<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 27, 1999
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)
<TABLE>
<S> <C>
DELAWARE 94-2712976
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
</TABLE>
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 July 26, 1999 there were 147,391,417 of the registrant's Common
Stock, $.01 par value, outstanding.
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LSI LOGIC CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 27, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets -- June 30, 1999 and
December 31, 1998........................................... 3
Consolidated Condensed Statements of
Operations -- Three-Month and Six-Month Periods Ended June
30, 1999 and 1998........................................... 4
Consolidated Condensed Statements of Cash Flows -- Six-Month
Periods Ended June 30, 1999 and 1998........................ 5
Management's Discussion and Analysis of Results of
Operations and Financial Condition.......................... 6
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 29
Item 4. Submission of Matters to a Vote of Security Holders......... 29
Item 5. Other Information........................................... 29
Item 6. Exhibits and Reports on Form 8-K............................ 30
</TABLE>
2
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------- ------------
<S> <C> <C>
Cash and cash equivalents................................... $ 190,530 $ 210,306
Short-term investments...................................... 154,613 81,220
Accounts receivable, less allowance for doubtful accounts of
$4,914 and $3,537......................................... 333,831 249,106
Inventories................................................. 191,485 181,440
Deferred tax assets......................................... 62,699 62,699
Prepaid expenses and other current assets................... 44,030 52,250
---------- ----------
Total current assets.............................. 977,188 837,021
---------- ----------
Property and equipment, net................................. 1,246,541 1,486,256
Goodwill and other intangibles.............................. 316,705 332,779
Other assets................................................ 215,281 167,749
---------- ----------
Total assets...................................... $2,755,715 $2,823,805
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 172,032 $ 195,228
Accrued salaries, wages and benefits........................ 67,632 47,988
Other accrued liabilities................................... 103,352 109,236
Income taxes payable........................................ 43,719 57,993
Current portion of long-term obligations.................... 72,051 187,852
---------- ----------
Total current liabilities......................... 458,786 598,297
---------- ----------
Long-term obligations and deferred income taxes............. 805,778 695,797
Minority interest in subsidiaries........................... 5,068 5,238
Commitments and contingencies............................... -- --
Stockholders' equity:
Preferred shares; $.01 par value; 2,000 shares
authorized............................................. -- --
Common stock; $.01 par value; 450,000 shares authorized;
145,967 and 143,867 shares outstanding................. 1,460 1,439
Additional paid-in capital.................................. 1,159,402 1,135,219
Retained earnings........................................... 290,445 368,378
Accumulated other comprehensive income...................... 34,776 19,437
---------- ----------
Total stockholders' equity........................ 1,486,083 1,524,473
---------- ----------
Total liabilities and stockholders' equity........ $2,755,715 $2,823,805
========== ==========
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
3
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LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues.............................................. $501,012 $336,272 $964,629 $669,002
-------- -------- -------- --------
Costs and expenses:
Cost of revenues.................................... 314,398 179,844 616,289 367,392
Research and development............................ 75,046 65,943 151,569 130,857
Selling, general and administrative................. 62,783 52,404 124,272 97,601
Acquired in-process research and development........ 4,600 -- 4,600 --
Restructuring of operations and other non-recurring
charges.......................................... 7,848 -- 5,871 --
Amortization of intangibles......................... 11,815 1,386 23,022 2,772
-------- -------- -------- --------
Total costs and expenses......................... 476,490 299,577 925,623 598,622
-------- -------- -------- --------
Income from operations................................ 24,522 36,695 39,006 70,380
Interest expense...................................... (9,620) (95) (20,200) (175)
Interest income and other expense..................... 2,459 5,470 4,195 13,480
-------- -------- -------- --------
Income before income taxes and cumulative effect of
change in accounting principle...................... 17,361 42,070 23,001 83,685
Provision for income taxes............................ 7,530 10,691 9,160 20,890
-------- -------- -------- --------
Income before cumulative effect of change in
accounting principle................................ 9,831 31,379 13,841 62,795
Cumulative effect of change in accounting principle... -- -- (91,774) --
-------- -------- -------- --------
Net income/(loss)..................................... $ 9,831 $ 31,379 $(77,933) $ 62,795
======== ======== ======== ========
Basic earnings per share:
Income before cumulative effect of change in
accounting principle............................. $ 0.07 $ 0.22 $ 0.10 $ 0.44
Cumulative effect of change in accounting
principle........................................ -- -- (0.64) --
-------- -------- -------- --------
Net income/(loss)................................... $ 0.07 $ 0.22 $ (0.54) $ 0.44
======== ======== ======== ========
Dilutive earnings per share:
Income before cumulative effect of change in
accounting principle............................. $ 0.06 $ 0.22 $ 0.09 $ 0.43
Cumulative effect of change in accounting
principle........................................ -- -- (0.61) --
-------- -------- -------- --------
Net income/(loss)................................... $ 0.06 $ 0.22 $ (0.52) $ 0.43
======== ======== ======== ========
Shares used in computing per share amounts:
Basic............................................... 145,622 143,168 144,883 142,868
======== ======== ======== ========
Dilutive............................................ 151,947 144,719 149,614 144,377
======== ======== ======== ========
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
4
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LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
1999 1998
--------- ---------
<S> <C> <C>
Operating activities:
Net (loss)/income........................................... $ (77,933) $ 62,795
Adjustments:
Depreciation and amortization............................. 190,752 91,701
Write-off of unamortized preproduction costs.............. 97,356 --
Acquired in-process research and development.............. 4,600 --
Non-cash restructuring and other non-recurring charges.... 827 --
Changes in:
Accounts receivable.................................... (87,639) (26,754)
Inventories............................................ (11,499) (3,191)
Prepaid expenses and other assets...................... 2,935 (29,363)
Accounts payable....................................... (26,091) (33,690)
Accrued and other liabilities.......................... 7,040 6,119
--------- ---------
Net cash provided by operating activities................... 100,348 67,617
--------- ---------
Investing activities:
Purchases of debt and equity securities
available-for-sale..................................... (198,577) (253,249)
Maturities and sales of debt and equity securities
available-for-sale..................................... 125,014 361,267
Purchase of equity securities............................. (117) (6,866)
Acquisition of a non-public technology company............ (6,779) --
Purchases of property and equipment, net of retirements... (28,503) (148,274)
--------- ---------
Net cash used for investing activities...................... (108,962) (47,122)
--------- ---------
Financing activities:
Proceeds from borrowings.................................. 345,000 --
Repayment of debt obligations............................. (368,302) (736)
Debt issuance costs....................................... (9,488) --
Issuance of common stock, net............................. 24,204 12,356
--------- ---------
Net cash (used for)/provided by financing activities........ (8,586) 11,620
--------- ---------
Effect of exchange rate changes on cash and cash
equivalents............................................... (2,576) (5,185)
--------- ---------
(Decrease)/increase in cash and cash equivalents............ (19,776) 26,930
Cash and cash equivalents at beginning of period............ 210,306 114,087
--------- ---------
Cash and cash equivalents at end of period.................. $ 190,530 $ 141,017
========= =========
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
5
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LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
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 except as noted below for unamortized
preproduction, acquired in-process research and development as discussed in Note
3 and the restructuring expenses as discussed in Note 5) 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/A for the year ended December 31, 1998.
On June 22, 1999, the Company completed a merger of Stealth Acquisition
Corporation, a wholly-owned subsidiary of the Company, with SEEQ Technology,
Inc. ("SEEQ") in a transaction accounted for as a pooling of interests, and SEEQ
became a wholly owned subsidiary of the Company. All financial information has
been restated retroactively to reflect the combined operations of the Company
and SEEQ as if the merger had occurred at the beginning of the earliest period
presented (see Note 2). Prior to the merger, SEEQ's fiscal year-end was the last
Sunday in September of each year whereas the Company operates on a year ending
on December 31.
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 condensed financial statements refer to the quarter's calendar
month end for convenience. The results of operations for the quarter ended June
30, 1999 are not necessarily indicative of the results to be expected for the
full year.
On April 14, 1999, the Company acquired all of outstanding capital stock of
ZSP Corporation. ("ZSP") in a merger transaction accounted for as a purchase.
Accordingly, the results of operations of ZSP and estimated fair value of assets
acquired and liabilities assumed were included in the Company's consolidated
condensed financial statements as of April 14, 1999, the effective date of the
purchase, through the end of the period (see Note 3). There are no significant
differences between the accounting policies of the Company and ZSP.
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 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 has
expensed the unamortized preproduction balance of $92 million associated with
the Gresham manufacturing facility, net of tax, on January 1, 1999 and has
presented it as a cumulative effect of a change in accounting principle in
accordance with SOP No. 98-5.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
condensed financial statements and the reported amounts of revenues and expenses
during the reported period. Actual results could differ from those estimates.
Certain items previously reported in specific financial statement captions
have been reclassified to conform with the 1999 presentation.
During the second quarter of 1999, one customer represented 11% of the
Company's consolidated revenues. There were no customers with revenues greater
than or equal to 10% of total consolidated revenues for the six months ended
June 30, 1999.
This Current Report on Form 10-Q 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. Actual results could differ significantly from
those projected in the forward-looking statements as a result of a number
6
<PAGE> 7
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
of risks and uncertainties, including the risk factors set forth in the
Company's Annual Report on Form 10-K/A for the year ended December 31, 1998 as
well as other periodic reports both previously and hereafter filed by the
Company with the Securities Exchange Commission. Statements made herein are as
of the date of the filing of this 10-Q with the Securities and Exchange
Commission and should not be relied upon as of any subsequent date. The Company
expressly disclaims any obligation to update information presented herein,
except as may otherwise be required by law.
NOTE 2 -- ACQUISITION OF SEEQ
As discussed in Note 1, on June 22, 1999, the Company completed a merger
with SEEQ. SEEQ was formed in January 13, 1981 to engage in the development,
production and sale of state-of-the-art, high technology semiconductor devices.
The stock for stock transaction was approved by the shareholders of SEEQ. As a
result of the merger, the separate existence of SEEQ ceased. Under the terms of
the Agreement and Plan of Reorganization and Merger, SEEQ's shareholders
received 0.0759 of a share of the Company's common stock for each SEEQ share.
Accordingly, the Company will issue up to 2.5 million shares of its common stock
for all the outstanding shares of SEEQ common stock. Additionally, outstanding
options to acquire SEEQ common stock were converted to options to acquire 0.4
million shares of the Company's common stock.
The merger was accounted for as a pooling of interests. Accordingly, the
Company's financial statements have been restated retroactively to include the
financial results of SEEQ for all periods presented. SEEQ's results of
operations are insignificant to the combined financial results (less than 3% by
income statement line item for the six months ended June 30, 1999), and
accordingly, separate results of operations of SEEQ and LSI are not presented.
Adjustments to conform accounting policies of SEEQ to those of LSI were not
significant to the combined financial results. There were no inter-company
transactions between the two companies for the periods presented.
Restructuring and merger related expenses associated with the SEEQ merger
In connection with the merger with SEEQ on June 22, 1999, LSI recorded $3
million in restructuring charges and $5 million in merger related expenses. The
merger expenses relate primarily to investment banking and other professional
fees directly attributable to the merger with SEEQ. The restructuring charge is
comprised of $2 million in write-downs of fixed assets which are duplicative to
the combined company, $0.5 million of exit costs relating to non-cancelable
building lease contracts and $0.5 million provision for severance costs related
to the involuntary termination of certain employees. The exit costs and employee
severance costs were recorded in accordance with EITF No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity". The fixed and other assets write-downs were recorded in accordance
with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." The restructuring actions as outlined by
the restructuring plan are intended to be completed by June 30, 2000, one year
from the date the reserve was taken. There was no activity against the SEEQ
restructuring reserves in the second quarter of 1999.
NOTE 3 -- ACQUISITION OF ZSP
As discussed in Note 1, on April 14, 1999, the Company acquired all of
outstanding capital stock of ZSP, a semiconductor company without a fabrication
facility that designs and markets programmable digital signal processors
("DSPs"). The acquisition was accounted for as a purchase. Accordingly, the
results of operations of ZSP and estimated fair value of assets acquired and
liabilities assumed were included in the Company's consolidated condensed
financial statements as of April 14, 1999, the effective date of the purchase,
through
7
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LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
the end of the period. There are no significant differences between the
accounting policies of the Company and ZSP.
The Company paid approximately $7 million in cash which included direct
acquisition costs of $0.6 million for investment banking legal and accounting
fees and liabilities assumed of $4.3 million. The total purchase price of $11.3
million was allocated to the estimated fair value of assets acquired and
liabilities assumed based on independent appraisals, where appropriate and
management estimates as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
Fair value of tangible net (liabilities)/assets............. $ (301)
In-process research and development......................... 4,600
Other current technology.................................... 2,600
Excess of purchase price over net assets acquired........... 4,370
-------
$11,269
=======
</TABLE>
The Company accrued approximately $0.7 million of exit costs for a
non-cancelable building lease contract and to prepare the building for sublease.
The exit costs were accrued as a liability assumed in the purchase price
allocation in accordance with EITF No. 95-3, "Recognition of Liabilities in
Connection with a Purchase Business Combination." The Company expects no other
additional liabilities that may result in an adjustment to the allocation of the
purchase price.
In-process research and development:
In connection with the purchase of ZSP, the Company recorded a $4.6 million
charge to in-process research and development during the second quarter of 1999.
The amount was determined by identifying research projects for which
technological feasibility had not been established and no alternative future
uses existed. The Company acquired ZSP's in-process DSP research and development
project that was targeted at the telecommunications market. This product is
being developed specifically for voice over net or voice over internet protocol
applications and is intended to have substantial incremental functionality,
greatly improved speed and a wider range of interfaces than ZSP's current
technology.
The value of the one project identified to be in progress was determined by
estimating the future cash flows from the project once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value. The percentage of completion
for the project was determined using milestones representing management's
estimate of effort, value added and degree of difficulty of the portion of the
project completed as of April 14, 1999, as compared to the remaining research
and development to be completed to bring the 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 (i) researching the market
requirements and the engineering architecture and feasibility studies, (ii)
design and verification milestones, and (iii) prototyping and testing the
product (both internal and customer testing). Development of ZSP's digital
signal processor project started in May 1998. As of April 14, 1999, the Company
estimated that the project was 65% complete.
However, development of the technology remains a substantial risk to the
Company due to factors including the remaining effort to achieve technical
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired. Company management believes that the in-process research and
development charge of $4.6 million is valued consistently with the SEC staff's
view regarding valuation methodologies. There can be no assurance, however, that
the SEC staff will not take issue with any assumptions used in the Company's
8
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LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
valuation model and require the Company to revise the amount allocated to
in-process research and development.
Useful life of intangible assets:
The amount allocated to current technology and residual goodwill is being
amortized over their estimated weighted average useful life of seven years using
a straight-line method.
NOTE 4 -- LICENSE AGREEMENT
The Company and Wafer Technology (Malaysia) Sdn. Bhd. ("WTM") are currently
definitizing an agreement under which the Company will grant licenses to WTM
with respect to certain of the Company's wafer fabrication technologies and will
provide associated manufacturing training and related services. In exchange, the
Company will receive cash and equity consideration preliminarily valued at $120
million over the period for which transfers and obligations of the Company are
scheduled to occur. Pursuant to an interim agreement, the Company has performed
certain obligations which were valued at $3.0 million. This amount was recorded
as an offset to the Company's research and development expenses during the
quarter ended June 30, 1999.
NOTE 5 -- RESTRUCTURING
SEEQ restructuring
In connection with the merger with SEEQ on June 22, 1999, LSI recorded $3
million in restructuring charges and $5 million in merger related expenses (see
Note 2). There were no changes to the SEEQ restructuring reserves in the second
quarter of 1999.
Restructuring reserve activity
During the second quarter of 1999, the Company utilized $1.1 million in
restructuring reserves which were originally established in the third quarter of
1998. The amounts utilized reflect severance payments of $0.6 million for
approximately 130 employees terminated during the second quarter and $0.5
million for lease terminations and other exit costs primarily in the U.S. and
Europe. See table below describing the 1998 restructuring.
During the first quarter of 1999, the Company determined that $2.5 million
of the restructuring reserve established in the third quarter of 1998 would not
be utilized because of a change in management's estimate of the reserve
requirements in the U.S., Europe and Japan. Accordingly, the restructuring
reserve reversal was included in the determination of income from operations for
the six month period ended June 30, 1999. The remaining restructuring reserve
activity in the first quarter is described in the table below.
Description of 1998 restructuring:
The Company remains committed to improving profitability and strengthening
competitiveness. As a result of identifying opportunities to streamline
operations and maximize the integration of Symbios, Inc. ("Symbios") acquired on
August 6, 1998 (see Note 6) into the Company's operations, the Company's
management, with the approval of the Board of Directors, committed itself to a
restructuring plan 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
costs relating to Symbios. As discussed in Note 6 of Notes to the Unaudited
Consolidated Condensed Financial Statements, integration costs relating to
Symbios were accrued
9
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LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
as a liability assumed in the purchase in accordance with EITF No. 95-3,
"Recognition of Liabilities in Connection with a Purchase Business Combination."
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 by the third quarter of 1999; $4.7 million for termination 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;
approximately $2.4 million in other exit costs, which result principally from
the consolidation and closure of certain design centers, sales facilities and
administrative offices primarily in the U.S. and Europe; and work force
reduction costs of $16.3 million.
Other exit costs include $0.9 million related to payments made for early
lease contract terminations and the write-down of surplus assets to their
estimated realizable value; $0.7 million for the write-off of excess licenses
for closed locations in Europe and $0.8 million of other exit costs associated
with the consolidation of design centers worldwide.
The workforce 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 for assets to be held
and used in 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 EITF 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.
The following table sets forth the Company's 1998 restructuring reserves as
of December 31, 1998 and activity against the reserve for the six month period
ended June 30, 1999:
<TABLE>
<CAPTION>
(IN THOUSANDS)
RESERVE/ RESERVE/
BALANCE TRANSLATION BALANCE TRANSLATION BALANCE
12/31/98 UTILIZED ADJUSTMENT 3/31/99 UTILIZED ADJUSTMENT 6/30/99
-------- -------- ----------- ------- -------- ----------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Write-down of manufacturing
facility(a)........................ $ 1,500 $ -- $(1,100) 400 $ 400
Other fixed asset related charges.... -- -- -- --
Payments to employees for
severance(b)....................... 11,600 (6,140) (820) 4,640 (640) 4,000
Lease terminations and maintenance
contracts(c)....................... 4,600 (550) (83) 3,967 (367) 3,600
Noncancelable purchase
commitments(c)..................... 1,600 (80) -- 1,520 1,520
Other exit costs(d).................. 1,200 (326) (530) 344 (124) 220
Cumulative currency translation
adjustment......................... 1,512 -- (500) 1,012 -- (400) 612
------- ------- ------- ------- ------- ----- -------
Total....................... $22,012 $(7,096) $(3,033) $11,883 $(1,131) $(400) $10,352
======= ======= ======= ======= ======= ===== =======
</TABLE>
- ---------------
(a) The $1.5 million balance at 12/31/98 for the write-down of the facility
related to machinery and equipment decommissioning costs.
(b) Amounts utilized represent cash payments related to the severance of
approximately 350 employees since 12/31/98 (approximately 130 in Q2 1999).
(c) Amounts utilized represent cash charges.
(d) Amounts utilized represent non-cash charges.
The Company expects to complete the activities underlying the restructuring
plan by September 1999.
10
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LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6 -- INTEGRATION OF SYMBIOS
On August 6, 1998, the Company completed the acquisition of all of the
outstanding capital stock of Symbios, Inc. 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 financial statements as of August 6, 1998, the effective
date of the purchase, through the end of the period. There are no significant
differences between the accounting policies of the Company and Symbios. The
allocation of the purchase price was disclosed in the Report on Form 10K/A for
the year ended December 31, 1998 previously filed with the Securities and
Exchange Commission.
The Company has taken certain actions to combine the Symbios operations
with those of 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. The Company finalized the integration plan as of December 31, 1998.
Accrued integration charges included $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 were based upon management's current
estimate of integration costs and are in accordance with EITF No. 95-3,
"Recognition of Liabilities in Connection with a Purchase Business Combination."
The following table sets forth the Company's Symbios integration reserve as
of December 31, 1998 and activity against the reserve for the six month period
ended June 30, 1999:
<TABLE>
<CAPTION>
(IN THOUSANDS)
DECEMBER 31, JUNE 30,
1998 1999
BALANCE UTILIZED BALANCE
-------------- -------- --------
<S> <C> <C> <C>
Payments to employees for severance and
relocation(a)...................................... $2,360 $(1,624) $ 736
Other exit costs(a).................................. 1,002 (474) 528
------ ------- ------
Total...................................... $3,362 $(2,098) $1,264
====== ======= ======
</TABLE>
- ---------------
(a) The amount utilized represents cash payments related to the severance and
relocation of approximately 160 employees. Utilization in Q2 1999 primarily
reflects severance payments of $0.4 million for 29 employees and other exit
costs of $0.5 million.
No significant adjustments were made to the reserve during the periods
presented. The Company expects to complete the activities underlying the
integration plan by August 1999.
NOTE 7 -- INVESTMENTS
The Company classifies its debt and marketable equity securities into an
available-for-sale category and values them at fair value in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," with unrealized gains and losses, net of taxes, reported in
shareholders' equity until realized. For all investment securities, unrealized
losses that are other than temporary are recognized in net income. Gains and
losses on securities sold are based on the specific identification method and
are reflected in net income. The Company currently does not actively trade
securities.
Short-term investments consist 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. As of June 30, 1999 and
December 31, 1998, the Company held $155 million and $81 million of
available-for-sale
11
<PAGE> 12
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
securities, respectively, that were classified as short-term investments on the
consolidated balance sheet. Short-term investments are recorded at amortized
cost, plus accrued interest, which approximates fair market value at June 30,
1999 and December 31, 1998. The contract maturities of these securities are
within one year. Realized gains and losses were not significant during the
quarters ended June 30, 1999 and 1998.
The Company held marketable equity securities with an aggregate carrying
value of $49 million that were classified as long-term assets on the
consolidated balance sheet as of June 30, 1999. There were no significant
investments in marketable equity securities as of December 31, 1998 as the
companies became publicly traded during the six month period ended June 30,
1999. Unrealized gains, net of the related tax effect, of $28 million are
included in accumulated other comprehensive income as of June 30, 1999. During
the quarter, realized gains and losses were not significant.
NOTE 8 -- 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.
As of June 30, 1999 and December 31, 1998, there were no interest rate swap or
currency swap contracts outstanding.
The Company enters into forward contracts and currency swaps to hedge firm
intercompany asset and liability positions denominated in non-functional
currencies. The following table summarizes by major currency the forward
exchange contracts outstanding as of June 30, 1999 and December 31, 1998. The
buy amounts represent the U.S. dollar equivalent of commitments to purchase
foreign currencies, and the sell amounts represent the U.S. dollar equivalent of
commitments to sell foreign currencies. Foreign currency amounts are translated
at rates current at June 30, 1999 and December 31, 1998.
<TABLE>
<CAPTION>
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Buy/(Sell):
Japanese Yen.......................................... $ 8,954 $--
Japanese Yen.......................................... (3,264) --
</TABLE>
These forward contracts 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 the underlying
exposure materializes or the hedged transaction is no longer expected to occur.
Deferred foreign gains and losses were not significant at June 30, 1999 and
December 31, 1998. Foreign currency transaction gains and losses included in
interest income and other were insignificant for the three and six-month periods
ended June 30, 1999 and 1998.
Currency option contracts were treated as hedges of third-party yen revenue
exposures. At June 30, 1999, total outstanding purchased currency option
contracts were $20 million. These contracts expire in September 1999. At
December 31, 1998, total outstanding purchased currency option contracts were
$130 million. These contracts expired quarterly through June 1999. 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 $0.3 million as of June 30, 1999 and $6 million as of December 31,
1998. The deferred premiums were included in other current assets.
12
<PAGE> 13
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
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 LSI Logic Japan Semiconductor, Inc., a wholly
owned subsidiary of the Company ("JSI"), from adjustable to fixed rates. The
contracts were closed because the underlying debt was repaid as discussed in
Note 10. 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.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 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, 2000. Upon adoption of SFAS No. 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 we believe the adoption of this statement will not have a
significant effect on our results of operations, the impact of the adoption of
SFAS No. 133 as of the effective date cannot be reasonably estimated at this
time.
NOTE 9 -- BALANCE SHEET:
<TABLE>
<CAPTION>
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Inventories:
Raw materials........................................ $ 30,902 $ 32,347
Work-in-process...................................... 81,113 53,042
Finished Goods....................................... 79,470 96,051
-------- --------
Total...................................... $191,485 $181,440
======== ========
</TABLE>
The Company had $97 million of unamortized preproduction engineering costs
at December 31, 1998 associated with the construction of a new manufacturing
facility in Gresham, Oregon. This new facility became operational as of December
1, 1998, at which time capitalized preproduction began to be amortized over the
expected useful life of the manufacturing technology of approximately four
years. In April 1998, the AcSEC released SOP No. 98-5, "Reporting on the Costs
of Start-up Activities." SOP No. 98-5 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 has
expensed the unamortized preproduction balance of $92 million, net of tax, on
January 1, 1999 and has presented it as a cumulative effect of a change in
accounting principle in accordance with SOP No. 98-5.
NOTE 10 -- DEBT
During March 1999, the Company issued $345 million of 4 1/4% Convertible
Subordinated Notes (the "Convertible Notes") due in 2004. The Convertible Notes
are subordinated to all existing and future senior debt, are convertible 60 days
following issuance into shares of the Company's common stock at a conversion
price of $31.353 per share and are redeemable at the option of the Company, in
whole or in part, at any time on or after March 20, 2002. Each holder of the
Convertible Notes has the right to cause the Company to repurchase all of such
holder's Convertible Notes at 100% of their principal amount plus accrued
interest upon the occurrence of certain events and in certain circumstances.
Interest is payable semiannually. The Company
13
<PAGE> 14
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
paid approximately $9.5 million for debt issuance costs related to the
Convertible Notes. The debt issuance costs are being amortized using the
interest method. The net proceeds of the Convertible Notes were used to repay
borrowings under the Company's 364 day facility and the Revolver as described
below.
On August 5, 1998, the Company entered into a credit agreement with 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, JSI, ABN AMRO and thereafter syndicated to a group of lenders
determined by ABN AMRO and the Company. 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. On December 22, 1998, the Company
borrowed an additional $30 million under the Revolver. The credit facilities
allow for borrowings at adjustable rates of LIBOR/TIBOR with a 1.25% spread. As
of March 31, 1999 the spread changed to 1%. 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
the principal reduced 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 JSI 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 5,
2002. Pursuant to the restated credit agreement, on August 30, 1998, JSI repaid
its existing 11.4 billion yen ($79.2 million) credit facility and borrowed 8.6
billion yen ($71 million at June 30, 1999) bearing interest at adjustable rates.
In March of 1999, the Company repaid the full $150 million outstanding under the
364 day Facility and $185.5 million outstanding under the Revolver primarily
using the proceeds from the Convertible Notes as described above. Borrowings
outstanding under the Revolver including the yen sub-facility were $370 million
as of June 30, 1999. As of June 30, 1999, the interest rate for the Revolver and
the yen sub-facility were 5.96% and 1.14%, respectively. The debt issuance costs
associated with these debt facilities were not significant.
In accordance with the terms of its existing credit agreement, the Company
must comply with certain financial covenants related to profitability, tangible
net worth, liquidity, senior debt leverage, debt service coverage and
subordinated indebtedness. As of June 30, 1999, the Company was in compliance
with these covenants.
NOTE 11 -- 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")."
<TABLE>
<CAPTION>
(IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)
THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------------
1999 1998
----------------------------- -----------------------------
PER-SHARE PER-SHARE
INCOME* SHARES+ AMOUNT INCOME* SHARES+ AMOUNT
------- ------- --------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS:
Net income available to common
stockholders........................ $9,831 145,622 $0.07 $31,379 143,168 $0.22
Effect of dilutive securities:
Stock options.......................... 6,325 1,551
Diluted EPS:
Net income available to common
stockholders........................ $9,831 151,947 $0.06 $31,379 144,719 $0.22
</TABLE>
14
<PAGE> 15
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
Options to purchase 704,863 and 7,477,499 shares were outstanding at June
30, 1999 and 1998, respectively, but were not included in the calculation of
diluted shares for the three month periods ended June 30, 1999 and 1998 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
$41.88 to $58.13 and $25.31 to $58.13 at June 30, 1999 and 1998, respectively.
For the three months ended June 30, 1999, common equivalent shares of 11,003,732
and interest expense of $2 million, net of taxes, associated with the
Convertible Notes (see Note 10) were excluded from the computation of diluted
earnings per share as a result of their antidilutive effect on earnings per
share
<TABLE>
<CAPTION>
(IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS)
SIX MONTHS ENDED JUNE 30,
--------------------------------------------------------------
1999 1998
------------------------------ -----------------------------
PER-SHARE PER-SHARE
INCOME* SHARES+ AMOUNT INCOME* SHARES+ AMOUNT
-------- ------- --------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS:
Net income before cumulative effect
of change in accounting
principle......................... $ 13,841 144,883 $ 0.10 $62,795 142,868 $0.44
------ -----
Cumulative effect of change in
accounting principle.............. (91,774) 144,883 (0.64) -- -- --
------
Net (loss)/income available to common
stockholders...................... (77,933) 144,883 (0.54) 62,795 142,868 0.44
------ -----
Effect of dilutive securities:
Stock options........................ 4,731 1,509
Diluted EPS:
Net income before cumulative effect
of change in accounting
principle......................... 13,841 149,614 0.09 62,795 144,377 0.43
------ -----
Cumulative effect of change in
accounting principle.............. (91,774) 149,614 (0.61) -- -- --
------
Net (loss)/income available to common
stockholders...................... $(77,933) 149,614 $(0.52) $62,795 144,377 $0.43
------ -----
</TABLE>
- ---------------
* Numerator -- + Denominator
Options to purchase 2,952,522 and 7,189,109 shares were outstanding at June
30, 1999 and 1998, respectively, but were not included in the calculation of
diluted shares for the six month periods ended June 30, 1999 and 1998 because
the exercise prices were greater than the average market price of common shares
in each respective period. The exercise price ranges of these options were
$32.13 to $58.13 and $25.31 to $58.13 at June 30, 1999 and 1998, respectively.
For the six month period ended June 30, 1999, common equivalent shares of
6,243,690 and interest expense of $3 million, net of taxes, associated with the
Convertible Notes (see Note 10) were excluded from the computation of diluted
earnings per share as a result of their antidilutive effect on earnings per
share
15
<PAGE> 16
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12 -- 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 differences between net income and comprehensive income, for the
Company, are due to foreign currency translation adjustments and unrealized
gains on available-for-sale securities. Comprehensive income for the current
reporting and comparable period in the prior year is as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -------------------
1999 1998 1999 1998
------- ------- -------- -------
<S> <C> <C> <C> <C>
Comprehensive income/(loss)........ $21,438 $15,168 $(67,963) $47,220
</TABLE>
NOTE 13 -- SEGMENT REPORTING
The Company operates in two reportable segments: the Semiconductor segment
and the Storage Systems segment. In the Semiconductor segment, the Company
designs, develops, manufactures and markets integrated circuits, including
application-specific integrated circuits ("ASICs"), application-specific
standard products ("ASSPs") and related products and services. Semiconductor
design and service revenues include engineering design services, licensing of
LSI's advanced design tools software, and technology transfer and support
services. The Company's customers use these services in the design of
increasingly advanced integrated circuits characterized by higher levels of
functionality and performance. The proportion of revenues from ASIC design and
related services compared to semiconductor product sales varies among customers
depending upon their specific requirements. In the Storage Systems segment, the
Company designs, manufactures, markets and supports high performance data
storage management and storage systems solutions and a complete line of
Redundant Array of Independent Disks ("RAID") storage systems, subsystems and
related software.
The following is a summary of operations by segment for the three and
six-month periods ended June 30, 1999.
<TABLE>
<CAPTION>
(IN THOUSANDS)
THREE MONTHS ENDED
JUNE 30, 1999
--------------------------------------------
SEMICONDUCTOR STORAGE SYSTEMS TOTAL
------------- --------------- --------
<S> <C> <C> <C>
Revenue...................................... $434,047 $66,965 $501,012
Income from operations....................... $ 17,317 $ 7,205 $ 24,522
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1999
--------------------------------------------
SEMICONDUCTOR STORAGE SYSTEMS TOTAL
------------- --------------- --------
<S> <C> <C> <C>
Revenue...................................... $830,154 $134,475 $964,629
Income from operations....................... $ 26,754 $ 12,252 $ 39,006
</TABLE>
The Storage Systems segment was added in August 1998 with the purchase of
Symbios, and therefore revenue and income from operations are not available for
the three and six-month periods ended June 30, 1998. Intersegment revenues for
the three and six-month periods ended June 30, 1999 were not significant.
16
<PAGE> 17
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The following is a summary of total assets by segment as of June 30, 1999
and December 31, 1998:
<TABLE>
<CAPTION>
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
1999 1998
---------- ------------
<S> <C> <C>
Assets by segment:
Semiconductor.............................................. $2,616,391 $2,700,295
Storage Systems............................................ 139,324 123,510
---------- ----------
Total assets............................................. $2,755,715 $2,823,805
========== ==========
</TABLE>
The Storage Systems segment did not meet the requirement for a reportable
segment as defined in SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information" as of December 31, 1998. However, for purposes of
comparability, total assets by segment as of December 31, 1998 were included in
the table.
NOTE 14 -- LEGAL MATTERS
A discussion of certain pending legal proceedings is included in Item 3 of
the Company's Annual Report on Form 10-K/A for the fiscal year ended December
31, 1998. Except as set forth in this Note, the information provided therein
remains unchanged. On February 26, 1999 a lawsuit alleging patent infringement
was filed in the United States District Court for the District of Arizona by the
Lemelson Medical, Education & Research Foundation, Limited Partnership against
eighty-eight electronics industry companies, including us. The case number is
CIV99-0377PHX RGS. The patents involved in this lawsuit generally relate to
semiconductor manufacturing and computer imaging, including the use of bar
coding for automatic identification of articles. The relief sought is an
injunction and damages in an unspecified amount. While we cannot make any
assurances regarding the eventual resolution of this matter, we do not believe
it will have a material adverse effect on our consolidated results of operations
or financial condition.
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.
17
<PAGE> 18
LSI LOGIC CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
GENERAL
We believe that our future operating results will continue to be subject to
quarterly variations based upon a wide variety of factors. These factors
include, among others:
- Cyclical nature of both the semiconductor industry and the markets
addressed by our products;
- Availability and extent of utilization of manufacturing capacity;
- Price erosion;
- Competitive factors;
- Timing of new product introductions;
- Changes in product mix;
- Fluctuations in manufacturing yields;
- Product obsolescence; and
- The ability to develop and implement new technologies.
Our 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 operations in one or more
of the global markets in which we do business. We operate in a technologically
advanced, rapidly changing and highly competitive environment. We predominantly
sell custom products to customers operating in a similar environment.
Accordingly, changes in the conditions of any of our customers may have a
greater impact on our operating results and financial position than if we
predominantly offered standard products that could be sold to many purchasers.
While we cannot predict what effect these various factors may have on our
financial results, the aggregate effect of these and other factors could result
in significant volatility in our future performance. To the extent our
performance may not meet expectations published by external sources, public
reaction could result in a sudden and significantly adverse impact on the market
price of our securities, particularly on a short-term basis.
We have international subsidiaries which operate and sell our products in
various global markets. We purchase a substantial portion of our raw materials
and equipment from foreign suppliers and incur labor and other operating costs
in foreign currencies, particularly at our Japanese manufacturing facilities. As
a result, we are exposed to international factors such as changes in foreign
currency exchange rates or weak economic conditions of the respective countries
in which we operate. We utilize forward exchange, currency swap, interest swap
and option contracts to manage our exposure associated with currency
fluctuations on intercompany transactions and certain foreign currency
denominated commitments. With the exception of purchased option contracts and
forward contracts, there were no currency swap or interest rate swap contracts
outstanding as of June 30, 1999 and December 31, 1998. (See Note 8 to the
Unaudited Consolidated Condensed Financial Statements.) Our corporate
headquarters and some of our manufacturing facilities are located near major
earthquake faults. As a result, in the event of a major earthquake, we could
suffer damages which could significantly and adversely affect our operating
results and financial condition.
There have been no significant changes in the market risk disclosures
during the second three months of 1999 as compared to the discussion in our 1998
Annual Report on Form 10-K/A for the year ended December 31, 1998.
While management believes that the discussion and analysis in this report
is adequate for a fair presentation of the information, we recommend that you
read this discussion and analysis in conjunction with Management's Discussion
and Analysis included in our 1998 Annual Report on Form 10-K/A for the year
ended December 31, 1998.
18
<PAGE> 19
LSI LOGIC CORPORATION
Statements in this discussion and analysis include forward looking information
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended and Section 21E of the Securities and Exchange Act of 1934, as amended.
These statements involve known and unknown risks and uncertainties. Our actual
results in future periods may be significantly different from any future
performance suggested in this report. Risks and uncertainties that may affect
our results may include, among others:
- Fluctuations in the timing and volumes of customer demand;
- Currency exchange rates;
- Availability and utilization of our manufacturing capacity;
- Timing and success of new product introductions; and
- Unexpected obsolescence of existing products.
The extent to which our plans for future cost reductions are realized also
may impact our future financial performance. We operate in an industry sector
where security values are highly volatile and may be influenced by economic and
other factors beyond our control. See additional discussion contained in "Risk
Factors", set forth in Part I of our 1998 Annual Report on Form 10-K/A for the
year ended December 31, 1998.
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'
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, including: 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 our 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,
we anticipate 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. We cannot assure you,
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 our proprietary software and
systems and software purchased from third parties. Failure of
19
<PAGE> 20
LSI LOGIC CORPORATION
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 complete. Based on
information currently available, we believe that our systems will not be
materially impacted by Year 2000 issues. However, we cannot assure you 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 through 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
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
ASSP and storage systems products, on the other hand, do implement chip and
system functionality designed by us. Such functionality 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. We cannot assure you
that a contingency plan in effect at the time of a system failure will
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 insignificant. We
currently estimate that the total cost of ongoing assessment, remediation,
testing and planning directly related to Year 2000 issues will amount to
approximately $15 million. Of this, approximately $7 million is expected to
consist of expenses attributed to redeployment of labor resources and overhead,
$3 million for the cost of software and external consulting fees and $5 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. We cannot assure you
that remediation and testing
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LSI LOGIC CORPORATION
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, we cannot assure you
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.
ADOPTION OF THE EURO
In 1998, we established a task force to address the issues raised by the
implementation of the European single currency (the "Euro"). Our primary focus
has been the changes needed to address a mix of Euro and local denomination
transactions during the transition period from January 1, 1999 through January
1, 2002.
As of January 1, 1999, we began transacting business in Euros. We
implemented a new bank account structure throughout Europe to accommodate
customers and vendors and to improve liquidity management in Europe.
We do not presently expect that the introduction and use of the Euro will
materially affect our foreign exchange and hedging activities or our use of
derivative instruments. We do not believe that the introduction of the Euro will
result in any significant increase in costs to us, and all costs associated with
the introduction of the Euro will be expensed in accordance with our policy. We
do not expect that the transition to the Euro will result in any competitive
pricing or will adversely impact any of our internal computer systems. While we
will continue to evaluate the impact of the Euro introduction over time, based
on currently available information, we do not believe that the introduction of
the Euro currency will have a significant adverse impact on our financial
condition or overall trends in results of operations.
RESULTS OF OPERATIONS
On June 22, 1999, we completed a merger of our wholly-owned subsidiary with
SEEQ in a transaction accounted for as a pooling of interests and SEEQ became a
wholly-owned subsidiary. All financial information has been restated
retroactively to reflect SEEQ and our combined operations as if the merger had
occurred at the beginning of the earliest period presented (see Note 2 to the
unaudited consolidated condensed financial statements). Prior to the merger,
SEEQ's fiscal year-end was the last Sunday in September of each year whereas we
operate on a fiscal year ending on December 31.
Where more than one material factor caused changes in results, we have
quantified each material factor throughout the MD&A where practicable.
Revenues
Revenues for the second quarter of 1999 increased $165 million or 49% to
$501 million compared to $336 million during the same period of 1998. The
material factors contributing to this increase included additional revenues from
the acquisition of Symbios in the third quarter of 1998 (see Note 6). The
increase was also attributable to increased demand for products used in
communications and networking applications. The increase was offset in part by
decreased demand for our component products used in computer product
applications.
Revenues for the first half of 1999 increased $296 million or 44% to $965
million compared to $669 million for the same period of the prior year. The
material factors contributing to the increase included additional revenues from
the acquisition of Symbios in the third quarter of 1998. The increase was also
attributable to increased demand for products used in communications and
networking applications. The
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LSI LOGIC CORPORATION
increase was offset in part by the decreased demand and lower average selling
prices for our component products used in computer and consumer product
applications.
One customer represented 11% of revenues for the three months ended June
30, 1999. There were no customers with revenues greater than or equal to 10% of
total consolidated revenues for the six months ended June 30, 1999.
OPERATING COSTS AND EXPENSES
Key elements of the consolidated statements of operations, expressed as a
percentage of revenues, were as follows:
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross margin............................................. 37% 47% 36% 45%
Research and development expenses........................ 15% 20% 16% 20%
Selling, general and administrative expenses............. 13% 16% 13% 15%
Amortization of intangibles.............................. 2% -- 2% --
Income from operations................................... 5% 11% 4% 11%
</TABLE>
Gross margin
The gross margin percentage decreased to 37% during the second quarter of
1999 from 47% in the same period in 1998 and decreased to 36% during the first
half of 1999 from 45% in the same period in 1998. The decrease reflected a
combination of the following elements:
- Changes in product mix primarily related to Symbios product additions
from August 6, 1998;
- Lower average selling prices, including the impact from currency
fluctuations; and
- Increased cost of revenues from commencing operations at our new
fabrication facility in Gresham, Oregon in December of 1998.
Our operating environment, combined with the resources required to operate
in the semiconductor industry, requires that we manage a variety of factors.
These factors include, among other things:
- Product mix;
- Factory capacity and utilization;
- Manufacturing yields;
- Availability of certain raw materials;
- Terms negotiated with third-party subcontractors; and
- Foreign currency fluctuations.
These and other factors could have a significant effect on our gross margin
in future periods.
Changes in the relative strength of the yen may have a greater impact on
gross margin than other foreign exchange fluctuations due to our large wafer
fabrication operations in Japan. Although the yen strengthened (the average yen
exchange rate for the second quarter and first half of 1999 increased 12% and
10%, respectively, from the same periods in 1998), the effect on gross margin
and net income was not significant because yen denominated sales offset a
substantial portion of yen denominated costs during the period. Moreover, we
hedged a portion of our remaining yen exposure. (See Note 8 to the Unaudited
Consolidated
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<PAGE> 23
LSI LOGIC CORPORATION
Condensed Financial Statements.) Future changes in the relative strength of the
yen or mix of foreign denominated revenues and costs could have a significant
effect on gross margins or operating results.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") expenses increased $9 million or 14% to
$75 million and $21 million or 16% to $152 million during the three and six
month periods ended June 30, 1999, respectively, compared to $66 million and
$131 million in the same periods of 1998, respectively. The material factors
resulting in this increase were the following:
- Expenditures for research and development activities which were a
continuation of research and development activities of the Symbios
business included in our unaudited consolidated financial statements in
the second quarter and the first half of 1999;
- Expenditures related to the continued development of advanced sub-micron
products and process technologies;
- Salary increases during the second quarter of 1999.
For the three and six months ended June 30, 1999, the above noted increases
were offset in part by $3 million which is directly attributable to a technology
transfer agreement entered into with a non-public technology company located in
Malaysia during the second quarter of 1999. (See Note 4 of the Notes to the
Unaudited Consolidated Condensed Financial Statements).
As a percentage of revenues, R&D expenses decreased to 15% and 16% for the
second quarter and the first half of 1999, respectively, compared to
approximately 20% for the comparable periods in 1998. The effects of our
restructuring programs in the third quarter of 1998 primarily accounted for the
decrease (see Note 5 of Notes to the Unaudited Consolidated Condensed Financial
Statements). As we continue our commitment to technological leadership in our
markets and realize the further benefit of cost savings from our restructuring
efforts, we are targeting our R&D investment in the second half of 1999 to be
approximately 13% of revenues.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expenses increased $11 million
or 20% to $63 million and $26 million or 27% to $124 million for the three and
six months ended June 30, 1999, respectively, compared to $52 million and $98
million during the same periods in 1998, respectively. The increase was
primarily attributable to the inclusion of current expenses relating to the
former Symbios business acquired on August 6, 1998 and salary increases in the
second quarter of 1999. As a percentage of revenues, SG&A expenses decreased to
approximately 13% for the three and six month periods ended June 30, 1999 from
16% and 15% during the same periods in 1998, respectively. We expect that SG&A
expenses as a percentage of revenues will decline to approximately 12% of
revenues during the second half of 1999 as we continue to realize the benefits
of cost savings from the restructuring programs established in the third quarter
of 1998.
RESTRUCTURING AND MERGER RELATED EXPENSES
Restructuring and merger related expenses were $8 million and $6 million
for the three and six month periods ended June 30, 1999, respectively. There
were no restructuring or merger related expenses recorded in the same periods of
1998. In connection with the merger with SEEQ on June 22, 1999 (see Note 2 of
the Notes to the Unaudited Consolidated Condensed Financial Statements), we
recorded $3 million in restructuring charges and $5 million in merger related
expenses. The merger expenses related primarily to investment banking and other
professional fees directly attributable to the merger with SEEQ. The
restructuring charge is comprised of $2 million in write-downs of fixed assets
which were duplicative to the combined company, $0.5 million of exit costs
relating to non-cancelable building lease contracts and $0.5 million provision
for severance costs related to the involuntary termination of certain employees.
The exit costs and employee severance costs were recorded in accordance with
EITF No. 94-3 "Liability Recognition
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<PAGE> 24
LSI LOGIC CORPORATION
for Certain Employee Termination Benefits and Other Costs to Exit an Activity."
The fixed and other assets write-downs were recorded in accordance with SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." The restructuring actions as outlined by the
restructuring plan are intended to be executed to completion by June 30, 2000,
one year from the date the reserve was taken.
The $6 million in restructuring and merger related expenses for the six
months ended June 30, 1999 also included a $2.5 million reversal of
restructuring reserves recorded in the first quarter of 1999. During the first
quarter of 1999, we determined that $2.5 million of the restructuring reserve
originally established in the third quarter of 1998 would not be utilized as a
result of the completion of activities in the U.S., Europe and Japan, including
the trade-in of certain software at a gain which was previously written down.
For a description of the restructuring costs recorded in the third quarter of
1998 and changes to the restructuring reserves in the second quarter of 1999,
refer to Note 5 of the Notes to the Unaudited Consolidated Condensed Financial
Statements.
The savings from the restructuring plan associated with the acquisition of
SEEQ are not considered to be significant.
As a result of the execution of restructuring plan announced in the third
quarter of 1998, we expect to realize savings in 1999 of approximately $37
million in reduced employee expenses, $10 million in depreciation savings and $3
million related to reduced lease and maintenance contract expenses primarily
associated with the reduction in the number of engineering design centers and
sales facilities and administrative offices worldwide. As of June 30, 1999, the
remaining cash requirements will be related primarily to severance payouts. The
resources for such payments will come from cash on hand at the time the
severance payouts are distributed.
IN-PROCESS RESEARCH AND DEVELOPMENT
On April 14, 1999, we acquired all of the outstanding capital stock of ZSP
for a total purchase price of $11.3 million which consisted of $7 million in
cash (which included approximately $0.6 million in direct acquisition costs),
and assumed liabilities up to $4.3 million in accordance with the purchase
agreement with ZSP. The merger was accounted for as a purchase (See Note 3 to
the Notes to the Consolidated Condensed Financial Statements). ZSP, a
development stage semiconductor company, was involved in the design and
marketing of programmable Digital Signal Processors ("DSPs") for use in wired
and wireless communications. The results of operations of ZSP and estimated fair
value of assets acquired and liabilities assumed were included in our
consolidated condensed financial statements as of April 14, 1999, the effective
date of the purchase, through the end of the period.
In connection with the purchase of ZSP, we recorded a $4.6 million charge
to in-process research and development ("IPR&D") during the second quarter of
1999. The amount was determined by identifying research projects for which
technological feasibility had not been established and no alternative future
uses existed. We acquired ZSP's in-process DSP research and development project
that was targeted at the telecommunications market. This product is being
developed specifically for voice over net or voice over internet protocol
applications and is intended to have substantial incremental functionality,
greatly improved speed and a wider range of interfaces than ZSP's current
technology.
The value of the one project identified to be in progress was determined by
estimating the future cash flows from the project once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value as defined below. The net cash
flows from the identified project are based on our estimates of revenues, cost
of sales, research and development costs, selling, general and administrative
costs and applicable income taxes for the project. These estimates were compared
and found to be in line with industry analysts forecasts of growth in the
telecommunications market. Estimated total revenues are expected to peak in the
years 2002 and 2003 and then decline in 2004 as other new products are expected
to become available. These projections are based on our estimates of market
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<PAGE> 25
LSI LOGIC CORPORATION
size and growth, expected trends in technology, and the expected timing of new
product introductions by us and our competitors.
We applied a royalty percentage of 25% of operating income for the project
in-process to attribute value for dependency on predecessor core technologies.
The discount rate used was 25% for the project, a rate 1,000 basis points higher
than the industry weighted average cost of capital estimated at approximately
15% to account for the risks associated with the inherent uncertainties
surrounding the successful development of the IPR&D, market acceptance of the
technology, the useful life of the technology, the profitability level of such
technology and the uncertainty of technological advances which could impact the
estimates described above.
The percentage of completion for the project was determined using
milestones representing management's estimate of effort, value added and degree
of difficulty of the portion of the project completed as of April 14, 1999, as
compared to the remaining research and development to be completed to bring the
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).
Development of ZSP's digital signal processor project started in May 1998.
As of April 14, 1999, we estimated the project was 65% complete. As of the
acquisition date, the cost to complete the project is estimated at $1 million
for the remainder of 1999.
However, development of the technology remains a substantial risk to us due
to the remaining effort to achieve technical feasibility, rapidly changing
customer markets and competitive threats from other companies. Additionally, the
value of other intangible assets acquired may become impaired. Our management
believes that the in-process research and development charge of $4.6 million is
valued consistently with the SEC staff's view regarding valuation methodologies.
There can be no assurances, however, that the SEC staff will not take issue with
any assumptions used in the valuation model and require us to revise the amount
allocated to in-process research and development.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES
Amortization of goodwill and other intangibles increased $11 million to $12
million and $20 million to $23 million in the three and six months ended June
30, 1999, respectively, compared to $1 million and $3 million during the same
periods in 1998, respectively. The increase was primarily related to
amortization of goodwill and other intangibles associated with the acquisition
of Symbios in the third quarter of 1998 and the acquisition of ZSP in the second
quarter of 1999.
INTEREST EXPENSE
Interest expense increased $10 million and $20 million for the three and
six month periods ended June 30, 1999 as compared to the same periods in the
prior year. The increase was attributable to interest expense on the bank debt
facility, which we entered into during the third quarter of 1998 to fund the
purchase of Symbios, and the Convertible Notes issued in March 1999. (See Note
10 of Notes to the Unaudited Consolidated Condensed Financial Statements.)
Additionally, in 1999, we did not capitalize any interest associated with the
construction of the new fabrication facility in Gresham, Oregon, as operations
of the facility commenced in December 1998.
25
<PAGE> 26
LSI LOGIC CORPORATION
INTEREST INCOME AND OTHER
Interest income and other decreased $3 million to $2 million and $9 million
to $4 million in the second quarter and the first half of 1999, respectively, as
compared to $5 million and $13 million during the same periods in 1998,
respectively. The decrease was primarily attributable to the following:
- A reduction in interest income attributable to lower average balances of
cash, cash equivalents and short-term investments during the first half
of 1999 as compared to the same period in the prior year. The lower
average balances of cash, cash equivalents and short term investments
resulted primarily from cash outlays associated with the purchase of
Symbios in the third quarter of 1998 and debt repayments, net of
borrowings, primarily during the first quarter of 1999; and
- The combination of slightly higher losses on both foreign exchange and
fixed asset disposals during the three and six months ended June 30, 1999
compared to the same periods of 1998.
PROVISION FOR TAXES
The tax provision for the three and six months ended June 30, 1999 was at
an effective rate of 43% and 40%, respectively, compared to 25% for the three
and six months ended June 30, 1998, respectively. The rate in the first half of
1999 was impacted by the write-offs relating to IPR&D, SEEQ merger costs and
restructuring charges during the second quarter of 1999. Our effective tax rate
can be above or below the U.S. statutory rate primarily due to non-deductible
IPR&D and merger and restructuring charges offset in part by earnings of our
foreign subsidiaries taxed at lower rates and the utilization of prior loss
carryovers and other tax credits.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
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 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, we expensed the
unamortized preproduction balance of $91.8 million associated with the Gresham
manufacturing facility, net of tax, on January 1, 1999 and presented it as a
cumulative effect of a change in accounting principle in accordance with SOP No.
98-5.
FINANCIAL CONDITION AND LIQUIDITY
Cash, cash equivalents and short-term investments increased by $53 million
during the first six months of 1999 to $345 million from $292 million at the end
of 1998. The increase was primarily generated from operations partially offset
by purchases of property and equipment, repayment of debt obligations, net of
borrowings, and purchases net of sales of equity securities.
Working capital increased by $279 million to $518 million at June 30, 1999
from $239 million at December 31, 1998. The increase in working capital was
primarily a result of the following elements:
- Lower current liabilities as a result of repayment of the short-term
portion of the debt facility in the first quarter of 1999, lower accounts
payable due to the timing of invoice receipt and payment, and lower
income taxes payable primarily resulting from the timing of payments; and
- Higher short-term investments, accounts receivable and inventories. The
increase in accounts receivable was attributable to higher sales in the
second quarter of 1999 as compared to the fourth quarter of 1998. The
increase in inventories reflected the expectation of continued sales
growth in 1999 that would be higher than the rate in 1998.
The increase in working capital was offset in part by lower prepaids and
other current assets and higher accrued salaries, wages and benefits as compared
to December 31, 1998. The increase in accrued salaries and wages related to the
timing of payments and accruals as of June 30, 1999 compared to December 31,
1998.
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LSI LOGIC CORPORATION
During the first six months of 1999, we generated $100 million of cash and
cash equivalents from operating activities compared to $68 million during the
same period in 1998. The increase in cash and cash equivalents provided from
operations was primarily attributable to:
- Higher net income (before depreciation and amortization, write-off of
unamortized preproduction costs, non-cash restructuring charges and the
gain on stock investments); and
- A decrease in prepaids and other assets and an increase in accrued and
other liabilities.
The decrease in prepaids and other assets was primarily attributable to a
$23 million increase in the accumulated amortization of goodwill and other
intangibles during the first half of 1999 offset in part by timing differences
of payments on prepaids and other current assets. The increase in accrued and
other liabilities was primarily due to an increase in accrued salaries and wages
and benefits offset in part by a decrease in income taxes payable.
The increased cash from operations was offset in part by an increase in
accounts receivable, inventories, and a decrease in accounts payable. The
increase in accounts receivable was primarily a result of higher revenues in the
first half of 1999 as compared to the first half of 1998. Inventories were
primarily higher as revenues are expected to continue to be higher for the
second half of 1999 as compared to 1998. The decrease in accounts payable was
primarily as a result of timing of invoice receipt and the higher volumes of
business in June 1999 compared to June 1998.
Cash and cash equivalents used in investing activities during the first six
months of 1999 were $109 million compared to $47 million during the same period
in 1998. The primary investing activities during the first six months of 1999
included the following:
- Purchases and sales of debt and equity securities available-for-sale;
- The acquisition of a non-public technology company; and
- Purchases of property and equipment.
The increase in cash used in investing activities during the first six
months of 1999 as compared to the same period in 1998 was primarily attributable
to a decrease in the maturities and sales of debt and equity securities
available-for-sale offset in part by a decrease in both the purchases of debt
and equity securities available for sale and purchases of property and
equipment. We believe that maintaining technological leadership in the highly
competitive worldwide semiconductor industry requires substantial ongoing
investment in advanced manufacturing capacity. Net capital additions were $29
million and $148 million during the first six months of 1999 and 1998,
respectively. The decrease in additions from 1998 was primarily attributable to
reduced purchases of property and equipment related to construction of the new
wafer fabrication facility in Gresham, Oregon. We expect to incur capital
expenditures of no more than $250 million in 1999.
Cash and cash equivalents used for financing activities during the first
six months of 1999 totaled $9 million, compared to $12 million provided by
financing activities in the same period of 1998. The increase in cash used
during the first six months of 1999 was primarily attributable to repayment of
the credit facility, net of proceeds, from the issuance of the new 4 1/4%
Convertible Subordinated Notes (see Note 4 to the Unaudited Consolidated
Condensed Financial Statements.) The increase in cash used is offset in part by
proceeds from sale of common stock issued pursuant to our employee stock option
and purchase plans.
During March of 1999, we issued $345 million of 4 1/4% Convertible
Subordinated Notes (the "Convertible Notes") due in 2004. The Convertible Notes
are subordinated to all existing and future senior debt, are convertible 60 days
following issuance into shares of our common stock at a conversion price of
$31.353 per share and are redeemable at our option, in whole or in part, at any
time on or after March 20, 2002. Each holder of the Convertible Notes has the
right to cause us to repurchase all of such holder's Convertible Notes at 100%
of their principal amount plus accrued interest upon the occurrence of certain
events and in certain circumstances. Interest is payable semiannually. We paid
approximately $9.5 million for debt issuance costs
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LSI LOGIC CORPORATION
related to the Convertible Notes. The debt issuance costs are being amortized
using the interest method. We used the net proceeds from the Convertible Notes
to repay debt obligations as outlined below.
On August 5, 1998, we entered into a credit agreement with JSI and ABN
AMRO. The credit agreement was restated and superseded by the Amended and
Restated Credit Agreement dated as of September 22, 1998 and thereafter
syndicated to a group of lenders determined by ABN AMRO and us. 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, we borrowed $150 million under the 364 day Facility and
$485 million under the Revolver. On December 22, 1998, we borrowed an additional
$30 million under the Revolver. The credit facilities allow for borrowings at
adjustable rates of LIBOR/TIBOR with a 1.25% spread. As of March 31, 1999 the
spread was 1%. 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 the principal reduced 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 JSI 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 5, 2002. Pursuant to the restated credit
agreement, on August 30, 1998, JSI repaid it's existing 11.4 billion yen ($79.2
million) credit facility and borrowed 8.6 billion yen ($70.5 million at June 30,
1999) bearing interest at adjustable rates. In March of 1999, we repaid the $150
million outstanding under the 364 day Facility and $185.5 million outstanding
under the Revolver primarily using proceeds from the Convertible Notes.
Borrowings outstanding under the Revolver including the yen sub-facility were
$370 million as of June 30, 1999. As of June 30, 1999, the interest rate for the
Revolver and the yen sub-facility were 5.96% and 1.14%, respectively. Debt
issuance costs were not significant.
In accordance with the existing credit agreement, we must comply with
certain financial covenants related to profitability, tangible net worth,
liquidity, senior debt leverage, debt service coverage and subordinated
indebtedness. As of June 30, 1999, we were in compliance with these covenants.
We believe that our level of financial resources is an important
competitive factor in our industry. Accordingly, we may, from time to time, seek
additional equity or debt financing. We believe that our existing liquid
resources and funds generated from operations, combined with funds from such
financing and our ability to borrow funds, will be adequate to meet our
operating and capital requirements and obligations through the foreseeable
future. However, we can provide 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 June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 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, 2000. Upon adoption of SFAS No. 133, we 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 we believe the adoption of this statement will not have a significant
effect on our results of operations, the impact of the adoption of SFAS No. 133
as of the effective date cannot be reasonably estimated at this time.
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<PAGE> 29
PART II
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Item 3, Legal Proceedings, of the Company's Annual
Report on Form 10-K/A for the fiscal year ended December 31, 1998 for a
discussion of certain pending legal proceedings. Except as set forth in Note 14,
the information provided at such reference regarding those matters remains
unchanged. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of LSI Logic Corporation was held on May
7, 1999 in San Francisco, California. Of the total 141,836,838 shares
outstanding as of the record date, 129,885,603 shares (91.576%) were present or
represented by proxy at the meeting. The table below presents the voting results
of election of the Company's Board of Directors:
<TABLE>
<CAPTION>
VOTES FOR VOTES WITHHELD
----------- --------------
<S> <C> <C>
Wilfred J. Corrigan...................................... 126,222,216 3,663,387
T.Z. Chu................................................. 126,335,524 3,550,079
Malcolm R. Currie........................................ 126,264,422 3,621,181
James H. Keyes........................................... 126,236,190 3,550,413
R. Douglas Norby......................................... 126,324,602 3,561,001
Matthew J. O'Rourke...................................... 126,261,844 3,623,759
</TABLE>
The stockholders approved an amendment to the 1991 Equity Incentive Plan to
increase the number of shares reserved for issuance thereunder by 6,250,000. The
proposal received 91,844,094 affirmative votes, 37,234,458 negative votes,
807,051 abstentions, and zero non-votes.
The stockholders approved an Amended and Restated Employee Stock Purchase
Plan to increase the number of shares reserved for issuance thereunder by
750,000, to change the enrollment dates, to reduce the length of the offering
period and to grant the Board of Directors authority to alter the purchase price
of the shares and make other administrative changes. The proposal received
17,965,530 affirmative votes, 11,087,704 negative votes, 832,369 abstentions,
and zero non-votes.
The stockholders approved an amendment to the 1995 Director Stock Option
Plan to increase the annual grant of options to each non-employee director to
12,500, which fully vest six months after grant. The proposal received
116,788,049 affirmative votes, 12,146,671 negative votes, 117,950,883
abstentions, and zero non-votes.
The stockholders approved the appointment of PricewaterhouseCoopers LLP as
independent accountants of the company. The proposal received 128,755,565
affirmative votes, 432,362 negative votes, 657,676 abstentions and zero
non-votes.
ITEM 5. OTHER INFORMATION.
STOCKHOLDER PROPOSALS
Proposals of stockholders intended to be presented at the Company's 2000
annual meeting of stockholders must be received at the Company's principal
executive offices not later than November 19, 1999 in order to be included in
the Company's proxy statement and form of proxy relating to the 2000 annual
meeting.
29
<PAGE> 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedules
(b) Reports on Form 8-K
On June 2, 1999, pursuant to Item 5 to report information set forth in the
Registrant's press release dated May 19, 1999.
On July 9, 1999, pursuant to Item 5 to report information set forth in the
Registrant's press release dated July 1, 1999.
On July 9, 1999, pursuant to Item 5 to report information set forth in the
Registrant's press release dated June 22, 1999.
On July 26, 1999, pursuant to Item 5 to report information set forth in the
Registrant's press release dated July 21, 1999.
30
<PAGE> 31
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: July 27, 1999 By /s/ R. DOUGLAS NORBY
------------------------------------
R. Douglas Norby
Executive Vice President Finance &
Chief Financial Officer
31
<PAGE> 32
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<C> <S>
27.1 Financial Data Schedule
27.2 Financial Data Schedule
</TABLE>
32
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 141,017
<SECURITIES> 278,111
<RECEIVABLES> 239,302
<ALLOWANCES> 2,641
<INVENTORY> 106,073
<CURRENT-ASSETS> 846,425
<PP&E> 1,782,902
<DEPRECIATION> (610,890)
<TOTAL-ASSETS> 2,163,950
<CURRENT-LIABILITIES> 404,727
<BONDS> 0
0
0
<COMMON> 1,432
<OTHER-SE> 1,636,140
<TOTAL-LIABILITY-AND-EQUITY> 2,163,950
<SALES> 669,002
<TOTAL-REVENUES> 669,002
<CGS> 367,392
<TOTAL-COSTS> 367,392
<OTHER-EXPENSES> 231,230
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (175)
<INCOME-PRETAX> 83,685
<INCOME-TAX> 20,890
<INCOME-CONTINUING> 62,795
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 62,795
<EPS-BASIC> 0.44
<EPS-DILUTED> 0.43
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 190,530
<SECURITIES> 154,613
<RECEIVABLES> 338,745
<ALLOWANCES> 4,914
<INVENTORY> 191,485
<CURRENT-ASSETS> 977,188
<PP&E> 2,135,410
<DEPRECIATION> 888,869
<TOTAL-ASSETS> 2,755,715
<CURRENT-LIABILITIES> 458,786
<BONDS> 0
0
0
<COMMON> 1,460
<OTHER-SE> 1,484,623
<TOTAL-LIABILITY-AND-EQUITY> 2,755,715
<SALES> 964,629
<TOTAL-REVENUES> 964,629
<CGS> 616,289
<TOTAL-COSTS> 616,289
<OTHER-EXPENSES> 309,334
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (20,200)
<INCOME-PRETAX> 23,001
<INCOME-TAX> 9,160
<INCOME-CONTINUING> 13,841
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (91,774)
<NET-INCOME> (77,933)
<EPS-BASIC> (0.54)
<EPS-DILUTED> (0.52)
</TABLE>
