<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
Amendment No. 1
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTER ENDED SEPTEMBER 27, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from _______ to ________
Commission File Number: 0-11674
LSI LOGIC CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2712976
(State of Incorporation) (I.R.S. Employer Identification Number)
1551 McCarthy Boulevard
Milpitas, California 95035
(Address of principal executive offices)
(408) 433-8000
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
As of March 28, 1999 there were 141,852,456 shares of the registrant's Common
Stock, $.01 par value, outstanding.
<PAGE> 2
LSI LOGIC CORPORATION
Form 10-Q/A
Amendment No. 1
FOR THE QUARTER ENDED SEPTEMBER 27, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
---
PART I FINANCIAL INFORMATION
<S> <C>
Item 1 Financial Statements
Consolidated Condensed Balance Sheets - September 30, 1998 and
December 31, 1997 3
Consolidated Condensed Statements of Operations - Three-Month and
Nine-Month Periods Ended September 30, 1998 and 1997 4
Consolidated Condensed Statements of Cash Flows - Nine-Month
Periods Ended September 30, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 6
Item 2 Management's Discussion and Analysis of Results of Operations and
Financial Condition 12
PART II OTHER INFORMATION
Item 1 Legal Proceedings 21
Item 5 Other Information 21
Item 6 Exhibits and Reports on Form 8-K 21
</TABLE>
2
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
--------------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 134,713 $ 104,571
Short-term investments 93,269 386,369
Accounts receivable, less allowance for
doubtful accounts of $3,152 and $2,597 284,002 210,141
Inventories 183,946 102,267
Other current assets 95,577 67,113
----------- -----------
Total current assets 791,507 870,461
----------- -----------
Property and equipment, net 1,410,150 1,123,909
Goodwill 348,311 20,852
Other assets 108,634 111,690
----------- -----------
Total assets $ 2,658,602 $ 2,126,912
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 211,154 $ 211,135
Accrued salaries, wages and benefits 59,788 38,422
Accrued restructuring costs 24,900 --
Other accrued liabilities 102,268 56,802
Income taxes payable 63,502 87,257
Current portion of long-term obligations and
short-term borrowings 152,911 44,615
----------- -----------
Total current liabilities 614,523 438,231
----------- -----------
Long-term obligations and deferred income taxes 599,709 117,511
Minority interest in subsidiaries 4,617 5,197
Commitments and contingencies -- --
Stockholders' equity:
Preferred shares; $.01 par value; 2,000
shares authorized; none outstanding -- --
Common stock; $.01 par value; 450,000 shares
authorized; 140,538 and 140,161 shares outstanding 1,405 1,401
Additional paid-in capital 997,408 965,422
Retained earnings 468,977 611,622
Cumulative translation adjustment (28,037) (12,472)
----------- -----------
Total stockholders' equity 1,439,753 1,565,973
Total liabilities and stockholders' equity $ 2,658,602 $ 2,126,912
=========== ===========
</TABLE>
See accompanying notes to unaudited consolidated
condensed financial statements.
3
<PAGE> 4
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues $ 390,365 $ 326,847 $ 1,045,316 $ 967,239
----------- ----------- ----------- -----------
Costs and expenses:
Cost of revenues 220,734 163,729 579,685 496,848
Research and development 77,733 57,746 206,421 166,198
Selling, general and administrative 59,055 49,036 153,397 143,368
Acquired in-process research and
development 145,500 2,850 145,500 2,850
Restructuring of operations and other
non-recurring charges 75,400 -- 75,400 --
Amortization of intangibles 7,338 1,156 10,110 3,188
----------- ----------- ----------- -----------
Total costs and expenses 585,760 274,517 1,170,513 812,452
----------- ----------- ----------- -----------
(Loss)/income from operations (195,395) 52,330 (125,197) 154,787
Interest expense (5,917) -- (5,917) (1,497)
Interest income and other expense (20,394) 9,295 (7,237) 25,407
----------- ----------- ----------- -----------
(Loss)/income before income taxes (221,706) 61,625 (138,351) 178,697
(Benefit)/provision for income taxes (16,584) 17,307 4,294 50,173
----------- ----------- ----------- -----------
Net (loss)/income $ (205,122) $ 44,318 $ (142,645) $ 128,524
=========== =========== =========== ===========
Net (loss)/income per share:
Basic $ (1.46) $ 0.31 $ (1.02) $ 0.93
=========== =========== =========== ===========
Diluted $ (1.46) $ 0.31 $ (1.02) $ 0.90
=========== =========== =========== ===========
Shares used in computing per share amounts:
Basic 140,827 141,827 140,523 137,873
=========== =========== =========== ===========
Dilutive 140,827 144,506 140,523 144,543
=========== =========== =========== ===========
</TABLE>
See accompanying notes to unaudited
consolidated condensed financial statements.
4
<PAGE> 5
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1998 1997
--------- ---------
<S> <C> <C>
Operating activities:
Net (loss)/ income $(142,645) $ 128,524
Adjustments:
Depreciation and amortization 150,703 122,240
Minority interest in net income of subsidiaries 221 566
Write-off of acquired in-process research and development 145,500 2,850
Non-cash restructuring and other non-recurring charges 75,400 --
Changes in:
Accounts receivable (16,349) (36,241)
Inventories (3,950) (12,339)
Other assets (13,404) (37,098)
Accounts payable (44,782) 96,536
Accrued and other liabilities (11,184) 54,996
--------- ---------
Net cash provided by operating activities 139,510 320,034
--------- ---------
Investing activities:
Purchases of debt and equity securities (301,782) (933,252)
Maturities and sales of debt and equity securities 594,546 996,775
Purchase of restricted equity securities (7,216) (6,681)
Purchases of property and equipment, net of retirements
and refinancings (231,694) (348,321)
Acquisition of stock from minority interest holders (599) --
Acquisition of Mint Technology, net of cash acquired -- (6,863)
Acquisition of Symbios, net of cash acquired (759,684) --
--------- ---------
Net cash used for investing activities (706,429) (298,342)
--------- ---------
Financing activities:
Proceeds from borrowings 694,682 34,193
Repayment of debt obligations (99,538) (67,260)
Issuance of common stock 12,480 15,254
Repurchase of common stock (5,661) (12,693)
--------- ---------
Net cash provided by (used for) financing activities 601,963 (30,506)
--------- ---------
Effect of exchange rate changes on cash and cash equivalents (4,902) (1,432)
--------- ---------
Increase (decrease) in cash and cash equivalents 30,142 (10,246)
Cash and cash equivalents at beginning of period 104,571 147,059
--------- ---------
Cash and cash equivalents at end of period $ 134,713 $ 136,813
========= =========
</TABLE>
See accompanying notes to unaudited
consolidated condensed financial statements.
5
<PAGE> 6
LSI LOGIC CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
In the opinion of the Company, the accompanying unaudited consolidated condensed
financial statements contain all adjustments (consisting only of normal
recurring adjustments with the exception of the in-process research and
development charge discussed in Note 2 and the restructuring charges as outlined
in Note 3) necessary to present fairly the financial information included
therein. While the Company believes that the disclosures are adequate to make
the information not misleading, it is suggested that these financial statements
be read in conjunction with the audited consolidated financial statements and
accompanying notes included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1997 and the report on Form 8-K and two amendments which
were filed with the Securities Exchange Commission on August 21, 1998 and
October 20, 1998 and March 31, 1999, respectively.
On August 6, 1998, the Company completed the acquisition of all of the
outstanding capital stock of Symbios, Inc. ("Symbios") from Hyundai Electronics
America ("HEA"). HEA is a majority owned subsidiary of Hyundai Electronics
Industries Co., Ltd. ("HEI"), a Korean corporation. The transaction was
accounted for as a purchase and accordingly, the results of operations of
Symbios and estimated fair value of assets acquired and liabilities assumed were
included in the Company's consolidated condensed financial statements as of
August 6, 1998, the effective date of the purchase through the end of the
period. The acquisition of Symbios is discussed further in Note 2. There are no
significant differences between the accounting policies of the Company and
Symbios.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the consolidated condensed financial statements
and accompanying notes. Actual results could differ from those estimates.
For financial reporting purposes, the Company reports on a 13 or 14 week quarter
with a year ending December 31. For presentation purposes, the consolidated
financial statements refer to the quarter's calendar month end for convenience.
The results of operations for the quarter ended September 30, 1998 are not
necessarily indicative of the results to be expected for the full year.
One customer represented 11% and 13% of the Company's consolidated revenue
during the third quarter and first nine months of 1998, respectively.
This Current Report on Form 10-Q/A contains forward looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. In particular, the assumptions set forth in
Note 2 and the Management Discussion and Analysis section of this Current Report
on Form 10-Q/A regarding revenue growth and cost of capital which underlie the
Company's calculation of the in-process research and development expenses
contain forward-looking statements and are qualified by the risks associated
with "Dependence on New Process Technologies and Products," "Manufacturing
Risks," "Capital Needs," "Fluctuations in Operating Results," "Competition,"
"Currency Risks," "Customer Concentration," "Cyclical Nature of the
Semiconductor Business" and "Acquisitions and Investment Alliances" and other
risks detailed in LSI Logic's Annual Report on Form 10-K for the year ended
December 31, 1997 and its Quarterly Reports on Form 10-Q for the quarters ended
March 31, 1998 and June 30, 1998 and other reports filed by LSI Logic with the
Securities Exchange Commission from time to time. Actual results could differ
materially from those projected in these forward-looking statements as a result
of the risks described above as well as other risk factors set forth in LSI
Logic's periodic reports both previously and hereafter filed with the Securities
Exchange Commission.
Note 2 - Acquisition of Symbios
As discussed in Note 1, the Company completed the acquisition of all of the
outstanding capital stock of Symbios from HEA on August 6, 1998.
The Company paid approximately $767 million in cash for all of the outstanding
capital stock of Symbios. The Company additionally paid approximately $6 million
in direct acquisition costs and accrued an additional $6 million as payable to
HEA relating to the resolution of certain obligations outlined in the Stock
Purchase Agreement. The purchase was financed using a combination of
6
<PAGE> 7
cash reserves and a new credit facility bearing interest at adjustable rates.
(See Note 4.) In addition, the Company assumed all of the options outstanding
under Symbios' 1995 Stock Plan with a calculated Black-Scholes value of $25
million. The total purchase price of Symbios was $804 million.
The total purchase price of $804 million was allocated to the estimated fair
value of assets acquired and liabilities assumed based on an independent
appraisal and management estimates. The purchase price and the related
allocation are subject to further refinement and change over the next year.
The total purchase price was allocated as follows (in millions):
<TABLE>
<CAPTION>
<S> <C>
Fair value of property, plant and equipment $252
Fair value of other tangible net assets 72
In-process research and development 146
Current technology 214
Assembled workforce and trademarks 37
Residual goodwill 83
----
$804
====
</TABLE>
Symbios Integration
The Company has taken certain actions to combine the Symbios operations with LSI
Logic and, in certain instances, to consolidate duplicative operations.
Adjustments to accrued integration costs related to Symbios were recorded as an
adjustment to the fair value of net assets in the purchase price allocation.
Accrued integration charges include $4 million related to involuntary separation
and relocation benefits for approximately 300 Symbios employees and $1.4 million
in other exit costs primarily relating to the closing of Symbios sales offices
and the termination of certain contractual relationships. The Symbios
integration related accruals are based upon management's current estimate of
integration costs and are in accordance with Emerging Issue Task Force ("EITF")
No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business
Combination." There was no activity against the integration reserves for the
period August 6, 1998 to September 30, 1998.
In-Process Research and Development
The Company reduced its estimate of the amount allocated to in-process research
and development ("IPR&D") on March 9, 1999 by $79.3 million from the $224.8
million previously reported in the third quarter of 1998 to $145.5 million.
Amortization of intangibles increased by $1.5 million from $5.8 million to $7.3
million for three months ended September 30, 1998 and from $8.6 million to $10.1
million for nine months ended September 30, 1998. The basic loss per share and
loss per share assuming dilution decreased from $2.01 to $1.46 for three months
ended September 30, 1998 and from $1.57 to $1.02 for nine months ending
September 30, 1998.
The amount originally allocated to IPR&D and intangible assets in the third
quarter of 1998 was made in a manner consistent with widely recognized appraisal
practices and in consultation with our independent accountants
PricewaterhouseCoopers at the date of acquisition. Subsequent to the
acquisition, the Securities and Exchange Commission ("SEC") staff expressed
views that took issue with certain appraisal practices generally employed in
determining the fair value of the in-process research and development that was
the basis for the Company's measurement of its in-process research and
development charge. The charge of $224.8 million, as first reported by the
Company, was based upon the work of an independent valuation firm that had
utilized the methodologies the SEC has since announced it does not consider
appropriate.
As a result of computing IPR&D using the SEC preferred methodology, the Company,
in consultation with its independent accountants, decided to revise the amount
originally allocated to IPR&D. The Company revised earnings for the third
quarter of 1998 and amended its Report on Form 10-Q and Report on Form 8-K/A
previously filed with the SEC.
The value assigned to IPR&D was determined by identifying research projects in
areas for which technological feasibility had not been established. These
include semiconductor projects of $ 94.6 million and storage systems projects of
$50.9 million. The value was determined by estimating the expected cash flows
from the projects once commercially viable, and discounting the net cash flows
back to their present value and then applying a percentage of completion.
7
<PAGE> 8
The percentage of completion for each project was determined using milestones
representing management's estimate of effort, value added, and degree of
difficulty of the portion of each project completed as of August 6, 1998 as
compared to the remaining research and development to be completed to bring each
project to technical feasibility. The development process is grouped into three
phases with each phase containing between one and five milestones. The three
phases are: researching the market requirements and the engineering architecture
and feasibility studies; the design and verification milestones; and the third
phase of prototyping and testing the product (both internal to the Company and
customer testing). Each of these phases has been subdivided into milestones and
then each of the projects was evaluated as to the milestone which it was at as
of August 6, 1998. The percentage of completion varied by individual project
ranging from 15% to 90% for semiconductors and from 5% to 85% for storage
systems.
If the projects discussed above are not successfully developed, the sales and
profitability of the combined company may be adversely affected in future
periods. Additionally, the value of other intangible assets acquired may become
impaired. Company management believes that the restated IPR&D charge of $145.5
million is valued consistently with the SEC staff's current views regarding
valuation methodologies. There can be no assurances, however, that the SEC staff
will not take issue with any assumptions used in the Company's valuation model
and require the Company to further revise the amount allocated to IPR&D.
Useful lives of intangible assets
The estimated weighted average useful life of the intangible assets for current
technology, assembled workforce, trademarks and residual goodwill, created as a
result of the acquisition, is approximately eight years.
Pro forma results
The following pro forma summary is provided for illustrative purposes only and
is not necessarily indicative of the consolidated results of operations for
future periods or that actually would have been realized had the Company and
Symbios been a consolidated entity during the periods presented. The summary
combines the results of operations as if Symbios had been acquired as of the
beginning of the periods presented.
The summary includes the impact of certain adjustments such as goodwill
amortization, changes in depreciation, estimated changes in interest income
because of cash outlays associated with the transaction and elimination of
certain notes receivable assumed to be repaid as of the beginning of the periods
presented, changes in interest expense because of the new debt entered into with
the purchase (see discussion in Note 4) and the repayment of certain debt
assumed to be repaid as of the beginning of the periods presented. Additionally,
restructuring charges of $75.4 million discussed in Note 3 and in-process
research and development of $145.5 million discussed above have been excluded
from the periods presented due to their non-recurring nature.
(in thousands, except per-share amounts)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------------
1998 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
Revenue $ 1,403,672 $ 1,425,275
Net income $ 47,696 $ 103,915
Basic EPS $ 0.34 $ 0.75
Diluted EPS $ 0.34 $ 0.72
</TABLE>
Note 3 - Restructuring
The Company remains committed to efforts to improve profitability and strengthen
competitiveness. As a result of identifying opportunities to streamline
operations and maximize the integration of Symbios into the Company's
operations, the Company's management, with the approval of the Board of
Directors, committed itself to a plan of action and recorded a $75.4 million
restructuring charge in the third quarter of 1998. The action undertaken
included a worldwide realignment of manufacturing capacity, the consolidation of
certain design centers and administrative offices, and a streamlining of the
Company's overhead structure to reduce operating expenses. The restructuring
charge excludes any integration charges related to Symbios. As discussed in Note
2, integration costs related to Symbios was accrued as a liability assumed in
the purchase in accordance with EITF 95-3.
8
<PAGE> 9
Restructuring costs include $37.2 million related primarily to fixed assets
impaired as a result of the decision to close a manufacturing facility in
Tsukuba, Japan; $4.7 million for terminations of leases and maintenance
contracts primarily in the U.S. and Europe; $ 1.7 million for non-cancelable
purchase commitments primarily in Europe; $13.1 million in fixed asset and other
asset write-downs primarily in the U.S., Japan, and Europe; and approximately
$2.4 million in other exit costs, which result principally from the
consolidation and closure of certain design centers, sales and administrative
offices primarily in the U.S. and Europe; and work force reduction costs of
$16.3 million. The work force reduction costs primarily include severance costs
related to involuntary termination of employment for approximately 900 employees
from manufacturing in Japan, and engineering, sales, marketing and finance
personnel located primarily in the U.S., Japan and Europe. The fair value of
assets determined to be impaired in accordance with the guidance in Statement of
Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of" were the
result of independent appraisals and use of management estimates. Severance
costs and other above noted exit costs were determined in accordance with
Emerging Issues Task Force No. 94-3 "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity". The restructuring
actions, as outlined by the plan, are intended to be executed to completion by
September 30, 1999, one year from the date the reserve was taken.
Note 4 - Debt
On August 5, 1998, the Company entered into a credit agreement by and among the
Company, LSI Logic Japan Semiconductor, Inc., a wholly owned subsidiary of the
Company ("LLJSI") and ABN AMRO Bank N.V. ("ABN AMRO"). The credit agreement was
restated and superseded by the Amended and Restated Credit Agreement dated as of
September 22, 1998 by and among the Company, LLJSI, ABN AMRO and thereafter
syndicated to a group of lenders determined by ABN AMRO. The credit agreement
consists of two credit facilities: a $575 million senior unsecured reducing
revolving credit facility ("Revolver"), and a $150 million senior unsecured
revolving credit facility ("364 day Facility").
On August 5, 1998, the Company borrowed $150 million under the 364 day Facility
and $485 million under the Revolver. The credit facilities allow for borrowings
at adjustable rates. Interest payments are due quarterly. The 364 day Facility
expires on August 3, 1999 at which time borrowings outstanding are payable in
full. The Revolver is for a term of four years with principal payments due
quarterly beginning on December 31, 1999. The Revolver includes a term loan
sub-facility in the amount of 8.6 billion yen made available to LLJSI over the
same term. The yen term loan sub-facility is for a period of four years with no
required payments until it expires on August 4, 2002. Pursuant to the above
noted restated credit agreement, on August 30, 1998, LLJSI repaid it's existing
11.4 billion yen ($79.2 million) credit facility and borrowed 8.6 billion yen
($59.7 million) bearing interest at adjustable rates. Borrowings outstanding
under the 364 day Facility and the Revolver including the yen sub-facility were
$694.7 million as of September 30, 1998.
The Company, in accordance with the new credit arrangement, must comply with
certain financial covenants related to profitability, tangible net worth,
working capital, senior and total debt leverage and subordinated indebtedness.
At September 30, 1998, the Company was in compliance with these covenants.
In December 1996, the Company entered into a credit arrangement with several
banks for a $300 million revolving line of credit expiring in December 1999. The
Company canceled this agreement on July 31, 1998.
Note 5 - Derivative financial instruments
The Company has foreign subsidiaries which operate and sell the Company's
products in various global markets. As a result, the Company is exposed to
changes in foreign currency exchange rates and interest rates. The Company
utilizes various hedge instruments, primarily forward contract, currency swap,
interest rate swap and currency option contracts, to manage its exposure
associated with firm intercompany and third-party transactions and net asset and
liability positions denominated in non-functional currencies. The Company does
not hold derivative financial instruments for speculative or trading purposes.
On August 5, 1998, the Company recognized a loss of $1.5 million from the
decision to close interest rate swap contracts which converted the interest
associated with yen borrowings by LLJSI from adjustable to fixed rates. The
contracts were closed because the underlying debt was repaid as discussed in
Note 4. Current period gains and losses associated with the interest rate swaps
are included in interest expense, or as other gains and losses at such time as
related borrowings are terminated. At September 30, 1998, there were no interest
rate swap contracts outstanding, however, the Company may enter into interest
rate swaps in the future.
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<PAGE> 10
The Company enters into forward contracts, currency swaps and currency option
contracts to hedge firm commitments, intercompany transactions and third party
exposures. The forward and currency swap contracts hedging firm intercompany
asset and liability positions denominated in non-functional currencies expired
on the last day of the third quarter ended September 30, 1998 and year ended
December 31, 1997. Currency swap contracts outstanding during the quarter are
considered identifiable hedges and realized and unrealized gains and losses are
deferred until settlement of the underlying commitments. They are recorded as
other gains or losses when a hedged transaction is no longer expected to occur.
Deferred foreign gains and losses were not material at September 30, 1998 and
December 31, 1997. Foreign currency transaction gains and losses included in
interest income and other were immaterial for the three and nine months ended
September 30, 1998 and 1997, respectively.
At September 30, 1998, total outstanding purchased currency option contracts
were $200 million. These contracts expire quarterly through June 1999. These
currency options were treated as hedges of third-party yen revenue exposures.
The realized and unrealized gains and option premiums are deferred until the
exposure underlying the option is recorded. The deferred premiums on all
outstanding options were $7 million as of September 30, 1998 and included in
other current assets. The Company closed option contracts not qualifying for
hedge accounting treatment during the third quarter of 1998 at a gain of $0.7
million.
In June, 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. It further provides criteria for derivative instruments to be
designated as fair value, cash flow and foreign currency hedges and establishes
respective accounting standards for reporting changes in the fair value of the
instruments. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Upon adoption of SFAS 133, the Company will be
required to adjust hedging instruments to fair value in the balance sheet, and
recognize the offsetting gain or loss as transition adjustments to be reported
in net income or other comprehensive income, as appropriate, and presented in a
manner similar to the cumulative effect of a change in accounting principle.
While the Company believes the adoption of this statement will not have a
material effect on the Company's results of operations as most derivative
instruments are closed on the last day of each fiscal quarter, the impact of the
adoption of SFAS 133 as of the effective date cannot be reasonably estimated at
this time.
Note 6 - Cash equivalents and short-term investments
Cash equivalents and short-term investments at September 30, 1998, consisted
primarily of U.S. and foreign corporate debt securities, commercial paper,
auction rate preferred stock, U.S. and foreign government and agency securities
and time deposits. Cash equivalents and short-term investments held at September
30, 1998 and at December 31, 1997 approximate fair market value and it is the
Company's intention to hold these investments for one year or less. As of
September 30, 1998, contractual maturities of available-for-sale securities were
$ 93.3 million maturing within one year. The Company currently does not actively
trade securities. Realized gains and losses are based on book value of specific
securities sold and were not material during the quarters ended September 30,
1998 and 1997.
Note 7 - Reconciliation of basic and diluted earnings per share
The following is a reconciliation of the numerators and denominators of the
basic and diluted per share computations as required by SFAS No. 128, "Earnings
Per Share ("EPS")."
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------
1998 1997
---------------------------------------- -------------------------------------
PER-SHARE PER-SHARE
(LOSS)* SHARES** AMOUNT INCOME* SHARES** AMOUNT
------- -------- ------ ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Net (loss)/ income available to
common stockholders $(205,122) 140,827 $(1.46) $44,318 141,827 $0.31
------ -----
Effect of Dilutive Securities
Common stock equivalents 2,679
Diluted EPS
Net (loss)/ income available to
common stockholders $(205,122) 140,827 $(1.46) $44,318 144,506 $0.31
------ -----
</TABLE>
10
<PAGE> 11
*Numerator **Denominator
Options to purchase approximately 13,008,994 and 2,418,138 which were
outstanding at September 30, 1998 and 1997 respectively, were not included in
the calculation because the exercise prices were greater than the average market
price of common shares in each respective quarter. The exercise price ranges of
these options were $18.94 to $58.13 and $33.25 to $58.13 at September 30, 1998
and 1997, respectively. For the three months ended September 30, 1998, common
equivalent shares of 1,454,000 were excluded from the computation of diluted
shares as a result of their antidilutive effect on earnings per share.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------
1998 1997
------------------------------------ --------------------------------------
PER-SHARE PER-SHARE
(LOSS)* SHARES** AMOUNT INCOME* SHARES** AMOUNT
------- -------- ------ ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Net (loss)/ income available to
common stockholders $(142,645) 140,523 $(1.02) $128,524 137,873 $0.93
------ -----
Effect of Dilutive Securities
Common stock equivalents 3,016
5-1/2% convertible subordinated notes $1,279 3,654
Diluted EPS
Net (loss)/ income available to
common stockholders $(142,645) 140,523 $(1.02) $129,803 144,543 $0.90
------ -----
</TABLE>
*Numerator **Denominator
Options to purchase approximately 11,241,908 and 637,039 which were outstanding
at September 30, 1998 and 1997 respectively, were not included in the
calculation because the exercise prices were greater than the average market
price of common shares in each respective quarter. The exercise price ranges of
these options were $22.38 to $58.13 and $35.00 to $58.13 at September 30, 1998
and 1997, respectively.
Note 8 - Balance sheet and cash flow information (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------- --------
<S> <C> <C>
Inventories:
Raw materials $ 46,350 $ 19,892
Work-in-process 73,046 58,621
Finished Goods 64,550 23,754
-------- --------
Total $183,946 $102,267
======== ========
</TABLE>
The September 30, 1998 inventory numbers are higher in part as a result of the
acquisition of Symbios on August 6, 1998. The Symbios contribution to the
numbers above is $76 million in total inventories, or $22 million for raw
materials, $31 million for work-in-process and $23 million for finished goods
inventories at September 30, 1998.
During the nine month period ended September 30, 1998, the Company capitalized
$51.5 million related to the preproduction engineering costs for its Gresham,
Oregon manufacturing facility. The unamortized preproduction balance at
September 30, 1998 is $86 million. In April 1998, The Accounting Standards
Executive Committee ("AcSEC") released Statement of Position ("SOP") No. 98-5,
"Reporting on the Costs of Start-up Activities." The new SOP is effective for
fiscal years beginning after December 15, 1998 and requires companies to expense
all costs incurred or unamortized in connection with start-up activities.
Accordingly, the Company will expense the unamortized preproduction balance as
of January 1, 1999 and present it as a cumulative effect of a change in
accounting principle in accordance with SOP 98-5.
The Company wrote-down to estimated fair values two long-term equity investments
during the third quarter. This included a $11.9 million write down of the
Company's $20.2 million investment in restricted shares of Chartered
Semiconductor Manufacturing Pte. LTD. ("CSM") and a $2.5 million write-down in
the Company's equity investment in another non-public technology company. The
11
<PAGE> 12
estimated fair values for these investments were based on third party financings
by CSM and management analysis of the two companies financial statements. The
decline in value of the investments was considered by management to be other
than temporary.
Note 9 - During the first nine months of 1998, the Company's Japanese sales
affiliate sold approximately $64.9 million of its accounts receivables through
non-recourse financing programs with two Japanese banks. These receivables were
discounted at short-term Yen borrowing rates (averaging approximately 0.41%) and
related fees were not material.
Note 10 - Purchases of Minority Interest
During the third quarter of 1998, the Company acquired approximately 107,880
shares of its Japanese affiliate from its minority interest shareholders for
approximately $0.6 million. The acquisition was accounted for as a purchase and
the excess of purchase price over the estimated fair value of the assets
acquired was allocated to goodwill and is being amortized over eight years using
the straight-line method. The Company owned approximately 93% of the Japanese
affiliate at September 30, 1998.
Note 11 - Comprehensive income
In January 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income." Comprehensive income is defined as the change in equity of a company
during a period from transactions and other events and circumstances excluding
transactions resulting from investments by owners and distributions to owners.
The primary difference between net income and comprehensive income, for the
Company, is due to foreign currency translation adjustments and gains and losses
on a long-term intercompany loan with the Company's Japanese affiliate.
Comprehensive income for the third quarter and first nine months of 1998 and
comparable periods in the prior year is as follows:
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
1998 1997 1998 1997
--------- ------- --------- --------
<S> <C> <C> <C> <C>
Comprehensive (loss)/ income $(199,581) $54,757 $(152,918) $139,713
========= ======= ========= ========
</TABLE>
Note 12 - Legal matters
A discussion of certain pending legal proceedings is included in Item 3 of the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1997. The information provided therein remains unchanged except as noted in Item
1 of part II of this Form 10-Q/A. The Company continues to believe that the
final outcome of such matters discussed will not have a material adverse effect
on the Company's consolidated financial position or results of operations. No
assurance can be given, however, that these matters will be resolved without the
Company becoming obligated to make payments or to pay other costs to the
opposing parties, with the potential, particularly if viewed on a quarterly
basis, for having an adverse effect on the Company's financial position or its
results of operations.
Certain additional claims and litigation against the Company have also arisen in
the normal course of business. The Company believes that it is unlikely that the
outcome of these claims and lawsuits will have a materially adverse effect on
the Company's consolidated financial position or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
GENERAL
The Company believes that its future operating results are and will continue to
be subject to quarterly variations based upon a wide variety of factors,
including the cyclical nature of both the semiconductor industry and the markets
addressed by the Company's products, the availability and extent of utilization
of manufacturing capacity, fluctuations in manufacturing yields, price erosion,
competitive factors, the timing of new product introductions, changes in product
mix, product obsolescence and the ability to develop and implement new
technologies. The Company's operating results could also be impacted by sudden
fluctuations in customer requirements, currency exchange rate fluctuations and
other economic conditions affecting customer demand and the cost of
12
<PAGE> 13
operations in one or more of the global markets in which the Company does
business. As a participant in the semiconductor industry, the Company operates
in a technologically advanced, rapidly changing and highly competitive
environment. The Company predominantly sells custom products to customers
operating in a similar environment. Accordingly, changes in the circumstances of
the Company's customers may have a greater impact on the Company than if the
Company predominantly offered standard products that could be sold to many
purchasers. While the Company cannot predict what effect these various factors
may have on its financial results, the aggregate effect of these and other
factors could result in significant volatility in the Company's future
performance and stock price. To the extent the Company's performance may not
satisfy expectations published by external sources, public reaction could result
in a sudden and significantly adverse impact on the market price of the
Company's securities, particularly on a short-term basis.
The Company currently has international subsidiaries which operate and sell the
Company's products in various global markets. The Company purchases a
substantial portion of its raw materials and equipment from foreign suppliers,
and incurs labor and other operating costs, particularly at its Japanese
manufacturing facility, in foreign currencies. As a result, the Company is
exposed to international factors such as changes in foreign currency exchange
rates or economic conditions of the respective countries in which the Company
operates. The Company utilizes various instruments, primarily forward exchange,
currency swap and currency option contracts to manage its exposure associated
with currency fluctuations on intercompany, certain foreign currency denominated
commitments and anticipated third party sales (see Note 5 to the Unaudited
Consolidated Condensed Financial Statements). Despite its hedging activities,
the Company continues to be exposed to the risks associated with fluctuation of
foreign currency exchange rates, particularly the Japanese yen. There can be no
assurance that such fluctuation will not cause a material adverse effect on the
Company's financial position or results of operations.
The Company's corporate headquarters and some of its manufacturing facilities
are located near major earthquake faults. As a result, in the event of a major
earthquake the Company could suffer damages which could materially and adversely
affect the operating results and financial condition of the Company.
There have been no significant changes in the market risk disclosures during the
first nine months of 1998 as compared to the discussion in the Company's 1997
Annual Report on Form 10-K for the year ended December 31, 1997.
While management believes that the discussion and analysis in this report is
adequate for a fair presentation of the information, management recommends that
this discussion and analysis be read in conjunction with Management's Discussion
and Analysis included in the Company's 1997 Annual Report on Form 10-K for the
year ended December 31, 1997, and its Quarterly reports of Form 10Q for the
quarters ending March 31, and June 30, 1998, and the Current Reports on Form 8-K
filed on August 21, 1998 and the Amendments filed on Form 8-K/A on October 20,
1998 and March 31, 1999 with the Securities Exchange Commission.
Statements in this discussion and analysis contain forward-looking information
and involve known and unknown risks and uncertainties, which may cause the
Company's actual results in future periods to be materially different from any
future performance suggested herein. In addition to the factors discussed above,
such factors may include, but may not necessarily be limited to fluctuations in
customer demand, both in timing and volumes, and fluctuations in currency
exchange rates. Also, the Company's ability to have available an appropriate
amount of production capacity in a timely manner can significantly impact the
Company's financial performance. The timing of new technology and product
introductions and the risk of early obsolescence are also important factors.
Further, the Company operates in an industry sector where the market value of
its securities is highly volatile and may be influenced by economic and other
factors beyond the Company's control. (See additional discussion contained in
"Risk Factors", set forth in Part 1 of the Company's Report on Form 10-K for the
year ended December 31, 1997).
YEAR 2000 DISCLOSURE
The following statement is a Year 2000 Readiness Disclosure under the Year
2000 Information and Readiness Disclosure Act of 1998.
As with many other companies, the Year 2000 computer issue presents risks
for us. We use a significant number of computer software programs and operating
systems in our internal operations, including applications used in our
financial, product development, order management and manufacturing systems.
There are areas in which the Year 2000 computer issue could negatively impact us
and our business. If internal systems do not properly recognize and process date
information for years into and beyond the turn of the century, there could be an
adverse impact on our operations. Moreover, if critical suppliers' or customers'
13
<PAGE> 14
systems or products fail because of a Year 2000 malfunction, there could be an
adverse impact on our operating results. Finally, our products could malfunction
as a result of a failure in date recognition. A Year 2000 problem could arise if
our systems were to fail to properly recognize and process date information for
several reasons: they could fail to properly recognize years that begin with the
digits "20" instead of "19"; they could attribute specially assigned meanings to
certain date code digits, such as "99"; or they could fail to recognize the year
2000 as a leap year. The inability of computer software programs to accurately
recognize, interpret and process date codes designating the year 2000 and beyond
could cause systems to yield inaccurate results or encounter operating problems,
including interruption of the business operations such systems control.
We are engaged in a comprehensive program to assess the Company's Year 2000 risk
exposure and to plan and implement remedial and corrective action where
necessary. We have reviewed all of our major internal systems, including human
resources, financial, engineering and manufacturing systems, to assess Year 2000
readiness and to identify critical systems that require correction or
remediation. Assessment of our design engineering systems and products was
completed in the first quarter of 1999. Based on the results of this assessment,
it is anticipated that remediation of critical systems will be completed and
tested by the end of the third quarter 1999. We believe that our existing HR,
financial and business software systems are Year 2000 ready. There can be no
assurances, however, that integration and testing of new, corrected or updated
programs or systems with which they interface will not result in necessary
corrective action to one or more critical systems. A significant disruption of
our financial or business systems would adversely impact our ability to process
orders, manage production and issue and pay invoices. Our inability to perform
these functions for a long period of time could result in a material impact on
our results of operations and financial condition.
Our manufacturing facilities incorporate sophisticated computer integrated
manufacturing systems which depend on a mix of the Company's proprietary
software and systems and software purchased from third parties. Failure of these
systems would cause a disruption in the manufacturing process and could result
in a delay in completion and shipment of products. Our assessment of the Year
2000 readiness of our manufacturing systems is approximately 85% complete. Based
on information currently available, we believe that our systems will not be
materially impacted by Year 2000 issues. However, there can be no assurance that
a significant disruption in systems resulting from a Year 2000 problem will not
occur. If the computer integration system fails for this or any other reason,
there could be a material adverse impact on our operating results and financial
condition.
We are working with critical suppliers of products and services to assess
their Year 2000 readiness with respect both to their operations and the products
and services they supply to us. Comprehensive inquiries have been sent and
responses are being monitored, with appropriate follow-up where required. This
analysis will continue well into 1999, with corrective action taken commensurate
with the criticality of affected products and services.
Our assessment program also has encompassed our own product offerings. Our
application specific integrated circuits ("ASICs") are custom-designed chips
which implement the customer's functional or engineering specifications. As
designer and manufacturer of the physical implementation of a customer's design
in silicon, we generally do not have specific knowledge of the role of the
customer's ASIC within the complete system for which it is intended. Whether the
chip will operate correctly depends on the system function and the software
design and integration, which will be determined independently by the customer
or other third party suppliers. Our application specific standard products
("ASSPs") and storage systems products, on the other hand, do implement chip and
system functionality designed by us. They include graphics processing,
audio/video signal decoding, data transmission, I/O control and data storage
whose functionality generally is not date dependent. We have completed our
assessment of the Year 2000 readiness of these products, and there is no
information to indicate that Year 2000 issues will have a material impact on
sales or functionality of our standard product offerings. Customers are seeking
assurances of our Year 2000 readiness with increasing frequency, and we are
endeavoring promptly and completely to address their concerns. However, we have
no control over a customer's Year 2000 readiness. Customers who believe that the
products they purchase from us may not be Year 2000 compliant may seek
alternative sources of supply. A significant decline in new orders or increase
in cancellations of existing backlog could have a material adverse impact on our
results of operations or financial condition.
We are at work on the development of various types of contingency plans to
address potential problems with critical internal systems and third party
interactions. Our contingency plans include procedures for dealing with a major
disruption of internal business systems, plans for long term factory shutdown
and identification of alternative vendors of critical materials in the event of
Year 2000 related disruption in supply. Contingency planning will continue
through at least 1999, and will depend heavily on the results of the remediation
and testing of critical systems. The potential ramifications of a Year 2000 type
failure are potentially far-reaching and largely unknown. There can be no
assurances that a contingency plan in effect at the time of a system failure
will
14
<PAGE> 15
adequately address the immediate or long term effects of a failure, or that such
a failure would not have a material adverse impact on our operations or
financial results in spite of prudent planning.
Our costs to date related to the Year 2000 issue consist primarily of
reallocation of internal resources to evaluate and assess systems and products
as described above and to plan our remediation and testing efforts. We have not
maintained detailed accounting records, but based on our review of department
budgets and staff allocations, we believe these costs to be immaterial. We
currently estimate that the total cost of ongoing assessment, remediation,
testing and planning directly related to Year 2000 issues will amount to
approximately $14 million. Of this, approximately $8 million is expected to
consist of expenses attributed to redeployment of labor resources and overhead,
$2 million for the cost of software and external consulting fees and $4 million
for additional capital expenditures. The capital expenditures represent the
early replacement of information technology equipment and software to obtain the
full benefits of year 2000 protections versus the normal technical obsolescence
replacement cycle. The estimate is based on the current assessment of the
projects and is subject to change as the projects progress. There can be no
assurance that remediation and testing will not identify issues which require
additional expenditure of material amounts which could result in an adverse
impact on financial results in future reporting periods.
Based on currently available information, management does not believe that
the Year 2000 issues discussed above related to internal systems or products
sold to customers will have a material adverse impact on our financial condition
or overall trends in results of operations. However, we are uncertain to what
extent we may be affected by such matters. In addition, there can be no
assurance that the failure to ensure year 2000 capability by a supplier not
considered critical or another third party would not have a material adverse
effect on us.
RESULTS OF OPERATIONS
The results of operations for the three and nine month periods presented include
the effect of the acquisition of Symbios from the date of acquisition, August 6,
1998 which is discussed in Note 2 to the Unaudited Consolidated Condensed
Financial Statements contained herein.
Revenues for the third quarter of 1998 increased $63.5 million or 19.4% as
compared to the third quarter of 1997. The increase was primarily attributable
to revenues of $89.4 million generated from Symbios included as of August 6,
1998 in the third quarter results. Excluding the effect of Symbios, revenues
decreased $25.9 million or 7.9% for the three month period ended September 30,
1998. The decrease was attributable to lower average selling prices for products
for consumer, computer and communications applications as well as the
unfavorable effect of foreign exchange, most notably for the Company's products
in consumer applications. Revenues for the first nine months of 1998 increased
$78.1 million or 8.1% compared to the same period in 1997. The increase included
revenues of $89.4 million related to Symbios included as of August 6, 1998.
Excluding the effect of Symbios, revenues for the nine month period decreased
$11.3 million or 1.2%. The decrease is primarily attributable to lower revenues
for computer and consumer product applications and overall lower average selling
prices as well as the unfavorable effect of foreign exchange, offset in part by
increased demand for the Company's products for communications applications.
One customer represented 11% and 13% of the Company's consolidated revenues
during the third quarter and first nine months of 1998.
Key elements of the statements of operations, expressed as a percentage of
revenues, were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Gross margin 43.5% 49.9% 44.5% 48.6%
Research and development expenses 19.9% 17.7% 19.7% 17.2%
Selling, general and administrative expenses 15.1% 15.0% 14.7% 14.8%
Income /(loss) from operations (50.1%) 16.0% (12.0%) 16.0%
</TABLE>
Key elements of the statements of operations, excluding Symbios, expressed as a
percentage of revenues, were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ----------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Gross margin 45.6% 49.9% 45.3% 48.6%
Research and development expenses 21.4% 17.7% 20.2% 17.2%
Selling, general and administrative expenses 16.1% 15.0% 14.9% 14.8%
Income /(loss) from operations (17.4)% 16.0% 1.9% 16.0%
</TABLE>
15
<PAGE> 16
Gross margin as a percentage of revenues decreased to 43.5% and 44.5% during the
third quarter and first nine months of 1998, respectively, from 49.9% and 48.6%
in the same periods in 1997. Excluding the effect of Symbios, gross margins
decreased to 45.6% and 45.3% during the third quarter and first nine months of
1998, respectively, from 49.9% and 48.6% in the same periods in 1997. The
decrease was primarily related to the combination of non-recurring inventory
charges taken during the third quarter and first nine months of 1998 and lower
average selling prices to a large customer offset partially by improved capacity
utilization. Although the average yen exchange rate for the third quarter and
the first nine months of 1998 weakened by approximately 21.1% and 13.3%,
respectively, from the same periods in 1997, the effect on gross margin and net
income was not material due to the Company's yen denominated sales offsetting a
substantial portion of its yen denominated costs and the Company's hedging of a
portion of its remaining yen exposures during these periods. However, there can
be no assurance that future changes in the relative strength of the yen, or the
mix of foreign denominated revenues and expenses, will not have a material
effect on gross margin or operating results.
The Company's operating environment, combined with the resources required to
operate in the semiconductor industry, requires managing a wide variety of
factors such as factory and capacity utilization, manufacturing yields, product
mix, availability of certain raw materials, terms negotiated with third-party
subcontractors and foreign currency exchange rate fluctuations. Factors
including the purchase and related integration of Symbios and the restructuring
activities discussed in Notes 2 and 3 to the Unaudited Consolidated Condensed
Financial Statements combined with the impact of bringing the new fabrication
facility in Gresham, Oregon on line, is expected to reduce gross margins in the
next two quarters as compared to the first three quarters of 1998.
The Company is currently constructing a new manufacturing facility in Gresham,
Oregon. This new facility is expected to become operational during the fourth
quarter of 1998 to accommodate anticipated future capacity requirements based on
growth and on shutdown of the manufacturing facility in Japan. If demand does
not absorb the Company's available capacity at a sufficient rate, or if
achieved, such demand is not sustained, the Company's gross margin and operating
results could be negatively impacted in future periods.
Research and development ("R&D") expenses increased $20.0 million, and $40.2
million to $77.7 million and $206.4 million , respectively, during the third
quarter and first nine months of 1998 compared to $ 57.7 million and $ 166.2
million during the same periods of 1997. Of the total increase for the third
quarter of 1998, $13.3 million related to the inclusion of Symbios R&D expenses
as of August 6, 1998. Excluding the effect of Symbios, R&D expenses increased
$6.7 million and $26.9 million or 11.6% and 16.2% for the three and nine month
periods ended September 30, 1998. The increase in R&D expenses is primarily
attributable to the Company's continued development of advanced sub-micron
products and the upgrade from 6 to 8 inch wafer fabrication capability at the
Company's Santa Clara research and development facility in California. As a
percentage of revenues, R&D expenses increased to 19.9% and 19.7% in the third
quarter and first nine months of 1998, respectively, compared to 17.7% and
17.2%, during the same periods in 1997. Excluding the effects of Symbios, R&D
expense as a percentage of revenues was 21.4% and 20.2% for the three and nine
month periods ended September 30, 1998. As the Company continues its commitment
to technological leadership in the high performance semiconductor market, it
anticipates continuing to invest in R&D at the rate of 19% to 21% of revenues
during the remainder of 1998.
Selling, general and administrative ("SG&A") expenses increased $10 million to
$59.1 million and $153.4 million, respectively, in the third quarter and first
nine months of 1998 compared to $49 million and $143.4 million during the same
periods in 1997. The increase is primarily attributable to the inclusion of
$10.7 million in expenses relating to Symbios as of August 6, 1998. Excluding
the effect of Symbios, SG&A expenses remained essentially flat for the three and
nine month periods ending September 30, 1998 as compared to the same periods in
1997. As a percentage of revenues, SG&A expenses increased to 15.1% in the third
quarter of 1998, and decreased to 14.7% in the first nine months of 1998,
compared to 15.0% and 14.8%, respectively, during the same periods in 1997.
Excluding the effects of Symbios, SG&A expenses were 16.1% and 14.9% for the
three and nine month periods ending September 30, 1998. The Company expects that
SG&A expenses as a percentage of revenues will decline as a result of the
restructuring actions discussed in Note 3 to the Unaudited Consolidated
Condensed Financial Statements.
The Company reduced its estimate of the amount allocated to IPR&D by $79.3
million from the $224.8 million amount previously reported in the third quarter
of 1998 to $145.5 million. Amortization of intangibles increased by $1.5 million
from $5.8 million to $7.3 million for three months ended September 30, 1998 and
from $8.6 million to $10.1 million for nine months ended September 30,
16
<PAGE> 17
1998. The basic loss per share and loss per share assuming dilution decreased
from $2.01 to $1.46 for three months ended September 30, 1998 and from $1.57 to
$1.02 for nine months ended September 30, 1998.
The Company allocated amounts to IPR&D and intangible assets in the third
quarter of 1998 in a manner consistent with widely recognized appraisal
practices and in consultation with its independent accountants
PricewaterhouseCoopers LLP at the date of acquisition of Symbios. Subsequent to
the acquisition, the SEC staff expressed views that took issue with certain
appraisal practices generally employed in determining the fair value of the
IPR&D that was the basis for the Company's measurement of its IPR&D charge. The
charge of $224.8 million, as first reported by the Company, was based upon the
work of an independent valuation firm that had utilized the methodologies the
SEC has since announced it does not consider appropriate.
As a result of computing IPR&D using the SEC preferred methodology, the Company,
in consultation with its independent accountants, decided to revise the amount
originally allocated to IPR&D. The Company has revised earnings for 1998 and
amended its Report on Form 10-Q and report on Form 8-K/A previously filed with
the Securities Exchange Commission.
The value assigned to IPR&D was determined by identifying research projects in
areas for which technological feasibility had not been established. These
include semiconductor projects of $ 94.6 million and storage systems projects of
$50.9 million. The value was determined by estimating the expected cash flows
from the projects once commercially viable, discounting the net cash flows back
to their present value and then applying a percentage of completion to the
calculated value as defined below.
Net cash flows. The net cash flows from the identified projects are based on the
Company's estimates of revenues, cost of sales, research and development costs,
selling, general and administrative costs, and income taxes from those projects.
These estimates are based on the assumptions mentioned below. The research and
development costs included in the model reflect costs to sustain projects, but
exclude costs to bring in-process projects to technological feasibility.
The estimated revenues are based on management projections of each in-process
project for semiconductor and storage systems products and the aggregated
business projections were compared and found to be in line with industry
analysts' forecasts of growth in substantially all of the relevant markets.
Estimated total revenues from the IPR&D product areas are expected to peak in
the year 2001 and decline from 2002 - 2005 as other new products are expected to
become available. These projections are based on the Company's estimates of
market size and growth, expected trends in technology, and the nature and
expected timing of new product introductions by the Company and its competitors.
Projected gross margins approximate Symbios' recent historical performance and
are in line with industry margins in the semiconductor and storage systems
industry sectors. The estimated selling, general and administrative costs are
consistent with Symbios' historical cost structure which is in-line with
industry averages at approximately 15% of revenues. Research and development
costs are consistent with Symbios' historical cost structure.
Royalty rate. The Company applied a royalty charge of 25% of operating income
for each in-process project to attribute value for dependency on predecessor
core technologies.
Discount rate. Discounting the net cash flows back to their present value is
based on the industry weighted average cost of capital ("WACC"). The industry
WACC is approximately 15% for semiconductors and 16% for storage systems. The
discount rate used in discounting the net cash flows from IPR&D is 20% for
semiconductor and 21% for storage systems, a 500 basis point increase from the
respective industry WACC's. This discount rate is higher than the industry WACC
due to inherent uncertainties surrounding the successful development of the
IPR&D, market acceptance of the technology, the useful life of such technology,
the profitability levels of such technology and the uncertainty of technological
advances which could potentially impact the estimates described above.
Percentage of completion. The percentage of completion for each project was
determined using milestones representing management's estimate of effort, value
added, and degree of difficulty of the portion of each project completed as of
August 6, 1998, as compared to the remaining research and development to be
completed to bring each project to technical feasibility. The development
process is grouped into three phases with each phase containing between one and
five milestones. The three phases are:
- Researching the market requirements and the engineering architecture
and feasibility studies;
- Design and verification milestones; and
- Prototyping and testing the product (both internal and customer
testing).
17
<PAGE> 18
Each of these phases has been subdivided into milestones, and then the status of
each of the projects was evaluated as of August 6, 1998. The percentage of
completion varied by individual project ranging from 15% to 90% for
semiconductors and from 5% to 85% for storage systems.
If the projects discussed above are not successfully developed, the sales and
profitability of the combined company may be adversely affected in future
periods. Additionally, the value of other intangible assets acquired may become
impaired. The Company's management and advisers believe that the restated IPR&D
charge of $145.5 million is valued consistently with the SEC staff's current
views regarding valuation methodologies. There can be no assurances, however,
that the SEC staff will not take issue with any assumptions used in the
Company's valuation model and require the Company to further revise the amount
allocated to IPR&D.
The Company remains committed to efforts to improve profitability and strengthen
competitiveness. As a result of identifying opportunities to streamline
operations and maximize the integration of Symbios into the Company's
operations, the Company's management, with the approval of the Board of
Directors, committed itself to a plan of action and recorded a $75.4 million
restructuring charge in the third quarter of 1998. The action undertaken
included a worldwide realignment of manufacturing capacity, the consolidation of
certain design centers and administrative offices, and a streamlining of the
Company's overhead structure to reduce operating expenses. The restructuring
charge excludes any integration charges related to Symbios. As discussed in Note
2, integration costs related to Symbios was accrued as a liability assumed in
the purchase in accordance with EITF 95-3.
Restructuring costs include $37.2 million related primarily to fixed assets
impaired as a result of the decision to close a manufacturing facility in
Tsukuba, Japan; $4.7 million for terminations of leases and maintenance
contracts primarily in the U.S. and Europe; $ 1.7 million for non-cancelable
purchase commitments primarily in Europe; $13.1 million in fixed asset and other
asset write-downs primarily in the U.S., Japan, and Europe; and approximately
$2.4 million in other exit costs, which result principally from the
consolidation and closure of certain design centers, sales and administrative
offices primarily in the U.S. and Europe; and work force reduction costs of
$16.3 million. The work force reduction costs primarily include severance costs
related to involuntary termination of employment for approximately 900 employees
from manufacturing in Japan, and engineering, sales, marketing and finance
personnel located primarily in the U.S., Japan and Europe. The fair value of
assets determined to be impaired in accordance with the guidance in Statement of
Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of" were the
result of independent appraisals and use of management estimates. Severance
costs and other above noted exit costs were determined in accordance with
Emerging Issues Task Force No. 94-3 "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity". The restructuring
actions, as outlined by the plan, are intended to be executed to completion by
September 30, 1999, one year from the date the reserve was taken.
Interest expense increased $5.9 million and $4.4 million for the three and nine
month periods ended September 30, 1998 as compared to the same period in the
prior year. The results are relatively the same excluding Symbios. The increase
for the three and nine month periods ended September 1998 is primarily
attributable to interest on the new credit facility entered into during the
third quarter of 1998 as discussed in Note 4 to the Unaudited Condensed
Consolidated Financial Statements, offset in part by interest capitalized as
part of the construction at the Company's new manufacturing facility in Gresham,
Oregon.
Interest income and other expense decreased $29.7 million and $32.6 million for
the three and nine month periods ended September 30, 1998 to a net expense of
$20.4 million and $7.2 million, respectively, as compared to the same periods in
1997. The decrease is primarily a result of the combination of a $14.4 million
write-down of the Company's equity investment in two non-public technology
companies with impairment indicators not considered to be temporary (see Note 8
to the Unaudited Consolidated Condensed Financial Statements), a $1.5 million
loss from the decision to close the interest rate swap at LLJSI (see Note 5 to
the Unaudited Condensed Consolidated Financial Statements), a $1.8 million
write-down of capitalized software and a $8.1 million write-down of fixed assets
to be disposed of along with a reduction of interest income generated from the
Company's lower average balances of cash and cash equivalents and short-term
investments during the third quarter and the first nine months of 1998 resulting
from cash outlays for the acquisition of Symbios as compared to same periods in
the prior year. The decrease in interest income and other during the first nine
months of 1998 is attributable to the items noted above offset in part by gains
from the sale of a building owned by a European affiliate in the second quarter
of 1998.
The Company recorded a (benefit)/provision for income taxes for the first three
and nine months of 1998 with an effective rate of (7.5)% and 3.1%, respectively
compared to a provision for income taxes of 28% for the three and nine months
ended September 30, 1997. The rate change is due to write-offs relating to
in-process research and development and restructuring charges during the third
18
<PAGE> 19
quarter of 1998 which are not currently deductible for tax purposes. Excluding
these charges, the effective tax rate would have been 25%, consistent with the
rate in the first half of 1998.
FINANCIAL CONDITION AND LIQUIDITY
The Company's cash, cash equivalents and short-term investments decreased $263
million during the first nine months of 1998 to $228 million from $491 million
at the end of 1997. The decrease is primarily due to cash used to acquire
Symbios in the third quarter of 1998, purchases of property and equipment and
higher amounts of cash used in the Company's operations. Working capital
decreased $255 million to $177 million at September 30, 1998 from $432 million
at December 31, 1997. The decrease in working capital is primarily a result of
cash reserves used to acquire Symbios and higher current liabilities as a result
of the short-term portion of the new debt facility entered into to by the
Company to purchase Symbios (see Note 4 to the Unaudited Consolidated Condensed
Financial Statements).
During the first nine months of 1998, the Company generated approximately $140
million of cash and cash equivalents from its operating activities compared with
$320 million during the same period in 1997. The decrease in cash and cash
equivalents provided from operations during the first nine months of 1998 as
compared to the same period a year ago is primarily attributable to decreases in
net income before depreciation and amortization, the in-process research and
development write-off and the non-cash restructuring charge, coupled with
decreases in accounts payable and accrued and other liabilities and lower
increases in accounts receivable, inventories and other assets as compared to
the same period in the previous year. The decrease in accounts payable reflects
a combination of factors primarily related to the timing of invoice receipt and
payment compared to the previous period and lower capital expenditures in the
first nine months of 1998 relative to the same period in the prior year for the
Company's manufacturing facility in Gresham, Oregon as it approaches completion.
This decrease in accounts payable is offset in part by the inclusion of Symbios
liabilities in the financial statements at September 30, 1998 (see Note 2 to the
Unaudited Consolidated Financial Statements). The decrease in accrued and other
liabilities is primarily attributable to lower income tax accruals resulting
primarily from lower taxable income and a lower effective income tax rate during
the first three quarters of 1998 as compared to the same period in 1997 offset
in part by the inclusion of Symbios in the financial statements at September 30,
1998 (see Note 2 to the Unaudited Consolidated Condensed Financial Statements)
which were not included for the same period in 1997.
Cash and cash equivalents used for investing activities during the first nine
months of 1998 were $706 million compared to $298 million during the same period
in 1997. The primary investing activities during the first nine months of 1998,
other than short-term investments in available for sale debt and equity
securities, included the purchase of Symbios, purchases of property and
equipment and additional investments in non-marketable shares of other
technology companies. The increase in cash used for investing activities from
the first nine months of 1998 as compared to the same period in 1997 is
primarily attributable to an increase from the purchase of Symbios, offset in
part by a decrease in purchases of property and equipment, net of retirements
and refinancings. The Company believes that maintaining technological leadership
in the highly competitive worldwide semiconductor industry requires substantial
ongoing investment in advanced manufacturing capacity. Capital additions were
$232 million and $348 million, net of retirements and refinancings, during the
first nine months of 1998 and 1997, respectively. The additions were primarily
for costs related to the new eight-inch wafer manufacturing facility in Gresham,
Oregon. The Company expects to spend approximately $25 million to bring the
Gresham facility to operational status during the fourth quarter of 1998.
Cash and cash equivalents provided by financing activities during the first nine
months of 1998 totaled approximately $602 million, compared to $31 million of
cash used in the same period of 1997. The primary financing activities during
the first nine months of 1998 are attributable to the new debt facility entered
into to fund the purchase of Symbios (see Note 4 to the Unaudited Condensed
Consolidated Financial Statements), net of debt repayments and the repurchase of
445,000 shares of common stock during the third quarter for approximately $6
million, offset in part by the issuance of common stock associated with the
employee stock purchase plan and employee stock option exercises. In the first
nine months of 1997, the primary activities from financing activities included
repayments of debt obligations offset in part by the issuance of common stock
associated with the employee stock purchase plan, employee stock option
exercises and the Company's repurchase of 400,000 shares of common stock for
approximately $13 million during the third quarter of 1997.
On August 5, 1998, the Company entered into a credit agreement by and among the
Company, LSI Logic Japan Semiconductor, Inc., a wholly owned subsidiary of the
Company ("LLJSI") and ABN AMRO Bank N.V. ("ABN AMRO"). The credit agreement was
restated and superseded by the Amended and Restated Credit Agreement dated as of
September 22, 1998 by and among the Company, LLJSI, ABN AMRO and thereafter
syndicated to a group of lenders determined by ABN AMRO. The credit agreement
consists of
19
<PAGE> 20
two credit facilities: a $575 million senior unsecured reducing revolving credit
facility ("Revolver"), and a $150 million senior unsecured revolving credit
facility ("364 day Facility").
On August 5, 1998, the Company borrowed $150 million under the 364 day Facility
and $485 million under the Revolver. The credit facilities allow for borrowings
at adjustable rates. Interest payments are due quarterly. The 364 day Facility
expires on August 3, 1999 at which time borrowings outstanding are payable in
full. The Revolver is for a term of four years with principal payments due
quarterly beginning on December 31, 1999. The Revolver includes a term loan
sub-facility in the amount of 8.6 billion yen made available to LLJSI over the
same term. The yen term loan sub-facility is for a period of four years with no
required payments until it expires on August 4, 2002. Pursuant to the above
noted restated credit agreement, on August 30, 1998, LLJSI repaid it's existing
11.4 billion yen ($79.2 million) credit facility and borrowed 8.6 billion yen
($59.7 million) bearing interest at adjustable rates. Borrowings outstanding
under the 364 day Facility and the Revolver including the yen sub-facility were
$694.7 million as of September 30, 1998.
The Company, in accordance with the new credit arrangement, must comply with
certain financial covenants related to profitability, tangible net worth,
working capital, senior and total debt leverage and subordinated indebtedness.
At September 30, 1998, the Company was in compliance with these covenants.
In December 1996, the Company entered into a credit arrangement with several
banks for a $300 million revolving line of credit expiring in December 1999. The
Company canceled this agreement on July 31, 1998.
The Company believes that its existing liquid resources and funds generated from
operations combined with funds from such financing and its ability to borrow
funds will be adequate to meet its operating and capital requirements and
obligations through the foreseeable future. There can be no assurance that such
additional financing will be available when needed or, if available, will be on
favorable terms. Any future equity financing will decrease existing
stockholders' equity percentage ownership and may, depending on the price at
which the equity is sold, result in dilution.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 1998, the Accounting Standards Executive Committee ("AcSEC") released
Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of Start-up
Activities". The new SOP is effective for fiscal years beginning after December
15, 1998 and requires companies to expense all costs incurred or unamortized in
connection with start-up activities. The Company will expense the unamortized
preproduction balance as of January 1, 1999 and present it as a cumulative
effect of a change in accounting principle in accordance with SOP 98-5.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. It further provides criteria for derivative instruments to be
designated as fair value, cash flow and foreign currency hedges, and establishes
respective accounting standards for reporting changes in the fair value of the
instruments. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Upon adoption of SFAS 133, the Company will be
required to adjust hedging instruments to fair value in the balance sheet, and
recognize the offsetting gain or loss as transition adjustments to be reported
in net income or other comprehensive income, as appropriate, and presented in a
manner similar to the cumulative effect of a change in accounting principle.
While the Company believes the adoption of this statement will not have a
material effect on the Company's results of operations as most derivative
instruments are closed on the last day of each fiscal quarter, the impact of the
adoption of SFAS 133 as of the effective date cannot be reasonably estimated at
this time.
20
<PAGE> 21
PART II
Item 1 Legal Proceedings
Reference is made to Item 3, Legal Proceedings, of the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997 for a discussion of
certain pending legal proceedings. The information provided at such reference
regarding those matters remains unchanged, except that the Delaware Supreme
Court affirmed the dismissal of the case granted in January 1998 by the Court of
Chancery. The Company continues to believe that the final outcome of such
matters will not have a material adverse effect on the Company's consolidated
financial position or results of operations. No assurance can be given, however,
that these matters will be resolved without the Company becoming obligated to
make payments or to pay other costs to the opposing parties, with the potential
for having an adverse effect on the Company's financial position or its results
of operations.
Item 5 Other Information.
Stockholder Proposals
Proposals of stockholders intended to be presented at the Company's 1999 annual
meeting of stockholders must be received at the Company's principal executive
offices not later than November 26, 1998 in order to be included in the
Company's proxy statement and form of proxy relating to the 1999 annual meeting.
Pursuant to new amendments to Rule 14a-4(c) of the Securities Exchange Act of
1934, as amended, if a stockholder who intends to present a proposal at the 1999
annual meeting of stockholders does not notify the Company of such proposal on
or prior to February 7, 1999, then management proxies would be allowed to use
their discretionary voting authority to vote on the proposal when the proposal
is raised at the annual meeting, even though there is no discussion of the
proposal in the 1999 proxy statement.
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedules
(b) Reports on Form 8-K
Pursuant to a Current Report on Form 8-K filed on July 2, 1998 the
Registrant reported the agreement to acquire all of the outstanding
capital stock of Symbios, Inc.
Pursuant to a Current Report on Form 8-K filed on August 21, 1998 the
Registrant reported the completion of the acquisition of all of the
outstanding capital stock of Symbios, Inc.
Pursuant to Amendment No. 1 to the Form 8-K filed on August 21, 1998,
filed on a Form 8-K/A on October 20, 1998 the Registrant filed Symbios
audited historical financial statements for the year ended December
31, 1997 and the unaudited financial statements for the six months
ending June 30, 1998 and pro forma financial statements reflecting the
acquisition of all of the outstanding stock of Symbios, Inc.
Pursuant to Amendment No. 2 to the Form 8-K/A filed on October 20,
1998, filed on a Form 8-K/A on March 31, 1999 the Registrant filed
restated pro forma financial statements reflecting the acquisition of
all of the outstanding stock of Symbios, Inc.
21
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LSI LOGIC CORPORATION
(Registrant)
Date: April 7, 1999 By /s/ R. Douglas Norby
------------------------------------
R. Douglas Norby
Executive Vice President Finance &
Chief Financial Officer
22
<PAGE> 23
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
27.1 Financial Data Schedule
27.2 Financial Data Schedule
</TABLE>
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 134,713
<SECURITIES> 93,269
<RECEIVABLES> 287,154
<ALLOWANCES> 3,152
<INVENTORY> 183,946
<CURRENT-ASSETS> 791,507
<PP&E> 2,108,808
<DEPRECIATION> 698,658
<TOTAL-ASSETS> 2,658,602
<CURRENT-LIABILITIES> 614,523
<BONDS> 0
0
0
<COMMON> 1,405
<OTHER-SE> 1,439,753
<TOTAL-LIABILITY-AND-EQUITY> 2,658,602
<SALES> 1,045,316
<TOTAL-REVENUES> 1,045,316
<CGS> 579,685
<TOTAL-COSTS> 579,685
<OTHER-EXPENSES> 590,828
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (5,917)
<INCOME-PRETAX> (138,351)
<INCOME-TAX> 4,294
<INCOME-CONTINUING> (142,645)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (142,645)
<EPS-PRIMARY> (1.02)
<EPS-DILUTED> (1.02)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 136,183
<SECURITIES> 507,732
<RECEIVABLES> 221,824
<ALLOWANCES> 3,749
<INVENTORY> 100,894
<CURRENT-ASSETS> 1,041,608
<PP&E> 1,634,099
<DEPRECIATION> 610,049
<TOTAL-ASSETS> 2,184,536
<CURRENT-LIABILITIES> 462,218
<BONDS> 0
0
0
<COMMON> 1,417
<OTHER-SE> 1,581,296
<TOTAL-LIABILITY-AND-EQUITY> 2,184,536
<SALES> 967,239
<TOTAL-REVENUES> 967,239
<CGS> 496,848
<TOTAL-COSTS> 496,848
<OTHER-EXPENSES> 315,604
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 178,697
<INCOME-TAX> 50,173
<INCOME-CONTINUING> 128,524
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 128,524
<EPS-PRIMARY> 0.93
<EPS-DILUTED> 0.90
</TABLE>
