<PAGE> 1
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 OCTOBER 1, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO ________
COMMISSION FILE NUMBER: 0-11674
---------------
LSI LOGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-2712976
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
1551 MCCARTHY BOULEVARD
MILPITAS, CALIFORNIA 95035
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 433-8000
(REGISTRANT'S TELEPHONE NUMBER)
---------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
As of October 30, 2000, there were 319,293,484 of the registrant's
Common Stock, $.01 par value, outstanding.
1
<PAGE> 2
LSI LOGIC CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
----
<S> <C>
PART I . FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Condensed Balance Sheets - September 30, 2000 and December 31, 1999 3
Consolidated Condensed Statements of Operations - Three Months and Nine Month Periods
Ended September 30, 2000 and 1999 4
Consolidated Condensed Statements of Cash Flows - Nine Month Periods Ended
September 30, 2000 and 1999 5
Notes to Consolidated Condensed Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 20
Item 3 Quantitative and Qualitative Disclosures About Market Risk 36
PART II. OTHER INFORMATION
Item 1 Legal Proceedings 37
Item 6 Exhibits and Reports on Form 8-K 37
</TABLE>
2
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands, except per-share amounts) 2000 1999
------------- -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 318,181 $ 250,603
Short-term investments 766,306 410,730
Accounts receivable, less allowances of $9,156 and $11,346 456,608 275,620
Inventories 289,563 243,896
Deferred tax assets 66,362 66,212
Prepaid expenses and other current assets 62,911 41,223
----------- ----------
Total current assets 1,959,931 1,288,284
Property and equipment, net 1,208,280 1,323,501
Goodwill and other intangibles 506,798 293,631
Other assets 335,265 301,189
----------- ----------
Total assets $ 4,010,274 $3,206,605
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 191,055 $ 189,293
Accrued salaries, wages and benefits 87,647 77,277
Other accrued liabilities 180,650 110,229
Income tax payable 103,315 41,536
Current portion of long-term obligations 1,228 56,996
----------- ----------
Total current liabilities 563,895 475,331
----------- ----------
Deferred tax liabilities 82,405 75,771
Other long-term obligations 975,321 793,461
----------- ----------
Total long-term obligations and deferred tax liabilities 1,057,726 869,232
----------- ----------
Commitments and contingencies (Note 13)
Minority interest in subsidiaries 5,998 6,210
----------- ----------
Stockholders' equity:
Preferred shares; $.01 par value; 2,000 shares authorized -- --
Common stock; $.01 par value; 1,300,000 shares authorized; 319,012 and
299,572 shares outstanding 3,190 2,996
Additional paid-in capital 1,806,596 1,271,093
Deferred compensation (Note 2) (182,457) --
Retained earnings 610,467 435,552
Accumulated other comprehensive income 144,859 146,191
----------- ----------
Total stockholders' equity 2,382,655 1,855,832
----------- ----------
Total liabilities and stockholders' equity $ 4,010,274 $3,206,605
=========== ==========
</TABLE>
See notes to unaudited consolidated condensed financial statements.
3
<PAGE> 4
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- -------------------------------
(In thousands, except per share amounts) 2000 1999 2000 1999
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues $ 727,578 $ 539,959 $ 1,987,092 $ 1,504,588
--------- --------- ----------- -----------
Costs and expenses:
Cost of revenues 412,808 325,785 1,146,286 942,074
Research and development 101,669 71,878 268,699 223,447
Selling, general and administrative 79,099 66,881 224,418 191,153
Acquired in-process research and development 54,155 -- 70,488 4,600
Restructuring of operations and other
non-recurring charges -- (7,934) 2,781 (2,063)
Amortization of non-cash deferred stock compensation(*) 19,179 -- 19,179 --
Amortization of intangibles 21,977 11,767 47,633 34,789
--------- --------- ----------- -----------
Total costs and expenses 688,887 468,377 1,779,484 1,394,000
--------- --------- ----------- -----------
Income from operations 38,691 71,582 207,608 110,588
Interest expense (10,176) (9,404) (31,392) (29,604)
Interest income and other, net 18,709 4,855 37,345 9,050
Gain on sale of equity securities 15,309 2,151 64,795 2,151
--------- --------- ----------- -----------
Income before income taxes and cumulative 62,533 69,184 278,356 92,185
effect of change in accounting principle
Provision for income taxes 44,437 17,260 103,441 26,420
--------- --------- ----------- -----------
Income before cumulative effect of change in 18,096 51,924 174,915 65,765
accounting principle
Cumulative effect of change in accounting principle -- -- -- (91,774)
--------- --------- ----------- -----------
Net income/(loss) $ 18,096 $ 51,924 $ 174,915 $ (26,009)
========= ========= =========== ===========
Basic earnings per share:
Income before cumulative effect of change
in accounting principle $ 0.06 $ 0.18 $ 0.57 $ 0.23
========= ========= =========== ===========
Cumulative effect of change in accounting
Principle -- -- -- (0.32)
--------- --------- ----------- -----------
Net income/(loss) $ 0.06 $ 0.18 $ 0.57 $ (0.09)
========= ========= =========== ===========
Dilutive earnings per share:
Income before cumulative effect of change
in accounting principle $ 0.06 $ 0.16 $ 0.52 $ 0.22
========= ========= =========== ===========
Cumulative effect of change in accounting
Principle -- -- -- (0.31)
--------- --------- ----------- -----------
Net income/(loss) $ 0.06 $ 0.16 $ 0.52 $ (0.09)
--------- --------- ----------- -----------
Shares used in computing per share amounts:
Basic 314,038 293,534 308,304 291,028
========= ========= =========== ===========
Dilutive 355,732 332,942 353,322 304,046
========= ========= =========== ===========
</TABLE>
(*) Amortization of non-cash deferred stock compensation, if not shown
separately, of $80, $13,472 and $5,627 would have been included in cost of
revenues, research and development and selling, general and administrative
expenses respectively for the three months and nine months ended September 30,
2000.
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
4
<PAGE> 5
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
(In thousands) 2000 1999
----------- ---------
<S> <C> <C>
Operating activities:
Net income/(loss) $ 174,915 $ (26,009)
Adjustments:
Depreciation and amortization 292,172 269,267
Amortization of non-cash deferred compensation 19,179 --
Write-off of unamortized preproduction costs -- 97,356
Acquired in-process research and development 70,488 4,600
Non-cash restructuring charges, net 2,781 (7,107)
Gain on sale of equity securities (64,795) (2,151)
Changes in:
Accounts receivable (178,952) (111,017)
Inventories (44,745) (31,848)
Prepaid expenses and other assets (56,934) 9,655
Accounts payable 1,954 6,549
Accrued and other liabilities 127,037 22,901
----------- ---------
Net cash provided by operating activities 343,100 232,196
----------- ---------
Investing activities:
Purchase of debt and equity securities available-for-sale (1,014,639) (353,776)
Maturities and sales of debt and equity securities available-for-sale 699,474 188,756
Purchases of equity securities (17,035) --
Proceeds from sales of stock investments 62,163 --
Acquisition of non-public technology companies (47,017) (6,779)
Purchases of property and equipment, net of retirement (120,218) (104,795)
----------- ---------
Net cash used in investing activities (437,272) (276,594)
----------- ---------
Financing activities:
Proceeds from borrowings 500,000 345,000
Repayment of debt obligations (376,357) (368,738)
Debt issuance costs (15,300) (9,488)
Issuance of common stock, net 109,627 48,786
Purchase of common stock under repurchase program (49,296) --
----------- ---------
Net cash provided by financing activities 168,674 15,560
----------- ---------
Effect of exchange rate changes on cash and cash equivalents (6,924) 4,509
----------- ---------
Increase/(decrease) in cash and cash equivalents 67,578 (24,329)
----------- ---------
Cash and cash equivalents at beginning of period 250,603 210,306
----------- ---------
Cash and cash equivalents at end of period $ 318,181 $ 185,977
=========== =========
</TABLE>
See notes to unaudited consolidated condensed financial statements.
5
<PAGE> 6
LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
In the opinion of LSI Logic Corporation (the "Company" or "LSI"), the
accompanying unaudited consolidated condensed financial statements contain all
adjustments (consisting only of normal recurring adjustments, except for
acquired in-process research and development, restructuring and other
non-recurring charges as discussed in Notes 2 and 3), necessary to present
fairly the financial information included therein. While the Company believes
that the disclosures are adequate to make the information not misleading, it is
suggested that these financial statements be read in conjunction with the
audited consolidated financial statements and accompanying notes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
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
September 30, 2000 are not necessarily indicative of the results to be expected
for the full year.
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 reporting periods. Actual results could differ from these estimates.
NOTE 2 -ACQUISITIONS
ACQUISITION OF DATAPATH:
On July 14, 2000, LSI acquired DataPath Systems, Inc. ("DataPath"), a
privately held supplier of communications chips for broadband, data networking
and wireless applications, pursuant to the terms of the Agreement and Plan of
Reorganization and Merger. DataPath's stockholders received 0.4269 shares of the
Company's common stock for each DataPath share. Accordingly, the Company issued
approximately 7.5 million shares of its common stock for all the outstanding
common shares of DataPath common stock. Additionally, outstanding options to
acquire DataPath common stock as of the acquisition date were converted to
options to acquire approximately 1.6 million shares of the Company's common
stock. The acquisition of DataPath is expected to enhance the Company's standard
product offerings in the Semiconductor segment.
The acquisition was accounted for as a purchase. Accordingly, the
results of operations of DataPath and estimated fair value of assets acquired
and liabilities assumed were included in the Company's consolidated condensed
financial statements as of July 14, 2000, 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 DataPath.
The total purchase price for DataPath was $421 million which includes
deferred compensation on unvested options and stock awards assumed as part of
the purchase. On July 1, 2000, FASB Interpretation ("FIN") No. 44, "Accounting
For Certain Transactions Involving Stock Compensation" was adopted by the
Company. The acquisition of DataPath closed on July 14, 2000, after the
effective date of the new interpretation. In accordance with FIN No. 44, the
intrinsic value of the options and restricted awards assumed as part of the
transaction and not vested as of the closing date was recorded as deferred
compensation to be amortized over the respective vesting periods of the options
and awards. For presentation purposes, the deferred compensation on restricted
stock awards and unvested options are included in the components of purchase
price noted below.
6
<PAGE> 7
The components of purchase price are as follows:
(in thousands)
<TABLE>
<S> <C>
Fair value of common shares issued $345,914
Fair value of options assumed 66,475
Direct acquisition costs 8,436
--------
Total purchase price $420,825
========
</TABLE>
The fair value of common shares issued was determined using a price of
approximately $46.11 per share which represents the average closing stock price
for the period two days before and after the date the number of LSI common
shares to be issued was fixed. The fair value of common shares issued includes
approximately $133.3 million of deferred stock compensation associated with
approximately 2.3 million restricted common shares which were assumed as part of
the transaction. The value of the restricted shares was determined using the
closing stock price on July 14, 2000, the date the acquisition was consummated.
The deferred compensation was included as a component of stockholders' equity
and will be amortized over the vesting period of the awards of two to three
years.
The fair value of the options assumed was determined using the
Black-Scholes value. The fair value includes approximately $68.3 million of
deferred stock compensation associated with the intrinsic value of unvested
options using the closing stock price on the date the transaction was
consummated. The deferred compensation was included as a component of
stockholders' equity and will be amortized over the remaining vesting period of
the options ranging from two to four years.
Direct acquisition costs consist of investment banking, legal and
accounting fees.
The total purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed based on independent appraisals and
management estimates as follows:
(In thousands)
<TABLE>
<S> <C>
Fair value of tangible net liabilities acquired $ (6,383)
In-process research and development 54,155
Other current technology 17,438
Excess of purchase price over net assets acquired 153,978
---------
Total purchase price excluding deferred compensation 219,188
---------
Total deferred compensation 201,637
---------
Total purchase price $ 420,825
---------
</TABLE>
In-process research and development:
In connection with the purchase of DataPath, the Company recorded a
$54.2 million charge to in-process research and development during the third
quarter of 2000. The amount was determined by identifying research projects for
which technological feasibility had not been established and for which no
alternative future uses existed. As of the acquisition date, there were various
projects that met the above criteria. The majority of the projects identified
consist of Read Channel, Asynchronous Digital Subscriber Line ("ADSL") and Tuner
technologies.
The value of the projects identified to be in progress was determined by
estimating the future cash flows from the projects 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 projects was determined using milestones representing estimates of
effort, value added and degree of difficulty of the portion of the projects
completed as of July 14, 2000, as compared to the total research and development
to be completed to bring the projects to technological 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
7
<PAGE> 8
engineering architecture and feasibility studies, (ii) design and verification
milestones, and (iii) prototyping and testing the product (both internal and
customer testing). As of July 14, 2000, the Company estimated the projects were
approximately 50%, 65% and 75% complete for Read Channel, ADSL and Tuner
technologies, respectively.
Development of the technology remains a substantial risk to the Company
due to factors including the remaining effort to achieve technological
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
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 six years
using the straight-line method.
ACQUISITION OF A DIVISION OF NEOMAGIC:
On April 13, 2000, the Company entered into an Asset Purchase Agreement
(the "Agreement") with Neomagic Corporation ("Neomagic"). Under the Agreement,
the Company acquired certain tangible and intangible assets from Neomagic which
includes NeoMagic's optical read-channel mixed-signal design team and RF
intellectual property. The acquisition is intended to enhance and accelerate the
Company's set-top decoder product offerings in the Semiconductor segment. The
Company offered employment to former Neomagic engineers in the United States and
United Kingdom. The acquisition was accounted for as a purchase. Accordingly,
the results of operations and the estimated fair value of assets acquired and
liabilities assumed were included in the Company's consolidated condensed
financial statements as of April 13, 2000, the effective date of the purchase.
The Company paid approximately $15.4 million in cash which included
direct acquisition costs of $0.2 million for investment banking, legal and
accounting fees. The total purchase price was allocated to the estimated fair
value of assets acquired and liabilities assumed based on independent appraisals
and management estimates as follows:
(In thousands)
<TABLE>
<S> <C>
Fair value of tangible net assets acquired $ 1,294
In-process research and development 6,400
Other current technology 3,800
Assembled workforce 2,000
Excess of purchase price over net assets acquired 1,871
-------
$15,365
=======
</TABLE>
In-process research and development:
In connection with the asset purchase from Neomagic, the Company
recorded a $6.4 million charge to in-process research and development during the
second quarter of 2000. The amount was determined by identifying research
projects for which technological feasibility had not been established and for
which no alternative future uses existed. As of the acquisition date, there was
only one project that met the above criteria. The project was for development of
a 2-chip controller chipset.
The value of the 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 based on research and development expenses
incurred as of April 13, 2000 for the project as a percentage of total research
and development expenses to bring the project to technological feasibility.
Development of the 2-chip controller chipset started in December of 1999. As of
April 13, 2000, the Company estimated that the project was 68% complete.
8
<PAGE> 9
Development of the technology remains a substantial risk to the Company
due to factors including the remaining effort to achieve technological
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
Useful life of intangible assets:
The amount allocated to current technology, assembled workforce and
residual goodwill is being amortized over their estimated weighted average
useful life of six years using the straight-line method.
ACQUISITION OF A DIVISION OF CACHEWARE, INC.:
On April 27, 2000, the Company entered into an Asset Purchase Agreement
("the Agreement") with Cacheware, Inc. ("Cacheware"). Under the agreement, the
Company acquired certain tangible and intangible assets associated with
Cacheware's storage area network business ("SAN Business"). The acquisition is
intended to provide a key technology to enhance the Company's SAN solutions. The
SAN Business will be included in the Company's SAN Systems segment. The Company
offered employment to former Cacheware engineers in the United States. The
acquisition was accounted for as a purchase. Accordingly, the results of
operations of the SAN Business and estimated fair value of assets acquired were
included in the Company's consolidated condensed financial statements as of
April 27, 2000, 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 the SAN Business.
The Company paid approximately $22.2 million in cash which included
direct acquisition costs of $0.2 million for investment banking, legal and
accounting fees. The total purchase price was allocated to the estimated fair
value of assets acquired based on independent appraisals and management
estimates as follows:
(In thousands)
<TABLE>
<S> <C>
Fair value of tangible net assets acquired $ 156
In-process research and development 8,345
Other current technology 4,051
Assembled workforce 1,160
Excess of purchase price over net assets acquired 8,488
-------
$22,200
=======
</TABLE>
In-process research and development:
In connection with the purchase of the SAN Business from Cacheware, the
Company recorded a $8.3 million charge to in-process research and development
during the second quarter of 2000. The amount was determined by identifying
research projects for which technological feasibility had not been established
and for which no alternative future uses existed. As of the acquisition date,
there was only one project that met the above criteria. The project was for
development of a SAN appliance for customers in the Company's SAN Systems
segment.
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 based on research and development expenses
incurred as of April 27, 2000 for the project as a percentage of total research
and development expenses to bring the project to technological feasibility.
Development of the SAN appliance was started in January of 1999. As of April 27,
2000, the Company estimated that the project was 90% complete.
9
<PAGE> 10
Development of the technology remains a substantial risk to the Company
due to factors including the remaining effort to achieve technological
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
Useful life of intangible assets:
The amount allocated to current technology, assembled workforce and
residual goodwill is being amortized over their estimated weighted average
useful life of six years using the straight-line method.
ACQUISITION OF INTRASERVER TECHNOLOGY, INC.:
On May 26, 2000, LSI acquired Intraserver Technology, Inc.
("Intraserver") pursuant to the terms of the Agreement and Plan of
Reorganization and Merger. Intraserver's stockholders received 2.2074 shares of
the Company's common stock for each Intraserver share. Accordingly, the Company
issued approximately 1.2 million shares of its common stock for all the
outstanding common shares of Intraserver common stock. Additionally, outstanding
options to acquire Intraserver common stock as of the acquisition date were
converted to options to acquire approximately 0.2 million shares of the
Company's common stock. The acquisition of Intraserver is expected to enhance
the Company's host adapter board and other product offerings in the network
computing and communications markets in the Semiconductor segment.
The acquisition was accounted for as a purchase. Accordingly, the
results of operations of Intraserver and estimated fair value of assets acquired
and liabilities assumed were included in the Company's consolidated condensed
financial statements as of May 26, 2000, 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 Intraserver.
The total purchase price for Intraserver was $62.9 million comprised of the
following components:
(in thousands)
<TABLE>
<S> <C>
Fair value of common shares issued $54,851
Fair value of options assumed 7,022
Direct acquisition costs 1,016
-------
$62,889
=======
</TABLE>
The fair value of common shares issued was determined using a price of
$45.83 per share which represents the average closing stock price for the period
two days before and after the date the number of LSI common shares to be issued
was fixed. The fair value of the options assumed was determined using the
Black-Scholes value. Direct acquisition costs consist of investment banking,
legal and accounting fees.
The total purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed based on independent appraisals and
management estimates as follows:
(In thousands)
<TABLE>
<S> <C>
Fair value of tangible net liabilities acquired $ (6,956)
In-process research and development 1,588
Other current technology 13,975
Trademarks 1,285
Assembled workforce 2,200
Excess of purchase price over net assets acquired 50,797
--------
$ 62,889
========
</TABLE>
10
<PAGE> 11
In-process research and development:
In connection with the purchase of Intraserver, the Company recorded a
$1.6 million charge to in-process research and development during the second
quarter of 2000. The amount was determined by identifying research projects for
which technological feasibility had not been established and for which no
alternative future uses existed. As of the acquisition date, there were various
projects that met the above criteria. The majority of the projects identified
are targeted for high-end data storage and communication devices where I/O
functionality and speed is critical.
The value of the projects identified to be in progress was determined by
estimating the future cash flows from the projects 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 projects was determined using milestones representing estimates of
effort, value added and degree of difficulty of the portion of the projects
completed as of May 26, 2000, as compared to the total research and development
to be completed to bring the projects to technological 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 Intraserver's
projects started primarily in January of 2000. As of May 26, 2000, the Company
estimated the projects were approximately 58% complete in aggregate (ranging
from 20% to 95%).
Development of the technology remains a substantial risk to the Company
due to factors including the remaining effort to achieve technological
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
Useful life of intangible assets:
The amount allocated to current technology, trademarks, assembled
workforce and residual goodwill is being amortized over their estimated weighted
average useful life of six years using the straight-line method.
Pro forma financial statements have not been included because the
acquisitions are not significant individually or in the aggregate.
NOTE 3 - RESTRUCTURING AND CERTAIN OTHER NON-RECURRING ITEMS
On February 22, 2000, the Company entered into an agreement with a third
party to outsource certain testing services presently performed by the Company
at its Fremont, California facility. The agreement provides for the sale and
transfer of certain test equipment and related peripherals for total proceeds of
approximately $10.7 million. The Company recorded a loss of approximately $2.2
million associated with the agreement.
In March of 2000, the Company recorded approximately $1.1 million of
non-cash compensation related expenses resulting from a separation agreement
entered into during the quarter with a former employee and a $0.5 million
benefit for the reversal of reserves established in the second quarter of 1999
for merger related expenses in connection with the merger with SEEQ Technology,
Inc. ("SEEQ") discussed below.
INTEGRATION OF SEEQ
In connection with the merger with SEEQ on June 22, 1999 accounted for
as a pooling of interests, the Company recorded approximately $2.9 million in
restructuring charges and $5.5 million in merger-related expenses which included
$0.5 million recorded by SEEQ in the first quarter of 1999. The merger expenses
related primarily to investment banking and other professional fees directly
attributable to the merger with SEEQ. The restructuring charge was comprised of
$1.9 million in write-downs of fixed assets which were duplicative to the
combined
11
<PAGE> 12
company, $0.5 million of exit costs relating to non-cancelable building lease
contracts and a $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 asset 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 were completed. Approximately $0.5 million of severance
was paid to three employees terminated during 1999. During the three months
ended March 31, 2000, approximately $480,000 of lease payments were made related
to the non-cancelable building lease contracts. There has been no activity since
March 31, 2000.
The following table sets forth the SEEQ restructuring reserves as of
June 22, 1999, the merger date, and activity against the reserve since then:
<TABLE>
<CAPTION>
Balance Balance Balance
(In thousands) June 22, 1999 Utilized December 31, 1999 Utilized March 31, 2000
------------- -------- ----------------- -------- --------------
<S> <C> <C> <C> <C> <C>
Write-down of fixed assets(a) $1,854 $(1,854) $ -- $--
Non-cancelable building lease contracts 490 (10) 480 (480) --
Payments to employees for severance 516 (516) -- -- --
------ ------- ---- ----- ----
Total $2,860 $(2,380) $480 $(480) $--
====== ======= ==== ===== ====
</TABLE>
(a) The amount utilized represents a write-down of fixed assets due to
impairment. The amount was accounted for as a reduction of the assets and
did not result in a liability.
NOTE 4 - LICENSE AGREEMENT
In the second quarter of 1999, the Company and Silterra Malaysia Sdn.
Bhd. (formerly known as Wafer Technology (Malaysia) Sdn. Bhd.) ("Silterra")
entered into a technology transfer agreement under which the Company grants
licenses to Silterra with respect to certain of the Company's wafer fabrication
technologies and provides associated manufacturing training and related
services. In exchange, the Company receives cash and equity consideration valued
at $120 million over three years for which transfers and obligations of the
Company are scheduled to occur. The Company transferred technology to Silterra
valued at $6 million for the three month period and $18 million for the nine
month period ended September 30, 2000, respectively. The amount was recorded as
an offset to the Company's R&D expenses. In addition, the Company provided
engineering training with a value of $1 million for the three month period and
$3 million for the nine month period ended September 30, 2000, respectively. The
amount was recorded as an offset to cost of revenues.
NOTE 5 - INVESTMENTS
All highly liquid investments purchased with an original maturity of
ninety days or less are considered to be cash equivalents and are classified as
held-to-maturity. Marketable short-term investments are generally classified and
accounted for as available-for-sale. Management determines the appropriate
classification of debt and equity securities at the time of purchase and
reassesses the classification at each reporting date. Investments in debt and
equity securities classified as held-to-maturity are reported at amortized cost
plus accrued interest, and securities classified as available-for-sale are
reported at fair value with unrealized gains and losses, net of related tax,
recorded as a separate component of comprehensive income in stockholders' equity
until realized. Interest and amortization of premiums and discounts for debt and
equity securities are included in interest income. Gains and losses on
securities sold are determined based on the specific identification method and
are included in other income. For all investment securities, unrealized losses
that are other than temporary are recognized in net income. The Company does not
hold these securities for speculative or trading purposes. The Company also
holds investments in restricted shares of technology companies. These
non-marketable shares are recorded at cost.
12
<PAGE> 13
As of September 30, 2000 and December 31, 1999, the Company held $171
million and $55 million of debt securities, respectively, and that were included
in cash and cash equivalents and $766 million and $411 million of debt and
equity securities, respectively, that were classified as short-term investments
on the Company's consolidated balance sheet. Debt securities consisted primarily
of U.S. and foreign corporate debt securities, commercial paper, auction rate
preferred stock, overnight deposits, certificate of deposit and U.S. government
and municipal agency securities. Unrealized holding gains and losses of
held-to-maturity securities and available-for-sale debt securities were not
significant and accordingly the amortized cost of these securities approximated
fair market value at September 30, 2000 and December 31, 1999. Contract
maturities of these securities were within one year as of September 30, 2000.
Realized gains and losses for held-to-maturity securities and available-for-sale
debt securities were not significant for the three month periods ended September
30, 2000 and 1999.
At September 30, 2000 and December 31, 1999, the Company had marketable
equity securities with an aggregate carrying value of $178 million and $153
million, $60 million and $25 million of which were classified as short-term
investments on the Company's consolidated balance sheet, respectively. The
remaining balance was included in other long-term assets. The unrealized gain of
$104 million and $90 million, net of the related tax effect of $56 million and
$48 million, on these equity securities was included in accumulated
comprehensive income as of September 30, 2000 and December 31, 1999,
respectively. In the third quarter of 1999, the Company adopted a program of
regular selling of marketable equity securities. During the three and nine month
periods ended September 30, 2000, the Company sold equity securities for
approximately $16 million and $62 million, respectively, in the open market,
realizing a pre-tax gain of approximately $15 million and $58 million,
respectively. In addition, the Company realized a pre-tax gain of approximately
$7 million associated with equity securities of a certain technology company
that was acquired by another technology company during the nine months ended
September 30, 2000.
NOTE 6 - DERIVATIVE FINANCIAL INSTRUMENTS
The Company has foreign subsidiaries, that 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 contracts 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.
The Company enters into forward contracts to hedge firm asset and
liability positions and cash flows denominated in non-functional currencies. The
following table summarizes by major currency the forward exchange contracts
outstanding as of September 30, 2000 and December 31, 1999. The buy amount
represents the U.S. dollar equivalent of commitments to purchase foreign
currencies, and the sell amount represents the U.S. dollar equivalent of
commitments to sell foreign currencies. Foreign currency amounts were translated
at rates current at September 30, 2000 and December 31, 1999. These contracts
will expire through June 2001.
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands) 2000 1999
------------- ------------
<S> <C> <C>
Buy/(Sell):
Japanese Yen $ 17,882 $ 22,194
Netherlands Guilder 5,534 43,145
British Pound 6,575 --
Euro 23,162 --
Japanese Yen (18,477) (3,397)
</TABLE>
These forward contracts are considered identifiable hedges, and
recognition of gains and losses is deferred until settlement of the underlying
commitments. Realized gains and losses are recorded as other income or expense
when the underlying exposure materializes or the hedged transaction is no longer
expected to occur. Realized gains and
13
<PAGE> 14
losses included in interest income and other were not significant for the three
and nine month periods ended September 30, 2000 and 1999.
Currency option contracts are treated as hedges of third-party yen
revenue exposures. At September 30, 2000, total outstanding purchased currency
option contracts were $54 million. These contracts expire in various dates
through December 2000. At December 31, 1999, there were no purchased currency
option contracts outstanding. Recognition of gains is deferred until the
exposure underlying the option is recorded. Option premiums are amortized over
the lives of the contracts. Realized gains and losses are recorded as an offset
to revenue and were not significant for the three and nine month periods ended
September 30, 2000 and 1999. There were no deferred premiums outstanding as of
December 31, 1999. The deferred premiums on all outstanding options were $2.3
million as of September 30, 2000, and are included in other current assets.
During the three month period ended September 30, 2000, the Company
hedged its minority equity position in certain publicly traded companies. The
hedge took the form of a collar and was constructed as a series of purchased put
and sold call options.
NOTE 7 - BALANCE SHEET DETAIL
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands) 2000 1999
------------- ------------
<S> <C> <C>
Inventories:
Raw materials $ 30,293 $ 20,294
Work-in-process 134,979 139,698
Finished goods 124,291 83,904
-------- --------
$289,563 $243,896
======== ========
</TABLE>
NOTE 8 - DEBT
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands) 2000 1999
------------- ------------
<S> <C> <C>
Notes payable to banks $ -- $ 379,823
Convertible Subordinated Notes 845,000 345,000
Capital lease obligations 2,641 3,948
--------- ---------
847,641 728,771
Current portion of long-term debt, capital lease obligations and
Short-term borrowings (1,228) (56,996)
--------- ---------
Long-term debt and capital lease obligations $ 846,413 $ 671,775
========= =========
</TABLE>
On February 18, 2000, the Company issued $500 million of 4% Convertible
Subordinated Notes (the "2000 Convertible Notes") due in 2005. The 2000
Convertible Notes are subordinated to all existing and future senior debt, are
convertible at any time following issuance into shares of the Company's common
stock at a conversion price of $70.2845 per share and are redeemable at the
Company's option, in whole or in part, at any time on or after February 20,
2003. Each holder of the 2000 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 paid
approximately $15.3 million for debt issuance costs related to the 2000
Convertible Notes. The debt issuance costs are being amortized using the
interest method. The net proceeds from the 2000 Convertible Notes were used to
repay bank debt outstanding with a balance of approximately $380 million as of
December 31, 1999 as described below.
During March of 1999, the Company issued $345 million of 4 1/4%
Convertible Subordinated Notes (the "1999 Convertible Notes") due in 2004. The
1999 Convertible Notes are subordinated to all existing and future senior
14
<PAGE> 15
debt, are convertible 60 days following issuance into shares of the
Company's common stock at a conversion price of $15.6765 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 paid approximately $9.5 million for debt issuance costs related to the
1999 Convertible Notes. The amount was capitalized in other assets and is being
amortized over the life of the 1999 Convertible Notes using the interest method.
The net proceeds of the 1999 Convertible Notes were used to repay existing debt
obligations 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, LSI Logic Japan Semiconductor, Inc. ("JSI"), ABN AMRO and
thereafter syndicated to a group of lenders determined by ABN AMRO and the
Company. The credit agreement consisted 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
allowed 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 expired on August 3, 1999 by which time
borrowings outstanding were fully paid in accordance with the credit agreement.
The Revolver is for a term of four years with the principal reduced quarterly
beginning on December 31, 1999. In November 1999, an amendment was made to the
credit agreement whereby mandatory repayments would not exceed the amount
necessary to reduce the commitment to $241 million. 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 then existing 11.4
billion yen ($79.2 million) credit facility and borrowed 8.6 billion yen ($84
million at December 31, 1999) bearing interest at adjustable rates. In March of
1999, the Company repaid the full $150 million outstanding under the 364-day
Facility and $186 million outstanding under the Revolver using the proceeds from
the 1999 Convertible Notes as described above. Borrowings outstanding under the
Revolver including the yen sub-facility were approximately $380 million as of
December 31, 1999. The Company repaid the outstanding balance for the Revolver
in February 2000. As of December 31, 1999, the interest rate for the Revolver
and the yen sub-facility was 7.07% and 1.29%, respectively.
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 September 30, 2000 and December 31, 1999, the
Company was in compliance with these covenants.
NOTE 9 -RECONCILIATION OF BASIC AND DILUTED EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic and
diluted per share amount computations as required by SFAS No. 128 "Earnings Per
Share" ("EPS") is as follows:
15
<PAGE> 16
<TABLE>
<CAPTION>
Three Months Ended September 30,
-------------------------------------------------------------------------------------
2000 1999
--------------------------------------- ---------------------------------------
Per-Share Per-Share
(In thousands except per share amounts) Income* Shares+ Amount Income* Shares+ Amount
-------- ------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS:
Net income available to
Common Stockholders
$ 18,096 314,038 $ 0.06 $ 51,924 293,534 $0.18
------- -----
Effect of dilutive securities:
Stock options and restricted
stock awards (Note 2) 19,686 17,400
4 1/4% Convertible
Subordinated Notes 2,750 22,008 2,750 22,008
Diluted EPS:
Net income available to
Common stockholders $ 20,846 355,732 $ 0.06 $ 54,674 332,942 $0.16
------- -----
</TABLE>
* Numerator
+ Denominator
Of the total options outstanding, approximately 10,230,209 shares and
3,894,826 shares were excluded from the computation of diluted shares for the
three months ended September 30, 2000 and 1999, respectively, because the
exercise prices of these options were greater than the average market price of
common shares for the respective three month periods. The exercise price of
these options ranged from $40.13 to $60.63 at September 30, 2000 and ranged from
$27.53 to $29.44 at September 30, 1999, respectively. For the three months ended
September 30, 2000, common equivalent shares of 7,113,944 and interest expense
of $3,750,000, net of taxes associated with the 2000 Convertible Notes were
excluded from the calculation of diluted shares because of their antidilutive
effect on earnings per share.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------------------------------------------
2000 1999
-------------------------------- -------------------------------
Per-Share Per-Share
(In thousands except per share amounts) 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 $174,915 308,304 $0.57 $ 65,765 291,028 $0.23
----- -----
Cumulative effect of change
in accounting principle -- -- (91,774) 291,028 (0.32)
Net income/(loss) available to
Common stockholders 174,915 308,304 0.57 (26,009) 291,028 (0.09)
----- -----
Effect of dilutive securities:
Stock options and restricted
stock awards (Note 2) 23,010 13,018
4 1/4% Convertible
Subordinated Notes 8,248 22,008 -- --
Diluted EPS:
Net income before cumulative
Effect of change in accounting
Principle (adjusted for assumed
Conversion of debt) 183,163 353,322 0.52 65,765 304,046 0.22
----- -----
Cumulative effect of change in
Accounting principle -- -- (91,774) 304,046 (0.31)
Net income/(loss) available to
Common stockholders $183,163 353,322 $0.52 $(26,009) 304,046 $(0.09)
----- -----
</TABLE>
* Numerator
+ Denominator
16
<PAGE> 17
Options to purchase 6,002,628 and 2,814,120 shares were outstanding at
September 30, 2000 and 1999, respectively, but were not included in the
calculation of diluted shares for the nine month periods ended September 30,
2000 and 1999 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 $52.13 to $72.25 and $20.94 to $29.44 at September 30, 2000
and 1999, respectively. For the nine month period ended September 30, 2000,
common equivalent shares of 5,872,237 and interest expense of $9.3 million, net
of taxes, associated with the 2000 Convertible Notes (see Note 8) were excluded
from the computation of diluted earnings per share as a result of their
antidilutive effect on earnings per share. For the nine months ended September
30, 1999, common equivalent shares of 16,035,178 and interest expense of $5.5
million, net of taxes associated with the 1999 Convertible Notes (See Note 8),
were excluded from the calculation of diluted shares because of their
antidilutive effect on earnings per share.
On July 28, 2000, the Company's Board of Directors authorized a stock
repurchase program in which up to five million shares of the Company's common
stock may be repurchased in the open market from time to time. Accordingly, the
Company repurchased 1.5 million shares of its common stock from the open market
for approximately $49.3 million during the third quarter of 2000. The
transactions were recorded as reductions to common stock and additional paid-in
capital.
NOTE 10 - COMPREHENSIVE INCOME
Comprehensive income is defined as a change in equity of a company
during a period from transactions and other events and circumstances excluding
transactions resulting from investments by owners and distributions to owners.
The primary difference between net income and comprehensive income, for the
Company, arises from foreign currency translation adjustments and unrealized
gains on available-for-sale securities, net of applicable taxes. Comprehensive
income for the current reporting period and comparable period in the prior year
is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
(In thousands) 2000 1999 2000 1999
------- -------- -------- -------
<S> <C> <C> <C> <C>
Comprehensive income/(loss) $13,754 $115,935 $173,583 $53,341
======= ======== ======== =======
</TABLE>
NOTE 11 -SEGMENT REPORTING
The Company operates in two reportable segments: the Semiconductor
segment and the Storage Area Network ("SAN") Systems segment. In the
Semiconductor segment, the Company designs, develops, manufactures and markets
integrated circuits, including application-specific integrated circuits,
(commonly known in the industry as ASICs), application-specific standard
products and related products and services. Semiconductor design and service
revenues include engineering design services, licensing of our 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. In the
SAN 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 Disk ("RAID") systems,
subsystems and related software.
17
<PAGE> 18
The following is a summary of operations by segment for the three and
nine months ended September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------ ----------------------------
(In thousands) 2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
REVENUES:
Semiconductor $618,390 $470,117 $1,696,062 $1,300,271
SAN Systems 109,188 69,842 291,030 204,317
-------- -------- ---------- ----------
Total $727,578 $539,959 $1,987,092 $1,504,588
======== ======== ========== ==========
INCOME FROM OPERATIONS:
Semiconductor $ 20,377 $ 64,213 $ 169,813 $ 90,968
SAN Systems 18,314 7,369 37,795 19,620
-------- -------- ---------- ----------
Total $ 38,691 $ 71,582 $ 207,608 $ 110,588
======== ======== ========== ==========
</TABLE>
Intersegment revenues for the periods presented above were not
significant. Restructuring of operations and other non-recurring items were
included in the Semiconductor segment.
One customer represented 11% of our total consolidated revenues for each
of the three month periods ended September 30, 2000 and 1999. In the
Semiconductor segment, there were two customers with revenues representing 11%
and 10% of total Semiconductor revenues for the three month period ended
September 30, 2000. No customer represented 10% or more of the total revenue in
the Semiconductor segment for the three month period ended September 30, 1999.
In the SAN Systems segment, there were three customers with revenues
representing 35%, 16% and 12% of total SAN Systems revenues for the three month
period ended September 30, 2000. In the SAN Systems segment, there were three
customers with revenues representing 30%, 28%, and 14% of total SAN Systems
revenues for the three month period ended September 30, 1999.
One customer represented 12% and 10% of our total consolidated revenues
for the nine month periods ended September 30, 2000 and 1999, respectively. In
the Semiconductor segment, no customer represented 10% or more of total revenues
for each of the nine month periods ended September 30, 2000 and 1999. In the SAN
Systems segment, there were four customers with revenues representing 29%, 19%,
14% and 12% of total SAN Systems revenues for the nine month period ended
September 30, 2000. For the nine month period ended September 30, 1999, there
were four customers with revenues representing 29%, 25%, 15% and 10% of total
SAN Systems revenues.
The following is a summary of total assets by segment as of September
30, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands) 2000 1999
------------- ------------
<S> <C> <C>
TOTAL ASSETS:
Semiconductor $3,748,767 $3,051,865
SAN Systems 261,507 154,740
---------- ----------
Total $4,010,274 $3,206,605
========== ==========
</TABLE>
Revenues from domestic operations were $453 million, representing 62% of
consolidated revenues, for the third quarter of 2000 compared to $313 million,
representing 58% of consolidated revenues, for the same period of 1999.
Revenues from domestic operations were $1,228 million, representing 62%
of consolidated revenues, for the nine month period ended September 30, 2000
compared to $904 million, representing 60% of consolidated revenues, for the
same period of 1999.
18
<PAGE> 19
NOTE 12 -LEGAL MATTERS
Reference is made to Item 3, Legal Proceedings, of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999 for a discussion
of certain pending legal proceedings. The information provided at such reference
regarding those matters remains unchanged except as explained below. The pending
litigation initiated by the Lemelson Medical, Education & Research Foundation,
Limited Partnership against certain electronics industry companies, including
LSI, that was described in the Company's prior reports has moved into the
discovery phase. These activities are ongoing and, as of yet, no trial date has
been set. In addition, the Company is a party to other litigation matters and
claims which are normal in the course of its operations. 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.
NOTE 13 -COMMITMENTS AND CONTINGENCIES
In March 2000, the Company entered into a master lease and security
agreement with a group of companies ("Lessor") for up to $250 million for
certain wafer fabrication equipment. Each lease supplement pursuant to the
transaction will have a lease term of three years with two consecutive renewal
options. The Company may, at the end of any lease term, return, or purchase at a
stated amount all the equipment. Upon return of the equipment, the Company must
pay the Lessor a termination value. Through September 30, 2000, the Company has
drawn down $53 million, $59 million and $46 million as the first, second and
third supplement, respectively, pursuant to the agreement. Minimum rental
payments under these operating leases, including option periods, are $35.6
million in 2001, $33.7 million in 2002, $29.0 million in 2003, $26.5 million in
2004 and $10.2 million in 2005. Under this lease, the Company is required to
maintain compliance with certain financial covenants. The Company was in
compliance with these covenants as of September 30, 2000.
NOTE 14 -SUBSEQUENT EVENTS
On October 31, 2000, the Company announced a definitive agreement to
acquire Syntax, Inc., ("Syntax"), a privately held software company based in
Seattle, Washington, in a stock transaction valued at approximately $58 million.
The acquisition is intended to enhance the power of scalable storage hardware
and the flexibility of cross-platform computing software to offer a complete
solution for centralized storage management. The acquisition will be accounted
for as a purchase and is expected to close during the fourth quarter of 2000.
On October 23, 2000, the Company entered into an Asset Acquisition
Agreement with ParaVoice Technologies, Inc. ("ParaVoice"), a subsidiary of
ParaGea Communications, Inc., located in Gaithersburg, Maryland. Under the
agreement, the Company acquired certain tangible and intangible assets
associated with ParaVoice's Voice over Internet Protocol ("VoIP") and Voice over
DSL ("VoDSL") technology for consideration of approximately $38.4 million in
cash. The acquisition is intended to combine VoIP and VoDSL technology with the
Company's ZSP digital signal processor to offer complete single-chip solutions
in the fast-growing global communication market. The acquisition will be
accounted for as a purchase and closed during the fourth quarter of 2000.
19
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
We believe that our future operating results will continue to be subject
to quarterly variations based upon a wide variety of factors detailed in Risk
Factors in Part I of our Annual Report on Form 10-K for the year ended December
31, 1999. These factors include, among others:
- Cyclical nature of both the semiconductor and SAN systems industries
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;
- Business and product market cycles;
- Economic and technological risks associated with our acquisition and
alliance activities; 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 condition 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 and distributors which operate and
sell our products globally. Further, we purchase a substantial portion of our
raw materials and manufacturing equipment from foreign suppliers and incur labor
and other operating costs in foreign currencies, particularly in our Japanese
manufacturing facilities. As a result, we are exposed to the risk of changes in
foreign currency exchange rates or declining economic conditions in these
countries. We utilize forward exchange and purchased currency option contracts
to manage our exposure associated with net asset and liability positions and
cash flows denominated in non-functional currencies. (See Note 6 of the Notes to
Unaudited Consolidated Condensed Financial Statements referred to hereafter as
"Notes.") There is no assurance that these hedging transactions will eliminate
exposure to currency rate fluctuations that could affect our operating results.
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.
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 our Annual Report on
Form 10-K for the year ended December 31, 1999.
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
20
<PAGE> 21
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.
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
Annual Report on Form 10-K for the year ended December 31, 1999.
RESULTS OF OPERATIONS
On January 25, 2000, we announced a two-for-one common stock split,
which was declared by the Board of Directors as a 100% stock dividend payable to
stockholders of record on February 4, 2000 as one new share of common stock for
each share held on that date. The newly issued common stock shares were
distributed on February 16, 2000. In the following discussion and analysis, all
references to number of shares, per share amounts and market prices of our
common stock have been restated to give retroactive recognition to the
two-for-one common stock split announced on January 25, 2000 for all periods
presented.
Where more than one significant factor contributed to changes in results
from year to year, we have quantified material factors throughout the MD&A where
practicable.
REVENUE: We operate in two reportable segments: the Semiconductor
segment and the Storage Area Network ("SAN") Systems segment. In the
Semiconductor segment, we design, develop, manufacture and market integrated
circuits, including application-specific integrated circuits, (commonly known in
the industry as ASICs), application-specific standard products and related
products and services. Semiconductor design and service revenues include
engineering design services, licensing of our advanced design tools software,
and technology transfer and support services. Our customers use these services
in the design of increasingly advanced integrated circuits characterized by
higher levels of functionality and performance. In the SAN Systems segment, we
design, manufacture, market and support high-performance data storage management
and storage systems solutions and a complete line of Redundant Array of
Independent Disk ("RAID") systems, subsystems and related software. (See Note 11
of the Notes.)
Total revenues for the third quarter of 2000 increased $187.6 million or
35% to $727.6 million from $540.0 million for the same period of 1999 on a
consolidated basis. We expect revenues to increase 10% in the fourth quarter of
2000 as compared to the third quarter of 2000. Revenues for the Semiconductor
segment increased $148.3 million or 32% to $618.4 million for the third quarter
of 2000 from $470.1 million for the same period of 1999. A significant factor
which contributed to this revenue growth included increased demand for products
used in communications and network computing applications, particularly in
broadband, networking, consumer and storage components. Revenues for the SAN
Systems segment increased $39.3 million or 56% to $109.2 million for the third
quarter of 2000 from $69.9 million for the same period of 1999 due to the
introduction of new products and continued growth in older ones primarily as a
result of rapid growth of the Internet. There were no significant intersegment
revenues during the periods presented.
Total revenues for the nine months ended September 30, 2000 increased
$482.5 million or 32% to $1,987.1 million from $1,504.6 million for the same
period of 1999 on a consolidated basis. Revenues for the Semiconductor segment
increased $395.8 million or 30% to $1,696.1 million for the nine months ended
September 30, 2000 from $1,300.3 million for the same period of 1999. A
significant factor which contributed to this revenue growth included increased
demand for products used in communications applications and network computing
applications, particularly in broadband, networking, consumer and storage
components. As a result of expected growth of the Internet infrastructure and
wireless communications applications, we expect demand for our products used in
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<PAGE> 22
communications and network computing applications to remain strong for the rest
of the year. Revenues for the SAN Systems segment increased $86.7 million or 42%
to $291.0 million for the nine months ended September 30, 2000 from $204.3
million for the same period of 1999 due to introduction of new products and
continued growth in older ones primarily as a result of rapid growth of the
Internet. We expect revenue in the SAN Systems segment to remain strong for the
remainder of the year. There were no significant intersegment revenues during
the periods presented.
One customer represented 11% of our total consolidated revenues for each
of the three month periods ended September 30, 2000 and 1999. In the
Semiconductor segment, there were two customers with revenues representing 11%
and 10% of total Semiconductor revenues for the three month period ended
September 30, 2000. No customer represented 10% or more of the total revenue in
the Semiconductor segment for the three month period ended September 30, 1999.
In the SAN Systems segment, there were three customers with revenues
representing 35%, 16% and 12% of total SAN Systems revenues for the three month
period ended September 30, 2000. In the SAN Systems segment, there were three
customers with revenues representing 30%, 28%, and 14% of total SAN Systems
revenues for the three month period ended September 30, 1999.
One customer represented 12% and 10% of our total consolidated revenues
for the nine month periods ended September 30, 2000 and 1999, respectively. In
the Semiconductor segment, no customer represented 10% or more of total revenues
for each of the nine month periods ended September 30, 2000 and 1999. In the SAN
Systems segment, there were four customers with revenues representing 29%, 19%,
14% and 12% of total SAN Systems revenues for the nine month period ended
September 30, 2000. For the nine month period ended September 30, 1999, there
were four customers with revenues representing 29%, 25%, 15% and 10% of total
SAN Systems revenues.
Revenues from domestic operations were $453 million, representing 62% of
consolidated revenues, for the third quarter of 2000 compared to $313 million,
representing 58% of consolidated revenues, for the same period of 1999.
Revenues from domestic operations were $1,228 million, representing 62%
of consolidated revenues, for the nine month period ended September 30, 2000
compared to $904 million, representing 60% of consolidated revenues, for the
same period of 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 ended Nine months ended
September 30, September 30,
--------------------- ---------------------
CONSOLIDATED: 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross profit margin 43% 40% 42% 37%
Research and development 14% 13% 14% 15%
Selling, general and administrative 11% 12% 11% 13%
Income from operations 5% 13% 10% 7%
</TABLE>
Key elements of the statement of operations for the Semiconductor and
SAN Systems segments, expressed as a percentage of revenues, were as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
--------------------- ---------------------
SEMICONDUCTOR SEGMENT: 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross profit margin 44% 41% 43% 38%
Research and development 15% 14% 15% 16%
Selling, general and administrative 11% 13% 11% 13%
Income from operations 3% 14% 10% 7%
</TABLE>
22
<PAGE> 23
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
--------------------- ---------------------
SAN SYSTEMS SEGMENT: 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross profit margin 38% 33% 38% 32%
Research and development 6% 9% 7% 9%
Selling, general and administrative 13% 11% 13% 10%
Income from operations 17% 11% 13% 10%
</TABLE>
GROSS MARGIN: We have advanced wafer manufacturing operations in Oregon,
Colorado, California and Japan. This allows us to maintain our ability to
provide products to customers with minimal disruption in the manufacturing
process due to economic and geographic risks associated with each geographic
location. During 1999, we entered into a technology transfer agreement with
Silterra Malaysia Sdn. Bhd. (formerly known as Wafer Technology (Malaysia) Sdn.
Bhd.) ("Silterra") under which we grant licenses to Silterra with respect to
certain of our wafer fabrication technologies and provide associated
manufacturing training and related services. In exchange, we will receive cash
and equity consideration valued at $120.0 million over three years during which
transfers and the performance of our obligations are scheduled to occur. (See
Note 4 of the Notes.) During the nine month periods ended September 30, 2000 and
1999, we provided engineering training in accordance with the agreement. The
engineering training was valued at $3.0 million and $1 million, respectively and
was recorded as a credit to cost of revenues. We will provide an additional $3.0
million of engineering training over the remaining contract term of two years,
which will be recorded as a credit to cost of revenues.
The gross margin percentage increased to 43% in the third quarter of
2000 from 40% in the same period of 1999 on a consolidated basis. The gross
margin percentage for the Semiconductor segment was 44% in the third quarter of
2000 compared to 41% in the same period of 1999.
The gross margin percentage increased to 42% during the nine months
ended September 30, 2000 from 37% in the same period of 1999 on a consolidated
basis. The gross margin percentage for the Semiconductor segment increased to
43% during the nine months ended September 30, 2000 compared to 38% in the same
period of 1999. The increase primarily reflected a combination of the following
factors:
- Increased production capacity utilization at our fabrication facility
in Gresham, Oregon, which commenced operations in December of 1998;
and
- Our focus on higher margin products used in communications and network
computing applications.
The increase in the gross margin was offset in part by a $11.1 million
charge associated with the elimination of a non-strategic product area in the
first quarter of 2000. The increase was also offset in part by an increase in
compensation related expenses.
The gross margin percentage for the SAN Systems segment was 38% in the
third quarter of 2000 compared to 33% in the same period of 1999. The gross
margin percentage for the SAN Systems segment was 38% for the nine months ended
September 30, 2000 compared to 32% in the same period of 1999. The increase was
primarily attributable to the combination of the following factors:
- Increased revenues in higher margin products in 2000; and
- Lower manufacturing overhead spending as a percentage of revenue in
2000 compared to the same period of 1999.
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;
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<PAGE> 24
- 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. We are targeting our overall gross margin percentage
to increase to approximately 44% by the end of 2000.
Changes in the relative strength of the yen may have a greater impact on
our gross margin than other foreign exchange fluctuations due to our wafer
fabrication operations in Japan. Although the yen strengthened (the average yen
exchange rate for the third quarter of 2000 and the nine month period ended
September 30, 2000 appreciated 3% and 8%, respectively, from the same periods of
1999), 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 6 of the Notes.) Future changes in the relative strength of the yen or
mix of foreign-denominated revenues and costs could have a significant effect on
our gross margin or operating results.
RESEARCH AND DEVELOPMENT: Research and development ("R&D") expenses
increased $29.8 million or 41% to $101.7 million during the third quarter of
2000 as compared to $71.9 million during the same period of 1999 on a
consolidated basis. R&D expenses for the Semiconductor segment increased $29.0
million or 44% to $94.9 million in the third quarter of 2000 from $65.9 million
in the same period of 1999. The increase was primarily attributable to an
increase in compensation expenses.
R&D expenses increased $45.2 million or 20% to $268.7 million during the
nine months ended September 30, 2000 as compared to $223.5 million during the
same period of 1999 on a consolidated basis. R&D expenses for the Semiconductor
segment increased $44.0 million or 21% to $248.8 million during the nine months
ended September 30, 2000 from $204.8 million in the same period of 1999.
The year-to-date increase was primarily attributable to expenditures
related to the continued development of advanced sub-micron products and process
technologies and increased compensation expenses. The increase was offset in
part by a $18.0 million research and development benefit associated with a
technology transfer agreement entered into with Silterra in Malaysia during
1999. (See Note 4 of the Notes.) A benefit of $9.0 million was recorded during
the nine month period ended September 30, 1999. We will receive an additional
$32.0 million in cash from Silterra over the remaining contract term of
approximately two years as consideration for technology to be transferred. The
benefit will be recorded to research and development.
R&D expenses for the SAN Systems segment increased $0.8 million or 13%
to $6.8 million in the third quarter of 2000 from to $6.0 million in the same
period of 1999. R&D expenses for the SAN Systems segment increased $1.2 million
or 6% to $19.9 million during the nine months ended September 30, 2000 from
$18.7 million in the same period of 1999. The increase is primarily attributable
to increased compensation expenses.
As a percentage of revenues, R&D expenses increased to 14% in the third
quarter of 2000 from 13% in the same period of 1999 on a consolidated basis. R&D
expenses as a percentage of revenues for the Semiconductor segment increased to
15% in the third quarter of 2000 from 14% in the same period of 1999. R&D
expenses as a percentage of revenues for the SAN Systems segment decreased to 6%
in the third quarter of 2000 from 9% in the same period of 1999.
As a percentage of revenues, R&D expenses decreased to 14% during the
nine months ended September 30, 2000 from 15% in the same period of 1999 on a
consolidated basis. R&D expenses as a percentage of revenues for the
Semiconductor segment decreased to 15% during the nine months ended September
30, 2000 from 16% in the same period of 1999. R&D expenses as a percentage of
revenues for the SAN Systems segment also decreased to 7% during the nine months
ended September 30, 2000 from 9% in the same period of 1999.
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<PAGE> 25
As we continue our commitment to technological leadership in our
markets, we are targeting our R&D investment in 2000 to be approximately 14% of
revenues on a consolidated basis.
SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative
("SG&A") expenses increased $12.2 million or 18% to $79.1 million during the
third quarter of 2000 as compared to $66.9 million in the same period of 1999 on
a consolidated basis. SG&A expenses for the Semiconductor segment increased $5.9
million or 10% to $65.3 million in the third quarter of 2000 from $59.4 million
in the same period of 1999. SG&A expenses for the SAN Systems segment increased
$6.3 million or 84% to $13.8 million in the third quarter of 2000 from $7.5
million in the same period of 1999. The increase in SG&A was primarily
attributable to an increase in compensation and commission expenses for sales
personnel.
SG&A expenses increased $33.3 million or 17% to $224.4 million during
the nine months ended September 30, 2000 as compared to $191.1 million in the
same period of 1999 on a consolidated basis. SG&A expenses for the Semiconductor
segment increased $17.2 million or 10% to $188.0 million in the nine months
ended September 30, 2000 from $170.8 million in the same period of 1999. SG&A
expenses for the SAN Systems segment increased $16.1 million or 79% to $36.4
million in the nine months ended September 30, 2000 from $20.3 million in the
same period of 1999. The increase in SG&A was primarily attributable to an
increase in compensation and commission expenses for sales personnel.
As a percentage of revenues, SG&A expenses decreased to 11% in the third
quarter of 2000 from 12% in the same period of 1999 on a consolidated basis.
SG&A expenses as a percentage of revenues for the Semiconductor segment
decreased to 11% in the third quarter of 2000 from 13% in the same period of
1999. SG&A expenses as a percentage of revenues for the SAN Systems segment
increased to 13% in the third quarter of 2000 from 11% in the same period of
1999.
As a percentage of revenues, SG&A expenses decreased to 11% in the nine
months ended September 30, 2000 from 13% in the same period of 1999 on a
consolidated basis. SG&A expenses as a percentage of revenues for the
Semiconductor segment decreased to 11% in the nine months ended September 30,
2000 from 13% in the same period of 1999. SG&A expenses as a percentage of
revenues for the SAN Systems segment increased to 13% in the nine months ended
September 30, 2000 from 10% in the same period of 1999. We expect that SG&A
expenses as a percentage of revenues will remain approximately at 11% of
revenues on a consolidated basis in 2000.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT: During the three months
ended September 30, 2000, we recorded a $54.2 million in-process research and
development ("IPR&D") charge associated the acquisition of DataPath Systems,
Inc. During the nine months ended September 30, 2000, we recorded a $70.5
million IPR&D charge associated with the acquisitions of DataPath Systems, Inc.,
Intraserver Technology, Inc. and the purchase of divisions of Neomagic Inc., and
Cacheware, Inc. During the nine months ended September 30, 1999, we recorded a
$4.6 million IPR&D charge associated with the acquisition of ZSP Technology,
Inc. See additional information provided below.
The amounts of IPR&D were determined by identifying research projects
for which technological feasibility had not been established and no alternative
future uses existed as of the respective acquisition dates.
DataPath Systems, Inc.:
On July 14, 2000, LSI acquired DataPath Systems, Inc. ("DataPath"), a
privately held supplier of communications chips for broadband, data networking
and wireless applications, pursuant to the terms of the Agreement and Plan of
Reorganization and Merger. DataPath's stockholders received 0.4269 shares of the
Company's common stock for each DataPath share. Accordingly, the Company issued
approximately 7.5 million shares of its common stock for all the outstanding
common shares of DataPath common stock. Additionally, outstanding options to
acquire DataPath common stock as of the acquisition date were converted to
options to acquire approximately 1.6 million shares of the Company's common
stock. The acquisition of DataPath is expected to enhance the Company's standard
product offerings in the communications market in the Semiconductor segment.
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<PAGE> 26
The total purchase price for DataPath was $421 million which includes
deferred compensation on unvested options and stock awards assumed as part of
the purchase. The acquisition was accounted for as a purchase. (See Note 2 of
the Notes). Accordingly, the results of operations of DataPath and estimated
fair value of assets acquired and liabilities assumed were included in the
Company's consolidated condensed financial statements as of July 14, 2000, the
effective date of the purchase, through the end of the period. On July 1, 2000,
we adopted FASB Interpretation ("FIN") No.44, "Accounting For Certain
Transactions Involving Stock Compensation". The acquisition of DataPath closed
on July 14, 2000, after the effective date of the new interpretation. In
accordance with FIN No. 44, the intrinsic value of the options and restricted
awards assumed as part of the transaction and not vested as of the closing date
was recorded as deferred compensation to be amortized over the respective
vesting periods of the options and awards. The total amortization of non-cash
deferred stock compensation during the third quarter of 2000 was $19.2 million
as shown in the statement of operations. Thus, cost of sales, research and
development and selling, general and administrative expenses as shown in the
statement of operations exclude amortization of non-cash deferred stock
compensation of $80,000, $13,472,000 and $5,627,000 respectively for the three
months and nine months ended September 30, 2000.
In connection with the purchase of DataPath, the Company recorded a
$54.2 million charge to in-process research and development during the third
quarter of 2000. The amount was determined by identifying research projects for
which technological feasibility had not been established and no alternative
future uses existed. As of the acquisition date, there were various projects
which met the above criteria. The majority of the projects identified consist of
Read Channel, Asynchronous Digital Subscriber Line ("ADSL") and Tuner
technologies.
The value of the projects identified to be in progress was determined by
estimating the future cash flows from the projects 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 net cash flows from the
identified projects were based on estimates of revenues, cost of revenues,
research and development costs, selling general and administrative costs and
applicable income taxes for the projects. These estimates do not account for any
potential synergies that may be realized as a result of the acquisition and are
in-line with industry averages and growth estimates in the semiconductor
industry. Total revenues for the projects are expected to extend through 2004,
2006 and 2007 for Read Channel, ADSL and Tuner Technologies, respectively. These
projections were based on estimates of market size and growth, expected trends
in technology, and the expected timing of new product introductions by us and
our competitors.
We applied a royalty rate of 20% to operating income for Read Channel
and ADSL projects and 3% for Tuner projects to attribute value for dependency on
predecessor core technologies. The discount rate used was 20% for the projects,
a rate of 500 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 July 14, 2000, as
compared to the remaining research and development to be completed to bring the
project to technological 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).
As of July 14, 2000, the Company estimated the projects were
approximately 50%, 65% and 75% complete in aggregate for Read Channel, ADSL and
Tuner Technologies, respectively. As of the acquisition date, the cost to
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<PAGE> 27
complete the projects is estimated at $ 8.3 million and $2.8 million for ADSL
and Tuner projects, respectively through early 2002 and $32.8 million for Read
Channel projects through 2004.
In connection with acquisitions during our second quarter of 2000, we recorded a
$16.3 million charge associated with acquired in-process research and
development ("IPR&D"). The amount was determined by identifying research
projects for which technological feasibility had not been established and no
alternative future uses existed as of the respective acquisition dates.
The charge is attributable to the acquisition of the following
companies: $6.4 million to a division of Neomagic, Inc.; $8.3 million to a
division of Cacheware, Inc., and; $1.6 million to Intraserver Technology, Inc.
These acquisitions were accounted for as purchases and are discussed further
below and in Note 2 of the Notes.
Division of Neomagic:
On April 13, 2000, we entered into an Asset Purchase Agreement (the
"Agreement") with Neomagic Corporation ("Neomagic"). Under the Agreement, we
acquired certain tangible and intangible assets from Neomagic which includes
NeoMagic's optical read-channel mixed-signal design team and RF intellectual
property. The acquisition is intended to enhance and accelerate our set-top
decoder product offerings in the Semiconductor segment. The acquisition was
accounted for as a purchase and the total purchase price was $15.4 million in
cash. Accordingly, the estimated fair value of assets acquired and liabilities
assumed were included in the Company's consolidated condensed financial
statements as of April 13, 2000, the effective date of the purchase.
In connection with the asset purchase from Neomagic, we recorded a $6.4
million charge to in-process research and development during the second quarter
of 2000. The project was for development of a 2-chip controller chipset.
The value of the project identified to be in process 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 net cash flows from the
identified projects were based on estimates of revenues, cost of revenues,
research and development costs, selling general and administrative costs and
applicable income taxes for the project. These estimates do not account for any
potential synergies that may be realized as a result of the acquisition, and are
in-line with industry averages and projected growth for the Semiconductor
market. Total revenues for the project are expected to extend through 2004.
These projections were based on estimates of market size and growth, expected
trends in technology, and the expected timing of new product introductions.
We applied a royalty rate of 30% to operating income for the project in
process to attribute value for dependency on predecessor core technologies. The
discount rate used was 30% for the project, a rate 730 basis points higher than
the industry weighted average cost of capital estimated at approximately 22.7%
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 based on
research and development expenses incurred as of April 13, 2000 for the project
as a percentage of total research and development expenses to bring the project
to technological feasibility. Development of the 2-chip controller chipset
started in December of 1999. As of April 13, 2000, the Company estimated that
the project was 68% complete. As of the acquisition date, the project costs were
estimated at $3 million for the remainder of 2000 and $4 million in 2001.
Division of Cacheware:
On April 27, 2000, we entered into an Asset Purchase Agreement ("the
Agreement") with Cacheware, Inc. ("Cacheware"). Under the agreement, we acquired
certain tangible and intangible assets associated with
27
<PAGE> 28
Cacheware's storage area network business. ("SAN Business"). The acquisition is
intended to provide a key technology to enhance our SAN solutions. The SAN
Business will be included in our SAN Systems segment. The acquisition was
accounted for as a purchase. Accordingly, the results of operations of the SAN
Business and estimated fair value of assets acquired were included in our
consolidated condensed financial statements as of April 27, 2000, the effective
date of the purchase, through the end of the period. We paid approximately $22.2
million in cash which included direct acquisition costs of $0.2 million for
investment banking legal and accounting fees. See Note 2 of the Notes.
The value of the 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 net cash flows from the
identified projects were based on estimates of revenues, cost of revenues,
research and development costs, selling general and administrative costs and
applicable income taxes for the project. These estimates do not account for any
potential synergies that may be realized as a result of the acquisition and are
in-line with industry averages for data storage and industry analysts' forecasts
of growth. Total revenues for the project are expected to extend through 2003.
These projections were based on estimates of market size and growth, expected
trends in technology, and the expected timing of new product introductions.
We applied a royalty rate of 30% to operating income for the project in
process to attribute value for dependency on predecessor core technologies. The
discount rate used was 30% for the project, a rate 880 basis points higher than
the industry weighted average cost of capital estimated at approximately 21.2%
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 based on
research and development expenses incurred as of April 27, 2000 for the project
as a percentage of total research and development expenses to bring the project
to technological feasibility.
Development of the SAN appliance was started in January 1999. As of
April 27, 2000, the Company estimated that the project was 90% complete. As of
the acquisition date, the project costs were estimated at $0.4 million for the
remainder of 2000.
Intraserver:
On May 26, 2000, LSI acquired Intraserver Technology, Inc.
("Intraserver") pursuant to the terms of the Agreement and Plan of
Reorganization and Merger. Intraserver's stockholders received 2.2074 shares of
the Company's common stock for each Intraserver share. Accordingly, the Company
issued approximately 1.2 million shares of its common stock for all the
outstanding common shares of Intraserver common stock. Additionally, outstanding
options to acquire Intraserver common stock as of the acquisition date were
converted to options to acquire approximately 0.2 million shares of the
Company's common stock. The acquisition of Intraserver is expected to enhance
the Company's host adapter board and other product offerings in the network
computing and communications markets in the Semiconductor segment.
The total purchase price for Intraserver was $62.9 million and the acquisition
was accounted for as a purchase. (See Note 2 of the Notes). Accordingly, the
results of operations of Intraserver and estimated fair value of assets acquired
and liabilities assumed were included in the Company's consolidated condensed
financial statements as of May 26, 2000, the effective date of the purchase,
through the end of the period.
In connection with the purchase of Intraserver, the Company recorded a
$1.6 million charge to in-process research and development during the second
quarter of 2000. The amount was determined by identifying research projects for
which technological feasibility had not been established and no alternative
future uses existed. As of
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<PAGE> 29
the acquisition date, there were various projects which met the above criteria.
The majority of the projects identified are targeted to high-end data storage
and communication devices, where I/O functionality and speed is critical.
The value of the projects identified to be in progress was determined by
estimating the future cash flows from the projects 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 net cash flows from the
identified projects were based on estimates of revenues, cost of revenues,
research and development costs, selling general and administrative costs and
applicable income taxes for the projects. These estimates do not account for any
potential synergies that may be realized as a result of the acquisition and are
in-line with industry averages and growth estimates in the storage and host bus
adapter sector of the semiconductor industry. Total revenues for the projects
are expected to extend through 2005. These projections were based on estimates
of market size and growth, expected trends in technology, and the expected
timing of new product introductions by us and our competitors.
We applied a royalty rate of 30% to operating income for the project in
process to attribute value for dependency on predecessor core technologies. The
discount rate used was 30% for the project, a rate of 700 basis points higher
than the industry weighted average cost of capital estimated at approximately
22% 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 May 26, 2000, as
compared to the remaining research and development to be completed to bring the
project to technological 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).
As of May 26, 2000, the Company estimated the projects were
approximately 58% complete in aggregate (ranging from 20% to 95%). As of the
acquisition date, the cost to complete the project is estimated at $ 0.5 million
for the remainder of 2000.
ZSP:
On April 14, 1999, LSI acquired all of outstanding capital stock of ZSP
Corporation ("ZSP") for a total of approximately $7 million in cash which
included approximately $0.6 million in direct acquisition costs. In addition,
LSI assumed liabilities up to $4.3 million in accordance with the purchase
agreement with ZSP. The merger was accounted for as a purchase (For description
of the acquisition of ZSP, see our Annual Report on Form 10-K). When acquired,
ZSP Corporation, as 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
the Company's consolidated condensed financial statements as of April 14, 1999,
the effective date of the purchase, through the end of the period ending
September 30, 1999.
In connection with the purchase of ZSP, we 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 DSP research and development project in
process that was targeted at the telecommunications market. This product is
being developed specifically for voice over net or voice over internet protocol
applications and will have substantial incremental functionality, greatly
improved speed and a wider range of interfaces than ZSP's current technology.
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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 LSI estimates of market size
and growth, expected trends in technology, and the expected timing of new
product introductions by LSI and its 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 inherent 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 technological 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. The
project was completed in 1999.
However, development of the above noted technologies remains a
significant risk to the Company due to the remaining effort to achieve
technological feasibility, rapidly changing customer markets and significant
competitive threats from numerous companies. Failure to bring the product to
market in a timely manner could adversely affect sales and profitability of the
combined company in the future. Additionally, the value of other intangible
assets acquired may become impaired.
RESTRUCTURING OF OPERATIONS AND OTHER NON-RECURRING ITEMS: There was no
restructuring of operations and other non-recurring items recorded in the second
and third quarter of 2000. During the first quarter of 2000, we recorded
restructuring of operations and other non-recurring net charges of $2.8 million.
The net charges reflected the combination of the following:
- On February 22, 2000, we entered into an agreement with a third party
to outsource certain testing services presently performed by the
Company at its Fremont, California facility. The agreement provides
for the sale and transfer of certain test equipment and related
peripherals for total proceeds of approximately $10.7 million. The
Company recorded a loss of approximately $2.2 million associated with
the agreement. (See Note 3 of the Notes.)
- In March of 2000, the Company recorded approximately $1.1 million of
non-cash compensation related expenses resulting from a Separation
Agreement entered into during the quarter with a former employee and a
$0.5 million benefit for the reversal of reserves established in the
second quarter of 1999 for merger related expenses in connection with
the merger with SEEQ Technology, Inc. ("SEEQ") discussed below.
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Restructuring of operations and other non-recurring net benefits were
$7.9 million and $2.1 million for the three and nine month periods ended
September 30, 1999, respectively. The benefit of $7.9 million during the third
quarter of 1999 was directly attributable to the reversal of restructuring
reserves associated with the restructuring charge originally established in the
third quarter of 1998 due to a change in management estimate in the U.S., Japan
and Europe (see our Annual Report on Form 10-K).
The net benefit of $2.1 million for the nine months ended September 30,
1999 reflected the combination of the following:
- Approximately $10.4 million of 1998 restructuring reserve reversals
associated with a change in management estimate (see our Annual Report
on Form 10-K). In addition to the $7.9 million as noted above,
approximately $2.5 million was reversed in the first quarter of 1999
which related to excess severance and other exit costs primarily in
the U.S., Japan and Europe.
- Approximately $2.9 million in restructuring charges and $5.4 million
in merger related expenses associated in connection with the merger
with SEEQ on June 22, 1999 (see our Annual Report on Form 10-K).
The savings from the restructuring plan associated with the acquisition of SEEQ
are not considered to be significant.
AMORTIZATION OF INTANGIBLES: Amortization of goodwill and other
intangibles increased $10.2 million or 86% to $22.0 million in the third quarter
of 2000 from $11.8 million in the same period of 1999. Amortization of goodwill
and other intangibles increased $12.8 million or 37% to $47.6 million in the
nine months ended September 30, 2000 from $34.8 million in the same period of
1999. The increase was primarily related to additional amortization of goodwill
associated with the acquisitions of DataPath in the third quarter of 2000,
Intraserver and divisions of Cacheware and Neomagic in the second quarter of
2000. (See Note 2 of the Notes).
AMORTIZATION OF NON-CASH DEFERRED STOCK COMPENSATION: Amortization of
non-cash deferred stock compensation of $19.2 million in the third quarter of
2000 is due to the adoption of FASB interpretation ("FIN") No. 44, "Accounting
for Certain Transactions Involving Stock Compensation" which was effective July
1, 2000. The acquisition of DataPath Systems, Inc. closed on July 14, 2000 after
the adoption of the new interpretation. (See Note 2 of the Notes).
INTEREST EXPENSE: Interest expense increased $0.8 million to $10.2
million in the third quarter of 2000 from $9.4 million in the same period of
1999. Interest expense increased $1.8 million to $31.4 million in the nine
months ended September 30, 2000 from $29.6 million in the same period of 1999.
The increase was primarily attributable to increased debt outstanding due to the
issuance of $500 million of 4% Convertible Subordinated Notes (see Note 8 of the
Notes), offset in part by lower interest rates.
INTEREST INCOME AND OTHER, NET: Interest income and other increased
$13.8 million to $18.7 million in the third quarter of 2000 from $4.9 million in
the same period of 1999. The increase was primarily attributable to a $5.7
million pre-tax gain on the sale of a U.S. facility in Fremont, California and
approximately $8.7 million of higher interest income due to higher average
balances of interest-generating cash, cash equivalents and short-term
investments and higher interest rates, offset in part by net losses on disposals
of fixed assets and bank fees.
Interest income and other increased $28.3 million to $37.4 million in
the nine months ended September 30, 2000 from $9.1 million in the same period of
1999. The increase was primarily attributable to a $5.7 million pre-tax gain on
the sale of a facility as mentioned above and approximately $23.7 million of
higher interest income due to higher average balances of interest-generating
cash, cash equivalents and short-term investments and higher interest rates,
offset in part by increased foreign exchange losses, net losses on disposals of
fixed assets and bank fees during the period.
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GAIN ON SALE OF EQUITY SECURITIES: In the third quarter of 1999, we
adopted a program of regular selling of marketable equity securities. During the
third quarter of 2000, we sold certain marketable equity securities for $16.4
million in the open market, realizing a pre-tax gain of approximately $15.3
million. During the nine months ended September 30, 2000, we sold certain
marketable equity securities for $62.2 million in the open market, realizing a
pre-tax gain of approximately $58.0 million. In the first quarter of 2000, we
also recognized a $6.8 million pre-tax gain associated with equity securities of
a certain technology company that was acquired by another technology company.
During the third quarter of 1999, we sold certain marketable equity securities
for $2.5 million in the open market, realizing a pre-tax gain of approximately
$2.1 million.
PROVISION FOR INCOME TAXES: The effective rate for the three and nine
months ended September 30, 2000 was 71% and 37%, respectively, compared to 25%
and 29%, respectively, for the three and nine months ended September 30, 1999.
The increase in the effective rate in the nine months ended September 30, 2000
was primarily related to the acquisition of DataPath resulting from items that
are not deductible for tax purposes. The rate in the nine months ended September
30, 1999 was impacted by write-offs relating to IPR&D, SEEQ merger costs and
restructuring charges during the second quarter of 1999. Our effective rate can
be above or below the U.S. statutory rate primarily due to non-deductible IPR&D,
merger and restructuring charges, and the recognition of taxable gains 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 became effective for fiscal years beginning after December 15, 1998 and
required 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 in
Oregon, net of tax, on January 1, 1999 and have 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 $423.2
million or 64% to $1,084.5 million as of September 30, 2000 from $661.3 million
as of December 31, 1999. The increase was primarily a result of proceeds from
issuance of the 2000 Convertible Notes, net of repayment of the existing debt,
and proceeds from our employee stock option and purchase plans, partially offset
by capital expenditures and cash paid for the purchase of common stock under our
repurchase program and the acquisition of non-public technology companies. (See
Note 2 of the Notes). The increase was also attributable to proceeds from the
sale of marketable equity securities in the open market. In the third quarter of
1999, we adopted a program of regular selling of marketable equity securities.
Short-term investments include $60 million of marketable equity securities which
we plan to sell within the next 12 months. (See Note 5 of the Notes.)
WORKING CAPITAL: Working capital increased $583 million or 72% to
$1,396.0 million as of September 30, 2000 from $813.0 million as of December 31,
1999. The increase was primarily a result of the following factors:
- $355.6 million higher short-term investments primarily attributable to
$315.2 million of purchases of debt and equity securities, net of
sales and maturities, with the proceeds from the 2000 Convertible
Notes and $35.0 million of marketable equity securities reclassified
from long-term assets as we plan to sell them within the next 12
months;
- $181.0 million higher net accounts receivable due to increased revenue
and the timing of shipments when comparing the third quarter of 2000
to the fourth quarter of 1999. Shipments during the fourth quarter of
1999 were more linear throughout the quarter whereas during the third
quarter of 2000, shipments increased towards the end of the quarter;
- $55.8 million lower current portion of long-term obligations resulting
from repayment of the Revolver. (See Note 8 of the Notes.); and
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- $45.7 million higher inventory reflects the expectation of continued
higher sales in 2000.
The above noted increases were offset in part by higher income taxes payable
due to the higher income tax rate applied for the nine months ended
September 30, 2000 primarily due to the DataPath acquisition.
CASH AND CASH EQUIVALENTS PROVIDED BY OPERATING ACTIVITIES: During the
nine months ended September 30, 2000, we generated $343.1 million of net cash
and cash equivalents from operating activities compared to $232.2 million
generated during the same period in 1999. The increase in net cash and cash
equivalents provided by operating activities was primarily attributable to
higher net income (before depreciation and amortization, write-off of acquired
in-process research and development, write-off of unamortized preproduction
costs, non-cash restructuring charges, amortization of non-cash deferred stock
compensation and gains on stock investments) and an increase in accrued and
other liabilities. The increase in accrued and other liabilities was primarily
attributable to higher income taxes payable due to a higher provision for income
taxes for the current period, net of payment and higher deferred tax liabilities
recorded in conjunction with the DataPath acquisition.
The increased net cash from operations during the nine months ended
September 30, 2000 as compared to the same period of 1999 was offset in part by
an increase in accounts receivable, prepaid and other assets and inventories.
The increase in accounts receivable is primarily due to the timing of shipments
for the respective periods. The increase in prepaid expenses and other assets
was primarily attributable to additional investments in equity securities, an
increase in unrealized gains on equity investments (See Note 5 of the Notes),
capitalized software, intellectual property and capitalized premiums on currency
option contracts, net of amortization, during the period. Option premiums are
amortized over the lives of the contracts (See Note 6 of the Notes). The
increase in inventories reflects the expectation of continued higher sales in
2000.
CASH AND CASH EQUIVALENTS USED IN INVESTING ACTIVITIES: Net cash and
cash equivalents used in investing activities was $437.3 million during the nine
months ended September 30, 2000, compared to $276.6 million in the same period
of 1999. The increase in net cash used in investing activities was primarily
attributable in part to higher purchases of debt and equity securities
available-for-sale and others, net of maturities and sales. The increase was
also attributable to higher capital expenditures and the acquisition of
non-public technology companies (See Note 2 of the Notes).
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 $120.2
million during the nine months ended September 30, 2000 and $104.8 million in
the same period of 1999. In order to maintain our position as a technological
market leader, we expect to increase the level of capital expenditures to be
approximately $550 million to $600 million in 2000 which includes approximately
$250 million associated with the master lease and security agreement discussed
in Note 13 of the Notes.
CASH AND CASH EQUIVALENTS PROVIDED BY FINANCING ACTIVITIES: Net cash and
cash equivalents provided by financing activities during the nine months ended
September 30, 2000 totaled $168.7 million compared to $15.6 million provided in
the same period of 1999. The increase was primarily attributable to proceeds
from the 2000 Convertible Notes, net of repayment of the Revolver (see Note 8 of
the Notes) and higher proceeds from our employee stock option and purchase plans
during the period. The increase was offset in part by debt issuance costs paid
associated with the 2000 Convertible Notes and cash paid for the purchase of
common stock under the repurchase program during the period.
On February 18, 2000, we issued the 2000 Convertible Notes due in 2005.
The 2000 Convertible Notes are subordinated to all existing and future senior
debt, are convertible at anytime following issuance into shares of our common
stock at a conversion price of $70.2845 per share and are redeemable at our
option, in whole or in part, at any time on or after February 20, 2003. Each
holder of the 2000 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 $15.3
million for debt issuance costs related to the 2000 Convertible Notes. The debt
issuance costs are being amortized using the interest method. We used the net
proceeds from the 2000 Convertible Notes to repay bank debt outstanding with a
balance of $380 million as of December 31, 1999. (See Note 8 of the Notes.) The
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remaining balance of the proceeds was used to augment our growing cash position
and to further strengthen our liquidity position.
During March of 1999, we issued the 1999 Convertible Notes due in 2004.
The 1999 Convertible Notes are subordinated to all existing and future senior
debt, are convertible in 60 days following issuance into shares of our common
stock at a conversion price of $15.6765 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 1999 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 related to the 1999 Convertible Notes. The debt issuance costs
are being amortized using the interest method. We used the net proceeds from the
1999 Convertible Notes to repay existing debt obligations. (See Note 8 of the
Notes.)
In accordance with the terms of our existing credit arrangement, 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 September 30, 2000, we were in compliance with these
covenants.
In order to remain competitive, we must continue to make significant
investments in new facilities and capital equipment. We may seek additional
equity or debt financing from time to time. 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 cannot be certain that additional financing will be
available on favorable terms. Moreover, any future equity or convertible debt
financing will decrease the percentage of equity ownership of existing
stockholders and may result in dilution, depending on the price at which the
equity is sold or the debt is converted.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 1998, the Financial Accounting Standards Board issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 requires that an entity recognizes all derivatives as either assets or
liabilities in the statement of financial position and measures 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 pursuant to the issuance
of SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133," which
deferred the effective date of SFAS No. 133 by one year. 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. In June 2000, the FASB issued SFAS
Statement No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities". SFAS No. 138 amends certain terms and conditions of SFAS
133. The Company will adopt SFAS No. 133 and 138 in our quarter ending March 31,
2001 and is currently assessing the impact, if any, on its consolidated
financial statements.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101,
("SAB 101"), "Revenue Recognition" in Financial Statements. SAB 101 summarizes
certain of the SEC's views in applying generally accepted accounting principles
to revenue recognition in financial statements. Management does not expect the
adoption of SAB 101 to have a material effect on the Company's operations or
financial position.
In March 2000, the FASB issued Interpretation No. 44 ("FIN"),
"Accounting for Certain Transactions Involving Stock Compensation - an
Interpretation of APB 25." This interpretation clarifies (a) the definition of
an employee for purposes of applying Opinion 25, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequence of various modifications to the terms of a previously
fixed stock option plan or award, and (d) the accounting for an exchange of
stock compensation awards in business combination. FIN No. 44 is effective July
1, 2000, however certain conclusions in this Interpretation cover specific
events that occur after
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either December 15, 1998, or January 12, 2000. To the extent that this
Interpretation covers events occurring during the period after December 15,
1998, or January 12, 2000, but before the effective date of July 1, 2000, the
effects of applying this Interpretation are recognized on a prospective basis
from July 1, 2000. The Company adopted FIN No. 44 in the quarter ended September
30, 2000.
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ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes in the market risk disclosures
during the three month period ended September 30, 2000 as compared to the
discussion in Part II of our Annual Report on Form 10-K for the year ended
December 31, 1999.
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PART II
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Item 3, Legal Proceedings, of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999 for a discussion
of certain pending legal proceedings. The information provided at such reference
regarding those matters remains unchanged except as explained below. The pending
litigation initiated by the Lemelson Medical, Education & Research Foundation,
Limited Partnership against certain electronics industry companies, including
LSI, that was described in the Company's prior reports has moved into the
discovery phase. These activities are ongoing and, as of yet, no trial date has
been set. In addition, the Company is a party to other litigation matters and
claims which are normal in the course of its operations. 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedules
(b) Reports on Form 8-K
On July 26, 2000, pursuant to Item 5 to report information set forth in
the Registrant's press release dated July 25, 2000.
On July 28, 2000, pursuant to Item 5 to report information set forth in
the Registrant's press release dated July 17, 2000.
On October 25, 2000, pursuant to Item 5 to report information set forth
in the Registrant's press release dated October 24, 2000.
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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: November 13, 2000 By /s/ R. Douglas Norby
---------------------------------
R. Douglas Norby
Executive Vice President Finance
& Chief Financial Officer
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
39
