<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 JULY 2, 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 August 1, 2000, there were 310,210,275 of the registrant's Common
Stock, $.01 par value, outstanding.
<PAGE> 2
LSI LOGIC CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2000
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
------
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1 Financial Statements
Consolidated Condensed Balance Sheets - June 30, 2000 and December 31, 1999 3
Consolidated Condensed Statements of Operations - Three Months and Six Month
Periods Ended June 30, 2000 and 1999 4
Consolidated Condensed Statements of Cash Flows - Six Month Periods Ended
June 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 19
Operations
Item 3 Quantitative and Qualitative Disclosures About Market Risk 32
PART II. OTHER INFORMATION
Item 1 Legal Proceedings 33
Item 4 Submission of Matters to a Vote of Security Holders 33
Item 5 Other Information 34
Item 6 Exhibits and Reports on Form 8-K 34
</TABLE>
2
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
June 30, December 31,
(In thousands, except per-share amounts) 2000 1999
--------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 295,137 $ 250,603
Short-term investments 647,392 410,730
Accounts receivable, less allowances of $9,187 and $11,346 400,287 275,620
Inventories 286,107 243,896
Deferred tax assets 66,375 66,212
Prepaid expenses and other current assets 75,709 41,223
--------------------------
Total current assets 1,771,007 1,288,284
Property and equipment, net 1,245,071 1,323,501
Goodwill and other intangibles 358,408 293,631
Other assets 315,946 301,189
--------------------------
Total assets $3,690,432 $3,206,605
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 175,006 $ 189,293
Accrued salaries, wages and benefits 75,649 77,277
Other accrued liabilities 142,286 110,229
Income tax payable 64,019 41,536
Current portion of long-term obligations 1,669 56,996
--------------------------
Total current liabilities 458,629 475,331
--------------------------
Deferred tax liabilities 82,401 75,771
Other long-term obligations 974,543 793,461
--------------------------
Total long-term obligations and deferred tax liabilities 1,056,944 869,232
--------------------------
Commitments and contingencies (Note 13)
Minority interest in subsidiaries 6,055 6,210
--------------------------
Stockholders' equity:
Preferred shares; $.01 par value; 2,000 shares authorized -- --
Common stock; $.01 par value; 1,300,000 shares authorized; 310,000 and
299,572 shares outstanding 3,100 2,996
Additional paid-in capital 1,424,132 1,271,093
Retained earnings 592,371 435,552
Accumulated other comprehensive income 149,201 146,191
--------------------------
Total stockholders' equity 2,168,804 1,855,832
--------------------------
Total liabilities and stockholders' equity $3,690,432 $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 Six Months Ended
June 30, June 30,
(In thousands, except per share amounts) 2000 1999 2000 1999
------------------------------------------------------------------
Revenues $ 644,328 $ 501,012 $ 1,259,514 $ 964,629
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Costs and expenses:
Cost of revenues 367,978 314,398 733,478 616,289
Research and development 86,801 75,046 167,030 151,569
Selling, general and administrative 75,079 62,783 145,319 124,272
Acquired in-process research and
development 16,333 4,600 16,333 4,600
Restructuring of operations and other
non-recurring charges -- 7,848 2,781 5,871
Amortization of intangibles 13,820 11,815 25,656 23,022
------------------------------------------------------------------
Total costs and expenses 560,011 476,490 1,090,597 925,623
------------------------------------------------------------------
Income from operations 84,317 24,522 168,917 39,006
Interest expense (10,323) (9,620) (21,216) (20,200)
Interest income and other, net 11,507 2,459 18,636 4,195
Gain on sale of equity securities 15,314 -- 49,486 --
------------------------------------------------------------------
Income before income taxes and cumulative 100,815 17,361 215,823 23,001
effect of change in accounting principle
Provision for income taxes 30,239 7,530 59,004 9,160
------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle 70,576 9,831 156,819 13,841
Cumulative effect of change in accounting
principle -- -- -- (91,774)
------------------------------------------------------------------
Net income/(loss) $ 70,576 $ 9,831 $ 156,819 $ (77,933)
------------------------------------------------------------------
Basic earnings per share:
Income before cumulative effect of change
in accounting principle $ 0.23 $ 0.03 $ 0.51 $ 0.05
------------------------------------------------------------------
Cumulative effect of change in accounting
principle -- -- -- (0.32)
------------------------------------------------------------------
Net income/(loss) $ 0.23 $ 0.03 $ 0.51 $ (0.27)
===================================================================
Dilutive earnings per share:
Income before cumulative effect of change
in accounting principle $ 0.21 $ 0.03 $ 0.46 $ 0.05
------------------------------------------------------------------
Cumulative effect of change in accounting
principle -- -- -- (0.31)
------------------------------------------------------------------
Net income/(loss) $ 0.21 $ 0.03 $ 0.46 $ (0.26)
===================================================================
Shares used in computing per share amounts:
Basic 308,275 291,244 305,464 289,766
===================================================================
Dilutive 353,120 303,894 351,155 299,228
===================================================================
</TABLE>
See accompanying notes to unaudited consolidated condensed financial statements.
4
<PAGE> 5
LSI LOGIC CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
(In thousands) 2000 1999
-------------------------
<S> <C> <C>
Operating activities:
Net income/(loss) $ 156,819 $ (77,933)
Adjustments:
Depreciation and amortization 187,798 190,752
Write-off of unamortized preproduction costs -- 97,356
Acquired in-process research and development 14,745 4,600
Non-cash restructuring charges, net 2,781 827
Gain on sale of equity securities (49,486) --
Changes in:
Accounts receivable (126,135) (87,639)
Inventories (43,037) (11,499)
Prepaid expenses and other assets (51,678) 2,935
Accounts payable (13,237) (26,091)
Accrued and other liabilities 53,075 7,040
-------------------------
Net cash provided by operating activities 131,645 100,348
-------------------------
Investing activities:
Purchase of debt and equity securities available-for-sale (684,199) (198,577)
Maturities and sales of debt and equity
securities available-for-sale 485,534 125,014
Purchases of equity securities (6,035) (117)
Proceeds from sales of stock investments 45,741 --
Acquisition of non-public technology companies (37,565) (6,779)
Purchases of property and equipment, net of retirement (83,537) (28,503)
-------------------------
Net cash used in investing activities (280,061) (108,962)
-------------------------
Financing activities:
Proceeds from borrowings 500,000 345,000
Repayment of debt obligations (375,786) (368,302)
Debt issuance costs (15,300) (9,488)
Issuance of common stock, net 90,166 24,204
-------------------------
Net cash provided by/(used in) financing activities 199,080 (8,586)
-------------------------
Effect of exchange rate changes on cash and cash equivalents (6,130) (2,576)
-------------------------
Increase/(decrease) in cash and cash equivalents 44,534 (19,776)
-------------------------
Cash and cash equivalents at beginning of period 250,603 210,306
-------------------------
Cash and cash equivalents at end of period $ 295,137 $ 190,530
=========================
</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 June
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 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 associated with
Neomagic's DVD Drive Electronics line of business ("DVD Business") 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 and DVD 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 of the DVD Business and
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, through the end of the period. There are no
significant differences between the accounting policies of the Company and the
DVD Business.
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, where appropriate 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>
6
<PAGE> 7
In-process research and development:
In connection with the purchase of the DVD Business 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 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 13, 2000 for the project as a percentage of total research
and development expenses to bring the project to technical 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.
However, development of the technology remains a substantial risk to the
Company due to factors including the remaining effort to achieve technical
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
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 a
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, where appropriate 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>
7
<PAGE> 8
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 technical 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.
However, development of the technology remains a substantial risk to the
Company due to factors including the remaining effort to achieve technical
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
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 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 shareholders 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 stock price around 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.
8
<PAGE> 9
The total purchase price was allocated to the estimated fair value of
assets acquired and liabilities assumed based on independent appraisals, where
appropriate 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>
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 remaining research and
development to be completed to bring the projects to technical feasibility. The
development process is grouped into three phases with each phase containing
between one and five milestones. The three phases are (i) researching the market
requirements and the engineering architecture and feasibility studies, (ii)
design and verification milestones, and (iii) prototyping and testing the
product (both internal and customer testing). Development of 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%).
However, development of the technology remains a substantial risk to the
Company due to factors including the remaining effort to achieve technical
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired may
become impaired.
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 a
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.
9
<PAGE> 10
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 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, Utilized March 31, 2000
1999
---------------------------------------------------------------------
<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 $12 million for the six month period
ended June 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 $2 million for the six
month period ended June 30, 2000, respectively. The amount was recorded as an
offset to cost of revenues.
10
<PAGE> 11
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 shareholders' 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.
As of June 30, 2000 and December 31, 1999, the Company held $162 million and
$55 million of debt securities, respectively, and that were included in cash and
cash equivalents and $647 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 June 30, 2000 and December 31, 1999. Contract maturities of
these securities were within one year as of June 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 June 30, 2000 and 1999.
At June 30, 2000 and December 31, 1999, the Company had marketable equity
securities with an aggregate carrying value of $176 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 $102 million and
$90 million, net of the related tax effect of $55 million and $48 million, on
these equity securities was included in accumulated comprehensive income as of
June 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 six month periods ended June 30, 2000, the
Company sold equity securities for approximately $16 million and $46 million,
respectively, in the open market, realizing a pre-tax gain of approximately $15
million and $42 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 six months period ended June 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 June 30, 2000 and December 31, 1999. The buy amount represents the U.S.
dollar equivalent
11
<PAGE> 12
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 June 30, 2000 and December
31, 1999. These contracts will expire through December 2000.
<TABLE>
<CAPTION>
June 30, December 31,
(In thousands) 2000 1999
------------------------
<S> <C> <C>
Japanese Yen $ 19,559 $ 22,194
Netherlands Guilder 5,184 43,145
British Pound 4,535 --
Japanese Yen (32,429) (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 losses included in interest income and other were
not significant for the three and six month periods ended June 30, 2000 and
1999.
Currency option contracts are treated as hedges of third-party yen revenue
exposures. At June 30, 2000, total outstanding purchased currency option
contracts were $135 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 six month periods ended June 30, 2000
and 1999. There were no deferred premiums outstanding as of December 31, 1999.
The deferred premiums on all outstanding options were $5.7 million as of June
30, 2000, and are included in other current assets.
During the three month period ended June 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>
June 30, December 31,
(In thousands) 2000 1999
-------------------------
<S> <C> <C>
Inventories:
Raw materials $ 27,377 $ 20,294
Work-in-process 145,850 139,698
Finished goods 112,880 83,904
-------------------------
$286,107 $243,896
=========================
</TABLE>
NOTE 8 -DEBT
<TABLE>
<CAPTION>
June 30, December 31,
(In thousands) 2000 1999
-------------------------
<S> <C> <C>
Notes payable to banks $ 95 $379,823
Convertible Subordinated Notes 845,000 345,000
Capital lease obligations 3,120 3,948
-------------------------
848,215 728,771
Current portion of long-term debt, capital
lease obligations and Short-term borrowings (1,669) (56,996)
-------------------------
Long-term debt and capital lease obligations $846,546 $ 671,775
=========================
</TABLE>
12
<PAGE> 13
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 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 June 30, 2000 and December 31, 1999, the
Company was in compliance with these covenants.
13
<PAGE> 14
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:
<TABLE>
<CAPTION>
Three Months Ended June 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 $70,576 308,275 $ 0.23 $ 9,831 291,244 $ 0.03
-------- --------
Effect of dilutive securities:
Stock options 22,837 12,650
4 1/4% Convertible
Subordinated Notes 2,750 22,008 -- --
Diluted EPS:
Net income available to
Common stockholders $73,326 353,120 $ 0.21 $ 9,831 303,894 $ 0.03
-------- --------
</TABLE>
* Numerator
+ Denominator
Of the total options outstanding, approximately 393,836 shares and 1,409,726
shares were excluded from the computation of diluted shares for the three months
ended June 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
$58.50 to $72.25 at June 30, 2000 and ranged from $20.94 to $29.07 at June 30,
1999, respectively. For the three months ended June 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. For the three
months ended June 30, 1999, common equivalent shares of 22,007,564 and interest
expense of $2.8 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.
14
<PAGE> 15
<TABLE>
<CAPTION>
Six Months Ended June 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 $156,819 305,464 $ 0.51 $ 13,841 289,766 $ 0.05
-------- --------
Cumulative effect of change
in accounting principle -- -- (91,774) 289,766 (0.32)
--------
Net income/(loss) available to
Common stockholders 156,819 305,464 0.51 (77,933) 289,766 (0.27)
-------- --------
Effect of dilutive securities:
Stock options 23,683 9,462
4 1/4% Convertible
Subordinated Notes 5,498 22,008 -- --
Diluted EPS:
Net income before cumulative
Effect of change in accounting
Principle (adjusted for assumed
Conversion of debt) 162,317 351,155 $ 0.46 13,841 299,228 0.05
-------- --------
Cumulative effect of change in
Accounting principle -- -- (91,774) 299,228 (0.31)
--------
Net income/(loss) available to
Common stockholders $162,317 351,155 $ 0.46 $(77,933) 299,228 $ (0.26)
-------- --------
</TABLE>
* Numerator
+ Denominator
Options to purchase 208,764 and 5,905,044 shares were outstanding at June
30, 2000 and 1999, respectively, but were not included in the calculation of
diluted shares for the six month periods ended June 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
$58.50 to $72.25 and $16.07 to $29.07 at June 30, 2000 and 1999, respectively.
For the six month period ended June 30, 2000, common equivalent shares of
5,258,169 and interest expense of $5.5 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 six months ended June 30, 1999, common equivalent shares of
12,487,580 and interest expense of $3.1 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.
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 Six Months Ended
June 30, June 30,
(In thousands) 2000 1999 2000 1999
-----------------------------------------------
<S> <C> <C> <C> <C>
Comprehensive income/(loss) $58,361 $27,688 $ 159,829 $(62,594)
-----------------------------------------------
</TABLE>
15
<PAGE> 16
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.
The following is a summary of operations by segment for the three and six
months ended June 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
(In thousands) 2000 1999 2000 1999
-------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES:
Semiconductor $547,285 $434,047 $1,077,672 $830,154
SAN Systems 97,043 66,965 181,842 134,475
------------------------------------------------------
Total $644,328 $501,012 $1,259,514 $964,629
=======================================================
INCOME FROM OPERATIONS:
Semiconductor $ 76,435 $ 17,317 $ 149,436 $ 26,754
SAN Systems 7,882 7,205 19,481 12,252
-------------------------------------------------------
Total $ 84,317 $ 24,522 $ 168,917 $ 39,006
=======================================================
</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 13% of our total consolidated revenues for the
three month period ended June 30, 2000. One customer represented 11% of our
total consolidated revenues for the three month period ended June 30, 1999. In
the Semiconductor segment, there was one customer with revenues representing 10%
of total Semiconductor revenues for the three month period ended June 30, 2000.
No customer represented 10% or more of the total revenue in the Semiconductor
segment for the three month period ended June 30, 1999. In the SAN Systems
segment, there were four customers with revenues representing 28%, 20%, 17% and
14% of total SAN Systems revenues for the three month period ended June 30,
2000. In the SAN Systems segment, there were three customers with revenues
representing 34%, 21%, and 15% of total SAN Systems revenues for the three month
period ended June 30, 1999.
One customer represented 13% of our total consolidated revenues for the six
month period ended June 30, 2000. No customers represented 10% or more of our
total consolidated revenues for the six month period ended June 30, 1999. In the
Semiconductor segment, one customer represented 10% of total Semiconductor
revenues for the six month period ended June 30, 2000. No customer represented
10% or more of the total revenue in the Semiconductor segment for the six month
period ended June 30, 1999. In the SAN Systems segment, there were four
customers with revenues representing 25%, 20%, 16% and 15% of total SAN Systems
revenues for the six month period ended June 30, 2000. For the six month period
ended June 30, 1999, there were three customers with revenues representing 29%,
24% and 17% of total SAN Systems revenues.
16
<PAGE> 17
The following is a summary of total assets by segment as of June 30, 2000
and December 31, 1999:
<TABLE>
<CAPTION>
June 30, December 31,
(In thousands) 2000 1999
--------------------------
<S> <C> <C>
TOTAL ASSETS:
Semiconductor $3,461,297 $3,051,865
SAN Systems 229,135 154,740
--------------------------
Total $3,690,432 $3,206,605
==========================
</TABLE>
Revenues from domestic operations were $404 million, representing 63% of
consolidated revenues, for the second quarter of 2000 compared to $311 million,
representing 62% of consolidated revenues, for the same period of 1999.
Revenues from domestic operations were $765 million, representing 61% of
consolidated revenues, for the first half of 2000 compared to $592 million,
representing 61% of consolidated revenues, for the same period of 1999.
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 June 30, 2000, the Company has drawn
down $53 million and $59 million as the first and second supplement,
respectively, pursuant to the agreement. Minimum rental payments under these
operating leases, including option periods, are $24.8 million in 2001, $23.4
million in 2002, $19.7 million in 2003, $18.8 million in 2004 and $4.6 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 June 30, 2000.
NOTE 14 -SUBSEQUENT EVENTS
On July 17, 2000, the Company acquired DataPath Systems, Inc. ("DataPath"),
a privately held supplier of communications chips for broadband, data networking
and wireless applications located in San Jose, California, in a stock
transaction valued at approximately $420 million. The acquisition of DataPath
will be accounted for as a purchase and accordingly the results of operations of
DataPath and the estimated fair value of assets acquired and
17
<PAGE> 18
liabilities assumed will be included in the Company's consolidated condensed
financial statements as of July 17, 2000.
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. The Company
repurchased one million shares of common stock in the open market following
approval of the stock repurchase program.
18
<PAGE> 19
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
19
<PAGE> 20
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 second quarter of 2000 increased $143.3 million or
29% to $644.3 million from $501.0 million for the same period of 1999 on a
consolidated basis. Revenues for the Semiconductor segment increased $113.3
million or 26% to $547.3 million for the second quarter of 2000 from $434.0
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 and storage components. Revenues for the SAN Systems segment
increased $30.0 million or 45% to $97.0 million for the second quarter of 2000
from $67.0 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 first half of 2000 increased $294.9 million or 31% to
$1,259.5 million from $964.6 million for the same period of 1999 on a
consolidated basis. Revenues for the Semiconductor segment increased $247.5
million or 30% to $1,077.7 million for the first half of 2000 from $830.2
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 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 communications and network computing
applications to remain strong for the rest of the year. Revenues for the SAN
Systems segment increased $47.4 million or 35% to
20
<PAGE> 21
$181.8 million for the first half of 2000 from $134.4 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 13% of our total consolidated revenues for the
three month period ended June 30, 2000. One customer represented 11% of our
total consolidated revenues for the three month period ended June 30, 1999. In
the Semiconductor segment, there was one customer with revenues representing 10%
of total Semiconductor revenues for the three month period ended June 30, 2000.
No customer represented 10% or more of the total revenue in the Semiconductor
segment for the three month period ended June 30, 1999. In the SAN Systems
segment, there were four customers with revenues representing 28%, 20%, 17% and
14% of total SAN Systems revenues for the three month period ended June 30,
2000. In the SAN Systems segment, there were three customers with revenues
representing 34%, 21%, and 15% of total SAN Systems revenues for the three month
period ended June 30, 1999.
One customer represented 13% of our total consolidated revenues for the six
month period ended June 30, 2000. No customers represented 10% or more of our
total consolidated revenues for the six month period ended June 30, 1999. In the
Semiconductor segment, one customer represented 10% of total Semiconductor
revenues for the six month period ended June 30, 2000. No customer represented
10% or more of the total revenue in the Semiconductor segment for the six month
period ended June 30, 1999. In the SAN Systems segment, there were four
customers with revenues representing 25%, 20%, 16% and 15% of total SAN Systems
revenues for the six month period ended June 30, 2000. For the six month period
ended June 30, 1999, there were three customers with revenues representing 29%,
24% and 17% of total SAN Systems revenues.
Revenues from domestic operations were $404 million, representing 63% of
consolidated revenues, for the second quarter of 2000 compared to $311 million,
representing 62% of consolidated revenues, for the same period of 1999.
Revenues from domestic operations were $765 million, representing 61% of
consolidated revenues, for the first half of 2000 compared to $592 million,
representing 61% 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 June 30, Six months ended June 30,
CONSOLIDATED: 2000 1999 2000 1999
----------------------------------------------------------
<S> <C> <C> <C> <C>
Gross profit margin 43% 37% 42% 36%
Research and development 13% 15% 13% 16%
Selling, general and administrative 12% 13% 12% 13%
Income from operations 13% 5% 13% 4%
</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 June 30, Six months ended June 30,
SEMICONDUCTOR SEGMENT: 2000 1999 2000 1999
----------------------------------------------------------
<S> <C> <C> <C> <C>
Gross profit margin 44% 38% 42% 37%
Research and development 15% 16% 14% 17%
Selling, general and administrative 12% 13% 11% 13%
Income from operations 14% 4% 14% 3%
</TABLE>
21
<PAGE> 22
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
SAN SYSTEMS SEGMENT: 2000 1999 2000 1999
----------------------------------------------------------
<S> <C> <C> <C> <C>
Gross profit margin 39% 34% 38% 32%
Research and development 7% 9% 7% 9%
Selling, general and administrative 12% 10% 12% 10%
Income from operations 8% 11% 11% 9%
</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 first half of 2000, we provided engineering
training in accordance with the agreement. The engineering training was valued
at $2.0 million and was recorded as a credit to cost of revenues. No such
benefit was recorded during the same period in 1999. We will provide an
additional $4.0 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 second quarter of 2000
from 37% in the same period of 1999 on a consolidated basis. The gross margin
percentage for the Semiconductor segment was 44% in the second quarter of 2000
compared to 38% in the same period of 1999.
The gross margin percentage increased to 42% in the first half of 2000 from
36% in the same period of 1999 on a consolidated basis. The gross margin
percentage for the Semiconductor segment was 42% in the first half of 2000
compared to 37% 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 39% in the
second quarter of 2000 compared to 34% in the same period of 1999. The gross
margin percentage for the SAN Systems segment was 38% in the first half of 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 the second quarter of
2000; and
- Lower manufacturing overhead spending as a percentage of revenue in the
second half of 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;
- Factory capacity and utilization;
- Manufacturing yields;
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- 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 second quarter of 2000 appreciated 10% from the same
period 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 $11.8 million or 16% to $86.8 million during the second quarter of
2000 as compared to $75.0 million during the same period of 1999 on a
consolidated basis. R&D expenses for the Semiconductor segment increased $10.6
million or 15% to $79.7 million in the second quarter of 2000 from $69.1 million
in the same period of 1999. The increase was primarily attributable to an
increase in compensation expenses.
Research and development ("R&D") expenses increased $15.4 million or 10% to
$167.0 million during the first half of 2000 as compared to $151.6 million
during the same period of 1999 on a consolidated basis. R&D expenses for the
Semiconductor segment increased $15.0 million or 11% to $153.9 million in the
first half of 2000 from $138.9 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 $12.0 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 $3.0 million was recorded during
the second quarter of 1999. We will receive an additional $38.0 million in cash
from Silterra over the remaining contract term of 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 $1.2 million or 20% to
$7.1 million in the second quarter of 2000 from to $5.9 million in the same
period of 1999. R&D expenses for the SAN Systems segment increased $0.4 million
or 3% to $13.1 million in the first half of 2000 from $12.7 million in the same
period of 1999.
As a percentage of revenues, R&D expenses decreased to 13% in the second
quarter of 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% in the second quarter of 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% in the second quarter of 2000 from 9% in the same period of 1999.
As a percentage of revenues, R&D expenses decreased to 13% in the first half
of 2000 from 16% in the same period of 1999 on a consolidated basis. R&D
expenses as a percentage of revenues for the Semiconductor segment decreased to
14% in the first half of 2000 from 17% in the same period of 1999. R&D expenses
as a percentage of revenues for the SAN Systems segment also decreased to 7% in
the first half of 2000 from 9% in the same period of 1999.
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.
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SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expenses increased $12.3 million or 20% to $75.1 million during the
second quarter of 2000 as compared to $62.8 million in the same period of 1999
on a consolidated basis. SG&A expenses for the Semiconductor segment increased
$7.3 million or 13% to $63.4 million in the second quarter of 2000 from $56.1
million in the same period of 1999. SG&A expenses for the SAN Systems segment
increased $5.0 million or 75% to $11.7 million in the second quarter of 2000
from $6.7 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.
Selling, general and administrative ("SG&A") expenses increased $21.0
million or 17% to $145.3 million during the first half of 2000 as compared to
$124.3 million in the same period of 1999 on a consolidated basis. SG&A expenses
for the Semiconductor segment increased $11.2 million or 10% to $122.7 million
in the first half of 2000 from $111.5 million in the same period of 1999. SG&A
expenses for the SAN Systems segment increased $9.8 million or 77% to $22.6
million in the first half of 2000 from $12.8 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 12% in the second
quarter of 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 12% in the second 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 12% in the second quarter of 2000 from 10% in the same period of
1999.
As a percentage of revenues, SG&A expenses decreased to 12% in the first
half of 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 first half 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 12% in the
first half of 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. 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 associated with Neomagic's DVD
Drive Electronics line of business ("DVD Business"), 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 and DVD
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 results of operations of the DVD Business and 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, through the end of the period.
In connection with the purchase of the DVD Business 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.
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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 PC DVD-ROM
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 technical 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 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.
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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 technical 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 shareholders 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 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 technical feasibility. The development process is grouped into three
phases with each phase containing between one and five milestones. The three
phases are:
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- 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 June
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.
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 technical feasibility. The development process is grouped into three
phases with each phase containing between one and five milestones. The three
phases are:
- Researching the market requirements and the engineering architecture and
feasibility studies;
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- 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 technical
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 operation and other non-recurring items recorded in the second
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.
Restructuring and merger related expenses were $8 million and $6 million for
the three and six month periods ended June 30, 1999, respectively. In connection
with the merger with SEEQ on June 22, 1999 (for description of the merger, see
our Annual Report on Form 10-K for the year ended December 31, 1999), we
recorded $3 million in restructuring charges and $5 million in merger related
expenses. The merger expenses relate primarily to investment banking and other
professional fees directly attributable to the merger with SEEQ. The
restructuring charge is comprised of $2 million in write-downs of fixed assets
which were duplicative to the combined company, $0.5 million of exit costs
relating to non-cancelable building lease contracts and $0.5 million provision
for severance costs related to the involuntary termination of 3 employees. The
exit costs and employee severance costs were recorded in accordance with EITF
No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity." The fixed and other assets write-downs were
recorded in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of ." The
restructuring actions as outlined by the restructuring plan are substantially
executed and completed by June 30, 2000.
The $6 million in restructuring and merger related expenses for the six
months ended June 30, 1999 included a $2.5 million reversal of restructuring
reserves originally established in the third quarter of 1998 and $0.5 million of
merger expenses recorded by SEEQ in the first quarter of 1999. During the first
quarter of 1999, we determined that $2.5 million of the restructuring reserve
originally established in the third quarter of 1998 would not be utilized as a
result of the completion of activities in the U.S., Europe and Japan, including
the trade-in of certain software at a gain which was previously written down
(for description of the restructuring costs recorded in 1998, see our Annual
Report on Form 10-K for the year ended December 31, 1999). 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 $2.0 million or 17% to $13.8 million in the second quarter of 2000
from $11.8 million in the same period of 1999. Amortization of
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goodwill and other intangibles increased $2.7 million or 12% to $25.7 million in
the first half of 2000 from $23.0 million in the same period of 1999. The
increase was primarily related to additional amortization of goodwill associated
with the acquisitions of Intraserver and divisions of Cacheware and Neomagic in
the second quarter of 2000. (See Note 2 of the Notes).
INTEREST EXPENSE. Interest expense increased $0.7 million to $10.3 million
in the second quarter of 2000 from $9.6 million in the same period of 1999.
Interest expense increased $1.0 million to $21.2 million in the first half of
2000 from $20.2 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 Subordinates Notes (see Note 8 of the Notes) which was used to
repay bank debt outstanding with a balance of $380 million during the first
quarter of 2000 as compared to the same period of 1999, which was in part offset
by lower interest rates.
INTEREST INCOME AND OTHER, NET. Interest income and other increased $9.0
million to $11.5 million in the second quarter of 2000 from $2.5 million in the
same period of 1999. The increase was primarily attributable to approximately
$9.0 million higher interest income in the second quarter of 2000 as compared to
the same period of 1999 due to a higher average balance of interest-generating
cash, cash equivalents and short-term investments and higher interest rates
during the second quarter of 2000 as compared to the same period of 1999.
Interest income and other increased $14.4 million to $18.6 million in the
first half of 2000 from $4.2 million in the same period of 1999. The increase
was primarily attributable to approximately $15.0 million higher interest income
during the first half of 2000 as compared to the same period of 1999 due to a
higher average balance of interest-generating cash, cash equivalents and
short-term investments and higher interest rates, offset in part by increased
foreign exchange losses during the first half of 2000 as compared to the same
period in 1999.
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 second
quarter of 2000, we sold certain marketable equity securities for $15.8 million
in the open market, realizing a pre-tax gain of approximately $15.3 million.
During the first half of 2000, we sold certain marketable equity securities for
$45.7 million in the open market, realizing a pre-tax gain of approximately
$42.7 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. There was no sale of marketable
equity securities during the first half of 1999.
PROVISION FOR INCOME TAXES. The tax provision for the three and six months
ended June 30, 2000 was at an effective rate of 30% and 27%, respectively,
compared to 43% and 40%, respectively, for the three and six months ended June
30, 1999. The rate in the first half of 2000 was impacted primarily by the
write-off of IPR&D and recognition of an intercompany gain on the sale of
certain intangible property subject to U.S. taxes in the second quarter. The
rate in the first half of 1999 was impacted by write-offs relating to IPR&D,
SEEQ merger costs and restructuring charges during the second quarter. 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.
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FINANCIAL CONDITION AND LIQUIDITY
Cash, cash equivalents and short-term investments increased $281.2 million
or 43% to $942.5 million as of June 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 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 $499.4 million or 61% to $1,312.4
million as of June 30, 2000 from $813.0 million as of December 31, 1999. The
increase was primarily a result of the following factors:
- $236.7 million higher short-term investments primarily attributable to
$198.7 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;
- $124.7 million higher net accounts receivable due to increased revenue and
the timing of shipments when comparing the second 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 second quarter of
2000, shipments increased towards the end of the quarter;
- $55.3 million lower current portion of long-term obligations resulting
from repayment of the Revolver. (See Note 8 of the Notes.);
- $42.2 million higher inventory reflects the expectation of continued
higher sales in 2000; and
- $34.5 million higher prepaid expenses and other current assets primarily
due to the fixed assets held for sale reclassified to current assets from
fixed assets (see Note 3 of the Notes).
CASH AND CASH EQUIVALENTS PROVIDED BY OPERATING ACTIVITIES. During the first
six months of 2000, we generated $131.6 million of net cash and cash equivalents
from operating activities compared to $100.3 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 and gains and losses on stock investments) and an increase
in accrued and other liabilities. The increase in accrued and other liabilities
was primarily attributable to higher income tax payable due to a provision for
income taxes for the current period, net of payment and higher accrued interest
expense due to the timing of the interest payment.
The increased net cash from operations during the first six months of 2000
as compared to the same period of 1999 was offset in part by an increase in
accounts receivable, prepaid expenses 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 the fixed assets held for sale reclassified to current assets
from fixed assets (see Note 3 of the Notes), 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 $280.1 million during the first six
months of 2000, compared to $109.0 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).
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<PAGE> 31
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 $83.5
million during the first six months of 2000 and $28.5 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 first six months of
2000 totaled $199.1 million compared to $8.6 million used 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.
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 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 June 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 June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
requires that an entity 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
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<PAGE> 32
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. We will adopt SFAS No. 133 and 138 in
our quarter ending March 31, 2001. While the Company believes the adoption of
the statements will not have a significant effect on the Company's results of
operations, the impact of the adoption of SFAS No. 133 and 138 as of the
effective date cannot be reasonably estimated at this time.
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 44"), "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 44 is effective July 1, 2000, however certain conclusions in
this Interpretation cover specific events that occur after 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.
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 June 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of LSI Logic Corporation was held on May
4, 2000 in Colorado Springs, Colorado. Proxies representing 282,278,011 shares
of common stock or 93% of the total outstanding shares were voted at the
meeting. The table below presents the voting results of election of the
Company's Board of Directors:
<TABLE>
<CAPTION>
Votes For Votes Withheld
--------- --------------
<S> <C> <C>
Wilfred J. Corrigan 281,306,363 971,648
T.Z. Chu 281,288,864 989,147
Malcolm R. Currie 281,238,801 1,039,210
James H. Keyes 281,318,378 959,633
R. Douglas Norby 281,315,161 962,850
Matthew J. O'Rourke 281,204,140 1,073,871
</TABLE>
The stockholders approved an amendment to the Restated Certificate of
Incorporation to increase the number of authorized shares of common stock to
1,300,000,000 shares. The proposal received 242,183,233 affirmative votes,
39,011,226 negative votes, 1,079,172 abstentions and 4,380 broker non-votes.
The stockholders approved an amendment to the Amended and Restated Employee
Stock Purchase Plan to increase the number of shares of common stock reserved
for issuance thereunder by 1,500,000. The proposal received 268,820,358
affirmative notes, 12,489,976 negative votes, 963,297 abstentions, and 4,380
broker non-votes.
The stockholders approved an amendment to the 1991 Equity Incentive Plan to
increase the number of shares of common stock reserved for issuance thereunder
by 10,000,000. The proposal received 180,707,507 affirmative votes, 97,510,114
negative votes, 1,056,010 abstentions, and 4,380 broker non-votes.
The stockholders approved the appointment of PricewaterhouseCoopers LLP as
independent accountants of the Company for the fiscal year 2000. The proposal
received 280,982,772 affirmative votes, 421,770 negative votes, 869,089
abstentions, and 4,380 broker non-votes.
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<PAGE> 34
ITEM 5. OTHER INFORMATION
Proposals of stockholders intended to be presented at the Company's 2001
annual meeting of stockholders must be received at the Company's principal
executive offices not later than November 24, 2000 in order to be included in
the Company's proxy statement and form of proxy relating to the 2001 annual
meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedules
(b) Reports on Form 8-K
On May 24, 2000, pursuant to Item 5 to report information set forth in the
Registrant's press release dated May 22, 2000.
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.
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<PAGE> 35
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: August 15, 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>
36
