 8.3% in the
first nine months 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 during 1999.
Selling, General and Administrative
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Selling, general and administrative. $14,786 $13,656 $43,890 $40,508
Percentage of sales................. 22.9% 26.0% 24.4% 26.9%
</TABLE>
Selling, general and administrative expenses increased in dollars in
both the third quarter and first nine months 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 third quarter and year-to-date
periods of 1999 when compared to the similar periods of 1998, primarily
as a result of higher sales.
Special Charges
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Special charges .................... -- $7,128 $4,686 $32,815
Percentage of sales................. 0.0% 13.6% 2.6% 21.8%
</TABLE>
ZiLOG recognized Special Charges of $4.7 million in the nine month
period ended October 3, 1999, consisting of $3.7 million for write-downs
of semiconductor test equipment held for sale and $1.0 million of purchased
in-process research and development projects in connection with the
acquisition of assets from Seattle Silicon. These charges were recorded
in the Company's second quarter which ended on July 4, 1999.
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 nine month periods of 1998 represent
primarily recapitalization-related expenses. Also, in the third quarter
of 1998, the Company recognized Special Charges of $1.6 million for
severence expenses in connection with the restructuring of operations in
its wafer fabrication facility located in Nampa, Idaho. See Note 5 to
the Condensed Consolidated Financial Statements for a summary of Special
Charges.
Other Income/(Expense), Net
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- ---------------------
Oct. 3, Oct. 4, Oct. 3, Oct. 4,
1999 1998 1999 1998
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Other income (expense), net......... ($6,464) ($6,509) ($19,962) ($14,870)
Percentage of sales................. -10.0% -12.4% -11.1% -9.9%
</TABLE>
Other expenses, net of interest income, was approximately $6.5 million
in both the third quarter of 1999 and 1998. For the first nine months
of 1999, other expenses, net were $20.0 million, compared to $14.9
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.
Income Taxes
Provisions for income taxes were $0.25 million and $0.75 million for the
three and nine month periods ended October 3, 1999, respectively,
compared to income tax benefits of $2.3 million and $13.0 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 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 third quarter ended October 3, 1999 EBITDA was $12.6 million as
compared to $5.3 million for the corresponding period in 1998. For the
nine month periods ended October 3, 1999 and October 4, 1998, EBITDA was
$33.9 million and $11.2 million, respectively. The increase in EBITDA
for both the three and nine month periods ended October 3, 1999 was
primarily the result of improved gross profit.
EBITDA represents earnings (losses) from operations before interest
income and expense (including amortization of deferred financing costs),
income taxes, depreciation, amortization of intangible assets, 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, which are measured under generally accepted
accounting principles, and EBITDA may not be comparable to similarly
titled measures presented by other companies.
Liquidity and Capital Resources
<TABLE>
<CAPTION>
October 3, December 31,
1999 1998
---------- -----------
<S> <C> <C>
Cash and cash equivalents ............................. $47,598 $50,856
Working capital........................................ $52,219 $46,807
</TABLE>
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 Interbaank 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 October 3, 1999. The calculated availability on the
Facility at October 3, 1999 was $40.0 million. The Facility has certain
financial covenants that apply depending on the level of borrowings
under the Facility.
ZiLOG's planned capital expenditures for 1999 are approximately $12.0
million, which are primarily for test equipment, design tools and
computer system upgrades.
Cash provided by operating activities was $11.9 million for the nine month
period ended October 3, 1999 as compared to cash used by operating activities
of $19.1 million in the similar period of 1998. The improvement in 1999
cash provided by operating activities was primarily attributable to increased
net sales, improved gross profit and lower special charges, contributing to
a smaller net loss in the current year. The use of cash by operating activities
in the nine month period ended October 4, 1998 was primarily attributable to
a net loss of $70.4 million, which reflected $32.8 million of special charges
in connection with the Company's recapitalization and restructuring activities.
Cash used by investing activities was $15.2 million for the nine months
ended October 3, 1999 and cash used by investing activities was $4.5
million 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 used by investing
activities in 1998 was smaller primarily because of capital expenditures
of $18.6 million, offset largely by the receipt of cash from the sale of
short-term investments of $14.1 million.
Cash provided by financing activities for the nine months ended October
3, 1999 was $38,000 and cash used by financing activities for the nine
months ended October 4, 1998 was $29.0 million. The use of cash by
investing activities in 1998 was primarily for cash transactions related
to the recapitalization and restructuring 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 approximated $5.9 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.
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 availability under 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 October 3, 1999 was approximately
$4.5 million. This was 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 was
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 gases. 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.
ZiLOG has developed a Y2K contingency plan to provide continued flow of
standard or commodity products to customers. ZiLOG plans to place
strategic inventory of standard products in various locations around the
world. The locations will be selected based on then current best advice
regarding the readiness of the infrastructure in those locations to
continue normal operations after January 1, 2000 and the ability to
service the region from that location. This inventory will be sized to
lessen the impact of supply chain disruptions of up to one month. In
addition, the Company will freeze all systems implementations and
upgrades beginning in early December, and the Company's Information
Technology staff will be on site at each of ZiLOG's major facilities
during the Y2K transition.
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 October 3, 1999, ZiLOG had $280 million of consolidated long-
term indebtedness and a capital deficiency of $84.3 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.
The Company has learned that it is being designed out of pointing device
applications at a number of customers. The bookings rate for peripheral
products decreased substantially in the third quarter of 1999, to
approximately $4.5 million from a prior run rate of approximately $8.0
to $9.0 million per quarter. This bookings trend is expected to result
in lower sales in peripheral products in the fourth quarter of 1999, and
in the foreseeable future. The foregoing is a forward-looking
statement. Results could differ materially.
The Company's overall average selling prices decreased slightly in the
first three quarters of 1999, when compared to the similar period of
1998. 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 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.
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 implemented 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 was properly installed without material
adverse effect on the Company, there can be no assurance that unforeseen
circumstances concerning ZiLOG's operation 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. The Company 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.
Any sales of new products 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 nine months of 1999, the Company's 10
largest customers accounted for approximately 46.5% of the Company's net
sales, with one distributor customer accounting for approximately 12.3%
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,
.35 and .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 .65 micron and .35 CMOS processes. A failure to
successfully transition eligible products to either the .35 micron or
.65 CMOS process could have a material adverse effect on the Company.
Manufacture of large complex integrated circuits 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 uses outside contract assemblers for packaging its products.
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 55.0% of the Company's net
sales in the first nine months of 1999 were to foreign customers as
compared to 49.2% 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 geo-political 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, geo-
political, 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 uses subcontractors for certain assembly and test services
located in the Philippines, Indonesia, Taiwan and Malaysia. The Company
also operates a test facility in the Philippines through two wholly
owned subsidiaries and has a significant capital investment at certain
of these facilities. The Company's reliance on personnel and assets and
its maintenance of inventories at these facilities entails certain
political and economic risks, including political instability and
expropriation, currency controls and exchange fluctuations, as well as
changes in tax laws, tariff and freight rates. No assurances of political or
economic stability in these countries can be given. The Company has not
experienced any significant interruptions in its business operations at
these locations to date. Nonetheless, any loss or disruption of
production could have a material adverse effect on the Company,
particularly if operations or air transportation from these locations
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 (dollars in thousands):
<TABLE>
<CAPTION>
1999 2005 Total Fair Value
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Cash Equivalents:
Fixed rate $41,868 $ -- $41,868 $41,868
Average interest rate 5.23% -- 5.23% --
Long-Term Debt:
Fixed rate -- $280,000 $280,000 $257,600
Stated interest 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 petitioned the California Supreme Court
for review of the denial of its motion for summary judgment. The
California Supreme Court denied the Company's petition for review
without making a decision on the merits of the dispute. 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 5. Other Information
James M. Thorburn resigned as Senior Vice President and Chief Financial
officer effective August 30, 1999 to become Senior Vice President and
Chief Operating Officer of ON Semiconductor. Gary Patten has accepted
an offer to become the Company's Chief Financial Officer.
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: November 16, 1999
ZiLOG, INC.
/s/ John Rodman
--------------------------
Vice President and
Corporate Controller
(Chief Accounting 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> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> OCT-03-1999
<CASH> 47,598
<SECURITIES> 0
<RECEIVABLES> 32,919
<ALLOWANCES> 323
<INVENTORY> 28,751
<CURRENT-ASSETS> 118,836
<PP&E> 417,858
<DEPRECIATION> 272,829
<TOTAL-ASSETS> 277,516
<CURRENT-LIABILITIES> 66,617
<BONDS> 280,000
0
25,000
<COMMON> 404
<OTHER-SE> (109,722)
<TOTAL-LIABILITY-AND-EQUITY> 277,516
<SALES> 179,776
<TOTAL-REVENUES> 179,776
<CGS> 119,692
<TOTAL-COSTS> 119,692
<OTHER-EXPENSES> 23,997
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21,727
<INCOME-PRETAX> (32,451)
<INCOME-TAX> 750
<INCOME-CONTINUING> (33,201)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (33,201)
<EPS-BASIC> 0.00
<EPS-DILUTED> 0.00
</TABLE>
