<PAGE>1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM 10-Q
------------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 3, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
------------------
Commission file number 1-10079
CYPRESS SEMICONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2885898
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3901 North First Street, San Jose, California 95134-1599 (Address of
principal executive offices and zip code)
Registrant's telephone number, including area code: (408) 943-2600
------------------
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
--- ---
The total number of shares of the registrant's common stock, outstanding as of
October 3, 1999, was 109,290,000.
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<PAGE>2
CYPRESS SEMICONDUCTOR CORPORATION
Page
----
Part I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets.............................. 3
Condensed Consolidated Statements of Operations.................... 5
Condensed Consolidated Statements of Cash Flows................... 7
Notes to Condensed Consolidated Financial Statements............... 9
Item 2. Management's Discussion and Analysis of Financial Condition.... 24
Item 3. Quantitative and Qualitative Disclosure About Market Risk...... 43
Part II -- OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 44
Item 6. Exhibits and Reports on Form 8-K..................................... 44
Signatures................................................................... 45
<PAGE>3
<TABLE>
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per-share data)
(Unaudited)
<CAPTION>
Oct. 3, Jan. 3,
1999 1999
------------ -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 128,876 $ 142,102
Short-term investments................................................... 73,915 18,459
---------- ----------
Total cash, cash equivalents and short-term investments.................. 202,791 160,561
Accounts receivable, net of allowances of $2,478 at October 3, 1999
and $3,050 at January 3, 1999.......................................... 93,253 68,955
Inventories, net......................................................... 79,270 65,096
Other current assets..................................................... 23,042 14,372
---------- ----------
Total current assets 398,356 308,984
Property, plant and equipment, net......................................... 352,323 348,936
Long-term investments...................................................... 105,572 57,046
Restricted investments..................................................... 61,288 59,742
Other assets............................................................... 47,704 8,223
---------- ----------
Total assets................................................. $ 965,243 $ 782,931
========== ==========
The accompanying notes form an integral part of these condensed consolidated financial statements.
<PAGE>4
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per-share data)
(Unaudited)
<CAPTION>
Oct. 3, Jan. 3,
1999 1999
------------ -----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................................... $ 69,756 $ 53,932
Accrued liabilities...................................................... 45,767 33,145
Deferred income on sales to distributors................................. 19,659 13,300
Income taxes payable..................................................... 24,635 13,591
---------- ----------
Total current liabilities............................................ 159,817 113,968
Convertible subordinated notes........................................... 160,000 160,000
Deferred income tax...................................................... 10,364 --
Other long-term liabilities.............................................. 8,076 10,240
---------- ----------
Total liabilities.................................................... 338,257 284,208
---------- ----------
Commitments and Contingencies (Note 10)
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000 shares authorized;
none issued and outstanding............................................ -- --
Common stock, $0.01 par value, 250,000 shares authorized;
114,271 and 109,586 issued;
109,290 and 96,298 outstanding at October 3, 1999 and January 3, 1999.. 1,143 1,096
Additional paid-in capital............................................... 509,944 481,640
Notes receivable from stockholders'...................................... (7,892) --
Retained earnings........................................................ 196,516 180,625
---------- ----------
699,711 663,361
Less shares of common stock held in treasury at cost:
4,981 and 13,288 shares at October 3, 1999 and January 3, 1999......... (72,725) (164,638)
---------- ----------
Total stockholders' equity........................................... 626,986 498,723
---------- ----------
Total liabilities and stockholders' equity....................... $ 965,243 $ 782,931
========== ==========
The accompanying notes form an integral part of these condensed consolidated financial statements.
</TABLE>
<PAGE>5
<TABLE>
CYPRESS SEMICONDUCTOR CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except per-share data)
(Unaudited)
<CAPTION>
Three Months Ended
--------------------------
<S> <C> <C>
Oct. 3, Sep. 28,
1999 1998
-------- --------
Revenues................................................................... $184,497 $ 143,791
-------- --------
Costs and expenses:
Cost of revenues......................................................... 98,528 96,419
Research and development................................................. 32,021 28,184
Selling, general and administrative...................................... 26,000 22,391
Acquisition and merger costs............................................. 1,879 --
Restructuring credits.................................................... -- (59)
-------- --------
Total operating costs and expenses................................... 158,428 146,935
-------- --------
Operating income (loss).................................................... 26,069 (3,144)
Interest expense........................................................... (2,458) (2,745)
Interest income and other.................................................. 4,196 4,926
-------- --------
Income (loss) before income taxes.......................................... 27,807 (963)
(Provision) benefit for income taxes....................................... (1,390) 2,771
-------- --------
Net income................................................................. $ 26,417 $ 1,808
======== ========
Net income per share:
Basic.................................................................... $ 0.25 $ 0.02
Diluted.................................................................. $ 0.23 $ 0.02
Shares used in per share calculations:
Basic.................................................................... 107,508 101,600
Diluted.................................................................. 117,103 105,492
The accompanying notes form an integral part of these condensed consolidated financial statements.
</TABLE>
<PAGE>6
<TABLE>
CYPRESS SEMICONDUCTOR CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except per-share data)
(Unaudited)
<CAPTION>
Nine Months Ended
--------------------------
<S> <C> <C>
Oct. 3, Sep. 28,
1999 1998
-------- --------
Revenues................................................................... $497,611 $ 409,320
-------- --------
Costs and expenses:
Cost of revenues......................................................... 277,561 313,486
Research and development................................................. 95,306 83,853
Selling, general and administrative...................................... 74,825 67,942
Acquisition and merger costs............................................. 11,683 --
Restructuring costs (credits)............................................ (3,811) 60,737
-------- --------
Total operating costs and expenses................................... 455,564 526,018
-------- --------
Operating income (loss).................................................... 42,047 (116,698)
Interest expense........................................................... (7,244) (8,548)
Interest income and other.................................................. 11,097 8,312
-------- --------
Income (loss) before income taxes.......................................... 45,900 (116,934)
(Provision) benefit for income taxes....................................... (2,319) 13,766
-------- --------
Net income (loss).......................................................... $ 43,581 $ (103,168)
======== ========
Net income (loss) per share:
Basic.................................................................... $ 0.42 $ (1.01)
Diluted.................................................................. $ 0.40 $ (1.01)
Shares used in per share calculations:
Basic.................................................................... 102,974 102,194
Diluted.................................................................. 109,040 102,194
The accompanying notes form an integral part of these condensed consolidated financial statements.
</TABLE>
<PAGE>7
<TABLE>
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<CAPTION>
Nine Months Ended
---------------------------
<S> <C> <C>
Oct. 3, Sep. 28,
1999 1998
--------- ---------
Cash flow from operating activities:
Net income (loss)........................................................ $ 43,581 $(102,833)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization.......................................... 80,332 94,067
Acquired in-process research and development........................... 4,019 --
Restructuring charges (reversals)...................................... (3,811) 60,737
Non-cash interest and amortization of debt issuance costs.............. 797 767
Changes in operating assets and liabilities:
Accounts receivable...................................................... (23,421) 2,493
Inventories.............................................................. (14,113) 16,550
Other assets............................................................. (9,748) 6,142
Accounts payable and accrued liabilities................................. 19,109 (5,909)
Deferred income.......................................................... 6,359 2,060
Income taxes payable..................................................... 11,044 (1,088)
---------- ----------
Net cash flow generated from operating activities.................... 114,148 72,986
---------- ----------
Cash flow from investing activities:
Purchase of investments.................................................. (139,587) (139,924)
Sale or maturities of investments........................................ 35,605 100,165
Acquisition of Anchor.................................................... (14,956) --
Acquisition of Arcus..................................................... (9,883) --
Acquisition of property, plant and equipment............................. (76,590) (51,544)
Acquisition of technology rights......................................... (6,950) --
Proceeds from the sale of equipment...................................... 7,679 1,981
---------- ----------
Net cash flow used for investing activities.......................... (204,682) (89,322)
---------- ----------
</TABLE>
<PAGE>8
<TABLE>
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands)
(Unaudited)
<CAPTION>
Nine Months Ended
---------------------------
<S> <C> <C>
Oct. 3, Sep. 28,
1999 1998
--------- ---------
Cash flow from financing activities:
Repurchase of common stock............................................... -- (50,425)
Retirement of convertible subordinated notes, net of issuance costs...... -- (4,325)
Repayment on debt........................................................ (2,653) (3,992)
Proceeds from put premiums............................................... -- 5,359
Re-issuance of treasury shares........................................... 52,814 --
Issuance of notes to employees........................................... (7,892) --
Issuance of common stock................................................. 36,950 10,684
Other long-term liabilities.............................................. (1,911) (2,126)
---------- ----------
Net cash flow generated by financing activities...................... 77,308 (44,825)
---------- ----------
Net decrease in cash and cash equivalents.................................. (13,226) (61,161)
Cash and cash equivalents, beginning of year............................... 142,102 157,468
---------- ----------
Cash and cash equivalents, end of quarter.................................. $ 128,876 $ 96,307
========== ==========
The accompanying notes form an integral part of these condensed consolidated financial statements.
</TABLE>
<PAGE>9
CYPRESS SEMICONDUCTOR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended October 3, 1999
(Unaudited)
NOTE 1 -- INTERIM STATEMENTS
- ----------------------------
In the opinion of management of Cypress Semiconductor Corporation
("Cypress"), the accompanying unaudited condensed consolidated financial
statements contain all adjustments (consisting solely of normal recurring
adjustments) necessary to present fairly the financial information included
therein. Cypress believes that the disclosures are adequate to make the
information not misleading. However, it is suggested that this financial data be
read in conjunction with the audited consolidated financial statements and
related notes thereto for the year ended January 3, 1999 included in Cypress's
1998 Annual Report on Form 10-K.
Beginning with its 1998 fiscal year-end, Cypress ended its fiscal months,
quarters and years on Sundays, rather than Mondays, bringing its fiscal period
ends in line with predominant industry practice. This change did not have a
significant effect on Cypress's condensed consolidated financial statements for
the three-month and nine-month periods ended October 3, 1999 as compared to the
respective three-month and nine-month periods ended September 28, 1998. For
interim financial reporting purposes, Cypress reports on a 13-week quarter. The
results of operations for the three-month and nine-month periods ended October
3, 1999 are not necessarily indicative of the results to be expected for the
full year.
NOTE 2 -- ACQUISITION OF ARCUS TECHNOLOGY COMPANIES
- ---------------------------------------------------
On June 30, 1999, Cypress acquired all of the outstanding capital stock of
Arcus Technology (USA), Inc. and the assets of Arcus Technology (India) Limited
(referred to as "Arcus" on a combined basis). Arcus specializes in new data
communications arenas including dense wave multiplexing (which allows multiple
signals to be transmitted over a single fiber optic cable) and "IP over SONET"
(the technology needed to code and decode Internet traffic to send it over the
telephone system). The acquisition was accounted for as a purchase. Accordingly,
the estimated fair value of assets acquired and liabilities assumed were
included in Cypress's condensed consolidated balance sheet as of June 30, 1999,
the effective date of the purchase. The results of operations from June 30, 1999
through Cypress's quarter end were not significant and were therefore excluded.
There are no significant differences between the accounting policies of Cypress
and Arcus.
Cypress acquired Arcus for $17.7 million, including cash of $11.5 million
and stock of $6.2 million, excluding direct acquisition costs of $0.8 million
for legal and accounting fees. Through October 3, 1999, Cypress paid $9.9
million in cash and issued $2.3 million in stock. The remaining $1.6 million in
cash will be paid and the remaining $3.9 million in stock will be issued as
<PAGE>10
certain performance milestones are reached. The total purchase price was
allocated to the estimated fair value of assets acquired and liabilities assumed
based on independent appraisals and management estimates as follows:
(In thousands)
--------------
Fair value of tangible net assets....... $ 391
In-process research and development..... 2,500
Current technology...................... 4,400
Assembled workforce..................... 1,600
Deferred compensation................... 5,553
Excess of purchase price over net assets
acquired................................ 3,264
--------------
$ 17,708
==============
To determine the value of the in-process technology, the expected future
cash flow attributable to the in-process technology was discounted, taking into
account the percentage of completion, utilization of pre-existing technology,
risks related to the characteristics and applications of the technology,
existing and future markets, and technological risk associated with completing
the development of the technology. The valuation approach used was a form of
discounted cash flow approach commonly known as the "percentage of completion"
approach whereby the cash flows from the technology are multiplied by the
percentage of completion of the in-process technology.
Cypress expects that the in-process technology will be completed within a
period of twelve to twenty-four months after the closing of the transaction,
however, there remain significant technical challenges that must be resolved in
order to complete the in-process technology.
To determine the value of the current technology, the expected future cash
flow attributable to the current technology was discounted, taking into account
risks related to the characteristics and applications of the technology,
existing and future markets, and assessment of the life cycle stage of the
technology. The value of the assembled workforce was derived by estimating the
costs to replace the existing employees, including recruiting, hiring and
training costs for each category of employee.
Development of in-process technology remains a substantial risk to Cypress
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.
The in-process research and development charge valuation was prepared by an
independent appraiser of technology assets, based on inputs from Cypress
management, utilizing valuation methodologies approved by the Securities and
Exchange Commission ("SEC"). However, there can be no assurance that the SEC
will not take issue with assumptions used in Cypress's valuation model and
require Cypress to revise the amount allocated to in-process research and
development.
The amounts allocated to current technology, assembled workforce and
residual goodwill are being amortized over their respective estimated useful
lives of between six and ten years using the straight-line method.
<PAGE>11
NOTE 3 -- ACQUISITION OF ANCHOR CHIPS, INC.
- -------------------------------------------
On May 25, 1999, Cypress acquired all of the outstanding capital stock of
Anchor Chips, Inc. ("Anchor"), a company that designs and markets
microcontroller chips to support the Universal Serial Bus. The acquisition was
accounted for as a purchase. Accordingly, the results of operations of Anchor
and the estimated fair value of assets acquired and liabilities assumed were
included in Cypress's condensed consolidated financial statements as of May 25,
1999, the effective date of the purchase through the end of the period. There
are no significant differences between the accounting policies of Cypress and
Anchor.
Cypress paid approximately $15.0 million in cash excluding direct
acquisition costs of $0.7 million for investment banking, legal and
accounting fees. The purchase price of $15.0 million was allocated to the
estimated fair value of assets acquired and liabilities assumed based on the
valuation completed by management, which is consistent with the methodology
applied by independent appraisers, as follows:
(In thousands)
Fair value of tangible net liabilities.. $ (919)
In-process research and development..... 1,519
Assembled workforce..................... 1,320
Current technology...................... 13,036
------------
$ 14,956
============
To determine the value of the in-process technology, the expected future
cash flow attributable to the in-process technology was discounted, taking into
account the percentage of completion, utilization of pre-existing technology,
risks related to the characteristics and applications of the technology,
existing and future markets, and technological risk associated with completing
the development of the technology. The valuation approach used was a form of
discounted cash flow approach commonly known as the "percentage of completion"
approach whereby the cash flows from the technology are multiplied by the
percentage of completion of the in-process technology.
Cypress expects that the in-process technology will be successfully
developed and that the in-process technology will be completed within a period
of twelve to twenty-four months after the closing of the transaction. Cypress
expects that the in-process technology will be successfully developed, however,
there remain significant technical challenges that must be resolved in order to
complete the in-process technology.
To determine the value of the current technology, the expected future cash
flow attributable to the current technology was discounted, taking into account
risks related to the characteristics and applications of the technology,
existing and future markets, and assessment of the life cycle stage of the
technology. The value of the assembled workforce was derived by estimating the
costs to replace the existing employees, including recruiting, hiring and
training costs for each category of employee.
<PAGE>12
Development of in-process technology remains a substantial risk to Cypress
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.
Cypress management believes that the in-process research and development charge
is valued consistently with valuation methodologies utilized by independent
appraisers of technology assets and valuation practices approved by the SEC.
However, there can be no assurance that the SEC will not take issue with
assumptions used in Cypress's valuation model and require Cypress to revise the
amount allocated to in-process research and development.
The amounts allocated to assembled workforce and current technology are
being amortized over their estimated useful lives of five-years using the
straight-line method. There was no goodwill associated with the acquisition of
Anchor.
NOTE 4 -- MERGER WITH IC WORKS INCORPORATED
- -------------------------------------------
On April 1, 1999, Cypress completed a merger with IC WORKS Incorporated
("ICW"), which was accounted for as a pooling of interests. The condensed
consolidated financial statements and the notes to the condensed consolidated
financial statements give effect to the merger for all periods presented. The
fiscal years of Cypress and ICW were different. ICW has changed its fiscal
year-end to coincide with that of Cypress. Cypress's consolidated statements of
operations for the three and nine-month periods ended September 28, 1998 have
been combined with ICW's consolidated statements of operations for the
corresponding three and nine-month periods ended September 25, 1998.
The results of operations previously reported by the separate companies
prior to the merger and included in the results of operations for the
nine-months ended October 3, 1999 and September 28, 1998 are presented below.
<TABLE>
Three months ended April 4, 1999:
- ---------------------------------
<CAPTION>
Cypress ICW Total
(In thousands)
--------- --------- ---------
<S> <C> <C> <C>
Total revenue........................... $ 130,380 $ 21,211 $ 151,591
Net income.............................. $ 5,962 $ 2,720 $ 8,684
Three months ended March 30, 1998:
- ----------------------------------
<CAPTION>
Cypress ICW Total
(In thousands)
--------- --------- ---------
<S> <C> <C> <C>
Total revenue........................... $ 116,953 $ 15,200 $ 132,153
Net loss................................ $ (93,973) $ (1,782) $ (95,755)
</TABLE>
<PAGE>13
During the quarter ended April 4, 1999, Cypress recorded merger-related
transaction costs of $3.7 million related to the acquisition of ICW. These
charges, which consist primarily of investment banking and other professional
fees, have been included under acquisition and merger costs in the Condensed
Consolidated Statements of Operations.
NOTE 5 -- CASH AND INVESTMENTS
- ------------------------------
<TABLE>
<CAPTION>
Oct. 3, Jan. 3,
1999 1999
------------ ----------
(In thousands)
<S> <C> <C>
Cash and cash equivalents............... $128,876 $142,102
Short-term investments.................. 73,915 18,459
Long-term investments................... 105,572 57,046
Restricted investments.................. 61,288 59,742
---------- ----------
Total......................... $369,651 $277,349
========== ==========
</TABLE>
NOTE 6 -- INVENTORIES
- ---------------------
<TABLE>
<CAPTION>
Oct. 3, Jan. 3,
1999 1999
----------- ----------
(In thousands)
<S> <C> <C>
Raw materials........................... $ 10,313 $ 8,939
Work-in-process......................... 38,514 35,399
Finished goods.......................... 30,443 20,758
---------- ---------
Total......................... $ 79,270 $ 65,096
========== =========
</TABLE>
NOTE 7 -- EARNINGS PER SHARE
- ----------------------------
Statement of Accounting Standards No. 128 ("SFAS 128") requires a
reconciliation of the numerators and denominators of the basic and diluted per
share computations. Basic earnings per share ("EPS") is computed by dividing net
income available to stockholders (numerator) by the weighted average number of
common shares outstanding (denominator) during the period. Diluted EPS is
<PAGE>14
computed using the weighted average number of common and all potential dilutive
common shares outstanding during the period. In computing diluted EPS, the
average stock price for the period is used in determining the number of shares
assumed to be purchased from the exercise of stock options. Following is a
reconciliation of the numerators and denominators of the basic and diluted EPS
computations for the periods presented below.
<TABLE>
Three months ended October 3, 1999 and September 28, 1998:
- ----------------------------------------------------------
<CAPTION>
October 3, 1999 September 28, 1998
------------------------------- -------------------------------
Per-Share Per-Share
Income Shares Amount Income Shares Amount
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
(In thousands, except per share amounts)
Basic EPS:
Net income............. $ 26,417 107,508 $ 0.25 $ 1,808 101,600 $ 0.02
Effects of dilutive
securities:
Stock options.......... -- 9,595 -- 3,892
--------- --------- --------- --------- --------- ---------
Diluted EPS:
Net income............. $ 26,417 117,103 $ 0.23 $ 1,808 105,492 $ 0.02
========= ========= ========= ========= ========= =========
Nine months ended October 3, 1999 and September 28, 1998:
- ---------------------------------------------------------
<CAPTION>
</TABLE>
<TABLE>
October 3, 1999 September 28, 1998
------------------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Per-Share Per-Share
Income Shares Amount Income Shares Amount
--------- --------- --------- --------- --------- ---------
(In thousands, except per share amounts)
Basic EPS:
Net income (loss)...... $ 43,581 102,974 $ 0.42 $(103,168) 102,194 $ (1.01)
Effects of dilutive
securities:
Stock options.......... -- 6,066 -- --
--------- --------- --------- --------- --------- ---------
Diluted EPS:
Net income (loss)...... $ 43,581 109,040 $ 0.40 $(103,168) 102,194 $ (1.01)
========= ========= ========= ========= ========= =========
</TABLE>
<PAGE>15
At October 3, 1999 and September 28, 1998, stock options outstanding were
19,353,000 and 24,681,000, respectively. Of the options outstanding, 19,000 and
17,275,000 shares, respectively, were excluded from the computation of diluted
EPS because their exercise prices were greater than the average market price of
common shares during the quarter. Convertible debentures outstanding at October
3, 1999 and September 28, 1998 convertible to 6,772,000 and 7,196,000 shares,
respectively, of common stock were also excluded from diluted EPS as their
effect was anti-dilutive.
NOTE 8 -- RESTRUCTURING AND OTHER NON-RECURRING COSTS
- -----------------------------------------------------
1998 RESTRUCTURING AND OTHER NON-RECURRING COSTS
------------------------------------------------
In March 1998, Cypress implemented an overall cost reduction plan and
recorded a $57.1 million restructuring reserve. The restructuring entailed:
o The shutdown of Fab 3, located in Bloomington, Minnesota and
consolidation of parts of Fab 3 operations with other operations of
Cypress.
o The discontinuance of the 0.6-micron 256k Static Random Access Memory
("SRAM") production in Fab 2 located in Texas.
o The conversion of an existing research and development fab located in
San Jose ("Fab 1") to eight-inch capability in order to be compatible
with the state of the art eight-inch Minnesota manufacturing facility.
o The transfer of Cypress's test operations from its subcontractor,
Alphatec, in Thailand to Cypress's production facility in the
Philippines.
The restructuring activities described above included the termination of
approximately 850 employees, primarily from manufacturing, both at Cypress and
at Alphatec.
Separate from the restructuring charge, Cypress recorded additional charges
of $27.3 million, which were recorded as operating expenses in the first quarter
of 1998. These charges were for inventory reserves ($15.8 million), the
write-off of pre-operating costs ($3.8 million), the write-off of an equity
investment ($3.1 million), costs incurred to reimburse a customer for certain
product expenses incurred ($2.5 million) and the write-off of obsolete equipment
in Fab 4 ($2.1 million). The write-down of inventory was made to establish
incremental reserves for excess inventory and was recorded as cost of revenues.
The write-off of pre-operating costs included $2.9 million related to
Cypress's wafer fabrication operation in Bloomington, Minnesota and $0.9 million
related to its assembly and test operation in the Philippines. As a result of
restructuring activities, Cypress wrote off its previously capitalized
pre-operating costs as an impaired asset due to uncertainties surrounding their
future economic benefits. These costs were written off to cost of revenues.
There were no capitalized pre-operating costs subsequent to the first quarter of
1998.
<PAGE>16
The $3.1 million write-off of the equity investment was recorded against
net interest and other income to reflect the decline in the value of an
investment. Selling, general and administrative costs included the write-off of
$2.5 million in costs incurred to reimburse a customer for certain product
expenses incurred. During Cypress's periodic review of equipment, some equipment
was identified as obsolete and $2.1 million was charged to cost of revenues to
write-off the obsolete equipment.
The following tables set forth charges taken against the reserve during the
three- and nine-month periods ended October 3, 1999.
<TABLE>
Three months ended October 3, 1999:
-----------------------------------
<CAPTION>
Balance Balance
Jul. 4, Oct. 3,
1999 Utilized Other 1999
-------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
Other fixed asset related charges(1)................. $ 2,454 $ (222) $ -- $ 2,232
======== ======== ======== ========
Nine months ended October 3, 1999:
----------------------------------
<CAPTION>
Balance Balance
Jan. 3, Oct. 3,
1999 Utilized Other 1999
-------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
Severance and other employee related charges(1) (2).. $ 2,309 (54) $ (2,255) $ --
Other fixed asset related charges(1)................. 3,030 (278) (520) 2,232
Provision for phase-down and consolidation of
manufacturing 339 -- (339) --
-------- -------- -------- --------
facilities(1)......................................
Total...................................... $ 5,678 $ (332) $ (3,114) $ 2,232
======== ======== ======== ========
- ----------
</TABLE>
(1) Classified on the Condensed Consolidated Balance Sheet as part of accrued
liabilities.
(2) The amount utilized represents cash payments related to severance of
approximately 850 employees.
<PAGE>17
During the quarter ended April 4, 1999, Cypress reversed $3.7 million of
previously provided restructuring costs. $2.2 million of severance and other
employee related charges and $0.3 million for the provision for phase-down and
consolidation of manufacturing facilities were reversed in conjunction with the
completion of the Alphatec restructuring activities. In addition, $0.5 million
was reversed for other fixed asset related charges based on the determination
that a portion of the fixed asset removal costs accrual would not be required.
These reversals related to Cypress's 1998 restructuring activities. Cypress also
reversed a $0.7 million reserve for fixed asset installation costs related to
its 1996 restructuring activities which was no longer required.
Restructuring activities associated with Fabs 2 and 3 were completed in May
and July 1998, respectively, consistent with Cypress's restructuring schedule
except for the disposal of equipment. Fab 1 restructuring was not completed in
January 1999 as originally planned. Cypress has initiated plans to convert its
R&D wafer facility in San Jose to eight-inch capability and expects to have the
conversion completed by June 2000. The Alphatec consolidation and transfer
activity was completed in January 1999, one month later than originally planned.
1997 RESTRUCTURING COSTS
------------------------
During the fourth quarter of 1997, Cypress (ICW) made a decision to shut
down its wafer fab located in San Jose. In connection with the shut down of the
wafer fab, Cypress (ICW) recorded a restructuring charge of $9.9 million related
to the impairment of assets ($3.9 million), non-cancelable operating lease
commitments ($3.6 million), costs associated with a reduction in work force
($0.2 million) and other transaction costs ($2.2 million). The other transaction
costs related primarily to inventory write-offs, expenses incurred to remove and
return leased equipment and brokerage and professional fees.
The following tables set forth charges taken against the reserve during the
three- and nine-month periods ended October 3, 1999. The actual liquidation of
substantially all of the impaired assets was completed in November 1998. The
balance of the reserve remaining will be utilized by March 2000 when the
operating lease commitments end.
<TABLE>
Three months ended October 3, 1999:
-----------------------------------
<CAPTION>
Balance Balance
Jul. 4, Oct. 3,
1999 Utilized 1999
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Operating lease costs(1)............................. $ 1,419 $ (974) $ 445
======== ======== ========
<PAGE>18
Nine months ended October 3, 1999:
----------------------------------
<CAPTION>
Balance Balance
Jan. 3, Oct. 3,
1999 Utilized 1999
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Operating lease costs(1)............................. $ 2,332 $(1,887) $ 445
Severance and other employee related charges(1)...... 60 (60) --
-------- -------- --------
Total...................................... $ 2,392 $ (1,947) $ 445
======== ======== ========
- ----------
</TABLE>
(1) Classified on the Condensed Consolidated Balance Sheet as part of accrued
liabilities.
NOTE 9 -- EQUITY AND DEBT TRANSACTIONS
- --------------------------------------
During the first quarter of 1999, Cypress filed a registration statement on
Form S-3 with the Securities and Exchange Commission. Under this shelf
registration, Cypress can through March 2001, sell any combination of debt
securities, preferred stock and common stock in one or more offerings up to a
total amount of $300.0 million. Pursuant to the shelf registration, on March 29,
1999, Cypress sold 7.2 million shares of common stock, including 4.7 million
shares it was required to sell to cure a taint to allow the merger with ICW to
be accounted for as a pooling of interests. Cypress received approximately $33.8
million proceeds, net of issuance costs, from the sale of these shares. The
remaining 2.5 million shares were sold by the selling stockholders. Cypress did
not receive any proceeds from the shares sold by the selling stockholders.
In March 1999, Cypress announced a program whereby all U.S. employees were
offered loans to facilitate the exercise of vested stock options. The loan
program was initiated to reduce the number of tainted shares to allow the merger
with ICW to be accounted for as a pooling of interests. Under the terms of the
program, only options which were vested as of March 1, 1999 and whose exercise
price was less than or equal to $9.75 could qualify for a loan. The loans,
including interest, are due at the earlier of three days following the sale of
the shares, within thirty days of the date the individual ceases to be an
employee of Cypress or 3 years from the grant date of the loan. The loans bear
interest and are secured by Cypress common shares. At October 3, 1999, loans
receivable under this program totaled $7.9 million.
During 1997, Cypress (ICW) entered into an agreement to borrow $2.0 million
from a third party with interest accruing at 6.0% per annum. The loan became due
simultaneously with the merger of Cypress and ICW and was repaid in April 1999.
Also during 1997, Cypress (ICW) issued promissory notes to three significant
customers for $2.0 million, $1.4 million and $0.3 million, bearing interest at
6.0%, 10.0% and 7.5%, respectively and due in October 2000, August 2000 and July
1999, respectively. As of October 3, 1999, a total of $0.8 million was payable
under the notes.
<PAGE>19
In fiscal years 1997 and 1998, the Board of Directors authorized the
repurchase of up to 14.0 million shares of Cypress's common stock. Through
January 3, 1999, 8.1 million shares had been repurchased under this entire
program for $67.5 million. On February 25, 1999, the Board of Directors
terminated the stock repurchase program to cure the tainted shares in order to
allow the merger with ICW to be accounted for as a pooling of interests. The
unsold repurchased shares were and are expected to continue to be used for
option exercises under Cypress's 1994 Stock Option Plan and stock purchases
under the Employee Stock Purchase Plan. During 1998, Cypress reissued 1.8
million shares of common stock under such plans. During the first nine months of
1999, Cypress reissued a total of 8.3 million shares in relation to the stock
offering described above and in conjunction with the 1994 Stock Option Plan and
Employee Purchase Plan. Such shares had been repurchased under the 1997/1998
plan and repurchase programs prior to 1997.
In 1997, Cypress (ICW) established a revolving line of credit with a bank
totaling up to $6.5 million. Cypress (ICW) cancelled this line of credit in June
1999. In July 1996, Cypress established a three-year $100.0 million unsecured
revolving credit facility with Bank of America National Trust and Savings
Association as agent on behalf of certain banks. During 1998, Cypress cancelled
this line of credit.
NOTE 10 -- LEGAL MATTERS
- ------------------------
The semiconductor industry has experienced a substantial amount of
litigation regarding patent and other intellectual property rights. From time to
time, Cypress has received, and may receive in the future, communications
alleging that its products or its processes may infringe on product or process
technology rights held by others. Cypress is currently, and may in the future
be, involved in litigation with respect to alleged infringement by Cypress of
another party's patents. In the future, Cypress may be involved with litigation
to:
Enforce its patents or other intellectual property rights.
Protect its trade secrets and know-how.
Determine the validity or scope of the proprietary rights of others.
Defend against claims of infringement or invalidity.
Such litigation has in the past and could in the future result in
substantial costs and diversion of management resources. Such litigation could
also result in payment of substantial damages and/or royalties or prohibitions
against utilization of essential technologies, and could have a material adverse
effect on Cypress's business, financial condition and results of operations.
During 1998, EMI Group of North America, Inc. ("EMI") filed suit against
Cypress in the Federal Court in Delaware, claiming that Cypress infringed on
four patents owned by EMI. Cypress and EMI entered into a license agreement in
February 1999, for one of the four patents in the lawsuit. EMI withdrew two of
the four patents from the lawsuit, including the patent related to the licensing
<PAGE>20
agreement. The case involving the two remaining patents went to trial in October
1999. The jury ruled in favor of Cypress claiming that none of the patent claims
was infringed by Cypress and that each asserted claim was invalid due to prior
art and physical impossibility (i.e. the patents require a step that is
physically impossible to perform). EMI may to file an appeal, although no such
appeal has been filed as of November 17, 1999. Should EMI appeal the decision of
the Federal Court, Cypress intends to defend itself vigorously. However, should
the outcome of this action be unfavorable, Cypress's business, financial
condition and results of operations could be materially and adversely affected.
In January 1998, an attorney representing the estate of Mr. Jerome Lemelson
contacted Cypress and charged that Cypress infringed certain patents owned by
Mr. Lemelson. On February 26, 1999, the Lemelson attorneys sued Cypress and 87
other companies for infringement of 16 patents. Cypress has reviewed and
investigated the allegations in the complaint and Cypress believes that the
suits are without merit. Cypress will vigorously defend itself in this matter.
While no assurance can be given regarding the outcome of this action, Cypress
believes that the final outcome of the matter will not have a material effect on
Cypress's consolidated financial position or results of operations. However,
because of the nature and inherent uncertainties of litigation, should the
outcome of this action be unfavorable, Cypress may be required to pay damages
and other expenses, which could have a material adverse effect on Cypress's
financial position and results of operations.
In June 1997, Cypress commenced a declaratory judgment action in the United
States District Court for the District of Nevada against the Li Second Family
Trust ("the Trust"). In this action, Cypress asked for declaratory relief to the
effect that a U.S. patent relating to a part of the process for manufacturing
semiconductors is unenforceable, invalid and not infringed by Cypress. The Trust
has counter-claimed for patent infringement on the same patent, alleging such
patent covers oxide-isolated integrated circuits. In May 1999, in a related
case, the United States District Court for the Eastern District of Virginia
ruled that the patent is unenforceable due to inequitable conduct by Dr. Li and
his attorneys in obtaining the patent. Cypress believes it has meritorious
defenses to the counter-claim and intends to defend itself vigorously. While no
assurance can be given regarding the outcome of this action, Cypress believes
that the final outcome of the matters will not have a material effect on
Cypress's consolidated financial position or results of operations. However,
should the outcome of this action be unfavorable, Cypress's business, financial
condition and results of operations could be materially and adversely affected.
On October 2, 1997, Cypress filed an action against Kevin Yourman, Joseph
Weiss, and their associated law offices in the Superior Court of California
("Superior Court") in Santa Clara County for malicious civil prosecution in the
underlying securities fraud actions initiated by Messrs. Yourman and Weiss in
1992. The underlying securities fraud actions were dismissed because no officer
of Cypress made any actionable false or misleading statements or omissions. An
appeal affirmed the lower court's finding that Messrs. Yourman and Weiss failed
to put forth evidence showing a genuine issue of fact with regard to any
statements by Cypress's officers. On May 4 1999, the Superior Court granted a
summary judgment motion by Messrs. Yourman and Weiss, holding that Messrs.
Yourman and Weiss had probable cause to bring the underlying litigation. Cypress
is appealing the decision. However, the results of litigation are unpredictable.
Cypress believes that this action, regardless of its outcome, will have little,
if any effect on Cypress's consolidated financial position or results of
operations.
<PAGE>21
In March 1999, Cypress signed a cross-license technology agreement with
Lucent Technologies Corporation cross-licensing essentially all semiconductor
patents of both companies. The terms of this cross-license agreement is not
expected to have a material effect on Cypress's consolidated financial position
or results of operations.
NOTE 11 -- COMPREHENSIVE INCOME
- -------------------------------
In fiscal 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income".
Comprehensive income refers to the change in the equity of a company during a
period from transactions except those resulting from investments by owners and
distributions to owners. Cypress adopted this statement as of the first quarter
of 1998 and has determined that it does not have any components of other
comprehensive income.
NOTE 12 -- SEGMENT REPORTING
- ----------------------------
Cypress has two reportable segments, Memory Products and Non-memory
Products. The Memory Products segment includes Static Random Access Memories
("SRAMs") and multichip modules. The Non-memory Products segment includes
programmable logic products, data communication devices, interface products,
computer products, non-volatile memory products and wafers manufactured by the
foundry. Cypress evaluates the performance of its two segments based on profit
or loss from operations before income taxes, excluding nonrecurring gains and
losses.
Cypress's reportable segments are strategic business units that offer
different products. Products that fall under the two segments differ in nature,
are manufactured utilizing different technologies and have a different
end-purpose. As such, they are managed separately. Memory Products are
characterized as a commodity, which is depicted by high unit sales volume and
lower gross margins. These products are manufactured using more advanced
technology. A significant portion of the wafers produced for Memory Products are
manufactured at Cypress's technologically advanced, eight-inch wafer production
facility located in Minnesota (Fab 4). Memory Products are used by a variety of
end-users but the product is used specifically for the storage and retrieval of
information. In contrast to Memory Products, unit sales of Non-memory Products
are generally lower than Memory Products, but sell at higher gross margins. Some
Non-memory Products are manufactured utilizing less technologically advanced
processes. A majority of wafers for Non-memory Products are manufactured at
Cypress's less technologically advanced six-inch Fab located in Texas (Fab 2).
Products in the Non-memory segment perform non-memory functions such as
floating-point mathematics, store fixed data that is not to be altered during
normal machine operations and data transfer and routing functions of signals
throughout a computer system.
<PAGE>22
The tables below set forth information about the reportable segments for
three- and nine-month periods ended October 3, 1999 and September 28, 1998.
Cypress does not allocate income taxes or non-recurring items to segments.
<TABLE>
Business Segment Net Revenues
- -----------------------------
<CAPTION>
Three Months Ended Nine Months Ended
------------------- -------------------
Oct. 3, Sep. 28, Oct. 3, Sep. 28,
1999 1998 1999 1998
-------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
Memory.................................... $ 67,574 $ 51,474 $188,444 $151,248
Non-memory................................ 116,923 92,317 309,167 258,072
-------- -------- -------- --------
Total consolidated revenues............. $184,497 $143,791 $497,611 $409,320
======== ======== ======== ========
Business Segment Profit (Loss)
- ------------------------------
<CAPTION>
Three Months Ended Nine Months Ended
------------------- -------------------
Oct. 3, Sep. 28, Oct. 3, Sep. 28,
1999 1998 1999 1998
-------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
Memory.................................... $ (4,655) $(20,861) $(23,511) $(84,642)
Non-memory................................ 32,603 17,658 73,430 28,681
Acquisition and merger costs.............. (1,879) -- (11,683) --
Restructuring credits (costs)............. -- 59 3,811 (60,737)
Interest income and other................. 4,196 4,926 11,097 8,312
Interest expense.......................... (2,458) (2,745) (7,244) (8,548)
-------- -------- -------- --------
Income (loss) before provision for income
taxes $ 27,807 $ (963) $ 45,900 $(116,934)
======== ======== ======== ========
</TABLE>
<PAGE>23
NOTE 13 -- RECENT ACCOUNTING PRONOUNCEMENTS
- -------------------------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supercedes and amends a
number of existing accounting standards. SFAS 133 requires that all derivatives
be recognized in the balance sheet at their fair market value. In addition,
corresponding derivative gains and losses should be either reported in the
statement of operations and stockholders equity, depending on the type of
hedging relationship that exists with respect to such derivatives. Adopting the
provisions of SFAS 133, which will be effective in fiscal year 2001, are not
expected to have a material effect on Cypress's consolidated financial
statements.
NOTE 14 -- SUBSEQUENT EVENTS
- ----------------------------
Cypress Acquires MAX 5000 Product Line from Altera
- --------------------------------------------------
On October 5, 1999, Cypress announced that it has signed a definitive
agreement with Altera Corporation ("Altera") to acquire Altera's MAX 5000
Programmable Logic Device ("PLD") product line and its equity interest in
Cypress's wafer fabrication facility in Round Rock, Texas ("Fab II") for
approximately $13.0 million. The acquisition will be accounted for as a
purchase. In 1988, Altera licensed its MAX 5000 family of products to Cypress in
consideration of manufacturing capacity. Altera later acquired a 17% equity
interest in the Round Rock wafer fabrication facility. By acquiring Altera's
equity interest in October 1999, Fab II is now 100% owned by Cypress.
<PAGE>24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Three and Nine Months Ended October 3, 1999
All references are to Cypress's fiscal quarters ended October 3, 1999 ("Q3
1999"), July 4, 1999 ("Q2 1999), April 4, 1999 ("Q1 1999), September 28, 1998
("Q3 1998"), June 29, 1998 ("Q2 1998") and March 30, 1998 ("Q1 1999"), unless
otherwise indicated. This report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of the factors set
forth in "Factors Affecting Future Results" and elsewhere in this report.
RESULTS OF OPERATIONS
- ---------------------
Revenues
--------
Revenues for Q3 1999 and the nine months ended October 3, 1999 were $184.5
million and $497.6 million, respectively. Revenues for Q3 1999 increased $40.7
million or 28.3% compared to revenues of $143.8 million for Q3 1998. Revenues of
$497.6 million for the nine-month period ended October 3, 1999 were $88.3
million or 21.6% higher than the $409.3 million recognized in the comparable
period of the prior fiscal year. Cypress derives its revenues from the sale of
Memory Products and Non-memory Products. Below is a summary of revenues derived
from the sale of Memory Products and Non-memory Products.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------- -------------------
Oct. 3, Sep. 28, Oct. 3, Sep. 28,
1999 1998 1999 1998
-------- -------- -------- --------
(In thousands)
<S> <C> <C> <C> <C>
Memory.................................... $ 67,574 $ 51,474 $188,444 $151,248
Non-memory................................ 116,923 92,317 309,167 258,072
-------- -------- -------- --------
Total consolidated revenues............. $184,497 $143,791 $497,611 $409,320
======== ======== ======== ========
</TABLE>
Sales from Memory Products include Static Random Access Memories ("SRAMs")
and multichip modules. Revenues from the sale of Memory Products for Q3 1999
increased $16.1 million or 31.3% over revenues from the sale of these products
for Q3 1998. Comparing Q3 1998 to Q3 1999, the sale of SRAMs increased $17.1
million partially offset by a decline in multichip module sales of $1.0 million.
<PAGE>25
The rise in Memory Product revenues as compared to Q3 1998 resulted from both
higher average selling prices ("ASPs") and an increase in unit sales. ASPs
increased 9.4% and unit sales increased 20.0% comparing Q3 1999 to Q3 1998. When
comparing revenues for the nine months ended October 3, 1999 to the comparable
period of the prior fiscal year, Memory Product sales increased $37.2 million or
24.6%. The net increase includes a $38.3 million increase in SRAM sales
resulting from higher unit sales and higher ASPs, partially offset by lower
multichip module sales of $1.1 million. Revenue growth for SRAM products can be
attributed to new product revenue, particularly in the data communications and
telecommunications markets. Sale of new products, such as the 4-Mbit MoBL ("More
Battery Life") SRAM, have resulted in higher unit sales and higher ASPs.
Non-memory Products include computer products, interface products, data
communication devices, non-volatile memory devices and programmable logic
products. Non-memory Products also include foundry revenues. Foundry revenues
represent the sale of wafers to customers. Revenues from the sale of Non-memory
Products increased $24.6 million or 26.7% comparing Q3 1999 to Q3 1998. The
growth related primarily to increases in sales of timing technology products of
$10.2 million, data communication devices of $7.4 million, interface products of
$6.4 million, and programmable logic products of $1.9 million. These increases
were partially offset by decreases in non-volatile memory of $0.4 million and
foundry revenue of $0.9 million. The revenue growth in computer products from Q3
1998 to Q3 1999 was primarily a result of the introduction of the BX clock chip
and greater acceptance of Cypress's clock products. The primary factors
contributing to the increase in data communication devices was higher unit sales
and higher ASPs, particularly in the specialty memory and channel line of
products. The increase in revenues for interface products can be attributed to
higher unit sales due to the growing market conversion to Universal Serial Bus
("USB") peripheral products. Interface products revenues for Q3 1999 also
benefited from the acquisition of Anchor. The net increase in programmable logic
devices was a result of higher unit sales, partially offset by a decline in
ASPs.
Sales of Non-memory Products for the first nine months of 1999 increased
$51.1 million or 19.8% compared to the same period of the prior fiscal year.
Significant factors contributing to the increase included higher revenues from
the sale of clock products in the timing technology division of $30.0 million,
rise in interface product sales of $12.1 million, and greater data communication
device sales of $11.7 million. The increase was attributable to higher unit
sales of these products offset in part by lower average selling prices for these
products. Revenues in the programmable logic products remained relatively
constant, growing $0.4 million comparing the nine month period ended October 3,
1999 to the same period a year ago. Also offsetting the net increase were
declines in foundry revenue of $2.6 million and non-volatile memory of $0.7
million due to lower unit sales and lower ASPs.
The semiconductor industry is highly cyclical and subject to significant
downturns including but not limited to diminished product demand, production
over-capacity and accelerated erosion of ASPs. Revenues have continued to be
impacted by fluctuations in ASPs. Should ASPs erode at a rate greater than
anticipated, gross margins could be materially adversely affected. Cypress
continues to introduce new products and new methods of reducing manufacturing
costs in order to mitigate the effects of ASPs on its gross margins.
<PAGE>26
Cost of Revenues
----------------
Cost of revenues as a percent of revenues decreased to 53.4% for Q3 1999
compared to 67.0% during Q3 1998. Cost of revenues as a percent of revenues for
the nine months ended October 3, 1999 was 55.8% compared to 76.6% for the same
period during fiscal 1998. Cost of revenues for the nine months ended September
28, 1998 included one-time non-recurring charges totaling $21.7 million. These
charges included $15.8 million related to the write-down of inventory, $3.8
million for the write-off of pre-operating costs and $2.1 million for the
write-off of certain equipment. Excluding these one-time non-recurring charges,
cost of revenues as a percent of revenues for the nine months ended September
28, 1998 would have been 71.3%. The decrease in manufacturing costs as a percent
of revenues from Q3 1998 to Q3 1999 and the nine months ended September 28, 1998
to the comparable period in fiscal 1999 reflects higher revenues due to a
combination of greater sales of higher margin products and higher unit sales
volumes.
The $15.8 million write down of inventory recorded in the first nine months
of fiscal 1998 arose due to the ongoing over-supply and continued inventory
corrections by end-user customers. The write-off of pre-operating costs during
the first half of fiscal 1998 included $2.9 million related to Cypress's wafer
fabrication operation in Bloomington, Minnesota and $0.9 million related to its
assembly and test operations in the Philippines. As a result of the
restructuring activities, Cypress wrote off its previously capitalized
pre-operating costs as an impaired asset due to uncertainties surrounding their
future economic benefits. There were no capitalized pre-operating costs
subsequent to the first quarter of 1998. The write-off of equipment during the
first nine months of fiscal 1998 was related to equipment identified as obsolete
during Cypress's periodic review of equipment and was no longer considered
useable.
In March 1998, Cypress announced restructuring activities for its domestic
wafer fabrication facilities and offshore back-end manufacturing operations.
Activities completed to date have increased Cypress's manufacturing
efficiencies. Cost of sales as a percent of revenues may impacted by a variety
of factors including but not limited to the following:
Product mix;
Factory capacity and utilization;
Manufacturing yields;
Availability of certain raw materials;
Terms negotiated with third-party contractors; and
Foreign currency fluctuations.
These and other factors could cause a significant increase or decrease on
our gross margin in future periods.
<PAGE>27
Research & Development
----------------------
Research and development ("R&D") expenditures for Q3 1999 were $32.0
million or 17.4% of revenues, compared to $28.2 million or 19.6% of revenues for
Q3 1998. R&D costs incurred for the nine months ended October 3, 1999 were $95.3
million or 19.2% of revenues compared to $83.9 million or 20.5% of revenues for
the comparable period in fiscal 1998. Even though absolute spending in R&D was
$3.8 million higher comparing Q3 1999 to Q3 1998, R&D expenditures as a
percentage of revenues declined as the increase in revenues far exceeded the
increase in spending. The $3.8 million increase in R&D costs from Q3 1998 to Q3
1999 relates primarily to costs associated with new product development at
Cypress's design centers and to the continued development of more advanced
process technologies. These factors also contributed to the $11.5 million
increase in R&D expenditures comparing the first nine months of fiscal 1998 to
the first nine months of fiscal 1999.
Cypress expects spending for R&D will continue to increase as Cypress
continues its efforts to accelerate the development of new products and
migration to more advanced process technologies. Cypress is continuing to
explore new markets and improve its design and process technologies in an effort
to increase revenues and reduce costs.
Selling, General and Administrative
-----------------------------------
Selling, general and administrative ("SG&A") expenses for Q3 1999 were
$26.0 million or 14.1% of revenues, compared to $22.4 million or 15.6% of
revenues for Q3 1998. SG&A costs incurred for the nine months ended October 3,
1999 were $74.8 million or 15.0% of revenues compared to $67.9 million or 16.6%
of revenues for the same period in fiscal 1998. Even though absolute spending in
SG&A was $3.6 million higher comparing Q3 1999 to Q3 1998, SG&A expenditures as
a percentage of revenues declined as the increase in revenues far exceeded the
increase in spending. The $3.6 million increase in SG&A costs from Q3 1998 to Q3
1999 relates primarily to higher commission expenses, salary and related benefit
costs and legal fees. These factors also contributed to an increase in SG&A
expenses from the first nine months of fiscal 1998 to fiscal 1999. This increase
has been partially offset by $2.5 million in costs incurred during the first
nine months of 1998 to reimburse a customer for certain product expenses
incurred that did not recur in 1999. The change in all other SG&A expenses from
Q3 1998 to Q3 1999 and from the first nine months of fiscal 1998 to the same
period in fiscal 1999 were not significant.
With the exception of variable spending such as incentive bonuses and
commissions, Cypress expects recurring SG&A spending to remain relatively
constant.
Acquisition and Merger Costs
----------------------------
During Q3 1999 and the nine months ended October 3, 1999, Cypress recorded
aggregate merger-related transaction costs of $1.9 million and $11.7 million,
<PAGE>28
respectively. The $1.9 million of costs incurred in Q3 1999 relate to the
amortization of intangible assets recorded during the Q2 1999 acquisitions of
Anchor and Arcus. The $11.7 million charged for the first nine months of 1999
also include $3.7 million for investment banking and other professional fees
incurred related to the merger with ICW and $6.1 million related to the Anchor
and Arcus acquisitions. The $6.1 million includes $4.0 million for in-process
research and development, $1.6 million for transaction costs, and $0.5 million
in amortization of intangibles. These acquisitions have been accounted for as a
purchase. See Note 2 regarding the acquisition of Arcus and Note 3 regarding the
acquisition of Anchor.
1998 Restructuring Costs and Non-recurring Charges
--------------------------------------------------
In March 1998, Cypress recorded a one-time, pre-tax restructuring charge of
$57.1 million and other non-recurring charges of $27.3 million. The $57.1
million restructuring charge entailed:
The shutdown of Fab 3 located in Bloomington, Minnesota and consolidation
of parts of Fab 3 operations with other operations of Cypress.
The discontinuance of the 0.6-micron 256k SRAM production in Fab 2 located
in Texas.
The conversion of an existing research and development fab located in San
Jose ("Fab 1") to eight-inch capability in order to be compatible with the state
of the art eight-inch Minnesota manufacturing facility.
The transfer of Cypress's test operations from its subcontractor, Alphatec,
in Thailand to Cypress's production facility in the Philippines.
The restructuring activities described above included the termination of
approximately 850 personnel, primarily from manufacturing, both at Cypress and
at Alphatec.
During Q2 1998, in conjunction with the closure of Fab 3, Cypress
established a reserve for $1.4 million to cover severance costs associated with
the reduction of work force at that location. This was based on the anticipated
level of payments that would be made to personnel that were included in the work
force reduction. As a part of a review of inventory, it was noted that Cypress
required an additional reserve of $0.5 million to cover inventory that was
written off. This related to a change in estimate regarding inventory that had
been previously reserved.
Separate from the restructuring charge, Cypress recorded additional charges
of $27.3 million, which were recorded as operating expenses in Q1 1998. These
charges were for inventory reserves ($15.8 million), the write-off of
pre-operating costs ($3.8 million), the write-off of an equity investment ($3.1
million), costs incurred to reimburse a customer for certain product expenses
incurred ($2.5 million) and the write-off of obsolete equipment in Fab 4 ($2.1
million). The write-down of inventory was made to establish incremental reserves
for excess inventory and was recorded as cost of revenues.
<PAGE>29
The write-off of pre-operating costs included $2.9 million related to
Cypress's wafer fabrication operation in Bloomington, Minnesota and $0.9 million
related to its assembly and test operation in the Philippines. As a result of
restructuring activities described above, Cypress wrote off its previously
capitalized pre-operating costs as an impaired asset due to uncertainties
surrounding their future economic benefits. Such costs were being amortized over
five years at a rate based on estimated units to be manufactured during that
period. There were no capitalized pre-operating costs subsequent to the first
quarter of 1998.
The $3.1 million write-off of the equity investment was recorded against
net interest and other income to reflect the decline in the value of an
investment. Selling, general and administrative costs included the write-off of
$2.5 million in costs incurred to reimburse a customer for certain product
expenses incurred. During Cypress's periodic review of equipment, some equipment
was identified as obsolete and $2.1 million was charged to cost of sales to
write-off the obsolete equipment.
Restructuring activities associated with Fabs 2 and 3 were completed in May
and July 1998, respectively, consistent with Cypress's restructuring schedule
except for the disposal of equipment. Fab 1 restructuring was not completed in
January 1999 as originally planned. Cypress has initiated plans to convert its
R&D wafer facility in San Jose to eight-inch capability and expects to have the
conversion completed by June 2000. The Alphatec consolidation and transfer
activity was completed in January 1999, one month later than originally planned.
1999 Restructuring Credits
--------------------------
During Q1 1999, Cypress reversed $3.7 million of previously provided
restructuring costs. $2.2 million of severance and other employee related
charges and $0.3 million for the provision for phase-down and consolidation of
manufacturing facilities were reversed in conjunction with the completion of the
Alphatec restructuring activities. In addition, $0.5 million was reversed for
other fixed asset related charges based on the determination that a portion of
the fixed asset removal costs accrual would not be required. These reversals
related to Cypress's 1998 restructuring activities. Cypress also reversed a
$0.7 million reserve for fixed asset installation costs related to its 1996
restructuring activities which was no longer required.
Interest Expense
----------------
Interest expense was $2.5 million and $7.3 million for Q3 1999 and the nine
months ended October 3, 1999, respectively, compared to $2.7 million and $8.5
million for Q3 1998 and the nine months ended September 28, 1998, respectively.
The interest expense is primarily associated with the 6.0% Convertible
Subordinated Notes ("Notes"), which were issued in September 1997 and are due in
2002. The $0.2 million decrease from Q3 1998 is attributable to the retirement
of $5.0 million and $10.0 million of the Notes in the third and fourth quarters
of 1998, respectively. The $1.2 million decrease from the nine months ended
September 28, 1998 to the same period in fiscal 1999 is due primarily to a $0.8
million decline in bond interest costs resulting from the bond retirement
<PAGE>30
previously discussed. The remaining $0.4 million decrease relates primarily to
interest costs associated with the revolving line of credit that was outstanding
during Q1 1998 and cancelled during the second quarter of 1998.
Interest Income and Other
-------------------------
Net interest income and other was $4.2 million and $11.1 million for Q3
1999 and the nine months ended October 3, 1999, respectively, compared to $4.9
million and $8.3 million for Q3 1998 and the nine months ended September 28,
1998, respectively. Net interest income and other includes interest income,
amortization of bond issuance costs, foreign exchange gains and losses and other
non-recurring items. The $0.7 million increase from Q3 1998 to Q3 1999 relates
primarily to higher interest income. The $2.8 million increase from the first
nine months of fiscal 1998 to the first nine months of fiscal 1999 relates
primarily to a non-recurring, pre-tax charge of $3.1 million recorded Q1 1998 to
reflect the decline in the value of an investment.
Taxes
-----
Cypress's effective tax rate for Q3 1999 and the nine months ended October
3, 1999 were 5.0% and 5.1%, respectively, resulting in an income tax expense of
$1.4 million and $2.3 million, respectively. For Q3 1998, Cypress recorded an
income tax benefit of $2.8 million even though it recorded a loss before taxes
of $1.0 million. The additional benefit recorded in Q3 1998 was the result of a
comprehensive study completed by Cypress in relation to additional R&D tax
credits. For the nine-month period ended September 28, 1998, Cypress recorded an
income tax benefit of $13.8 million. The benefit was primarily attributable to
the utilization of loss carrybacks, the utilization of research and development
tax credits and non-U.S. income taxed at lower tax rates than U.S. tax rates,
principally related to Cypress's operations in the Philippines. Cypress's
effective rate varies from the U.S. statutory rate due to non-deductible
in-process research and development charges and merger costs offset by
utilization of loss carryovers, earnings of foreign subsidiaries taxed at lower
rates and tax credits. The tax benefit recognized during fiscal 1998 is less
than the expected statutory rate on Cypress's loss due to limitations on
Cypress's ability to carry such losses back to prior periods. The income tax
rate for the first nine months of 1998 was 11.7%.
During 1998, the United States Internal Revenue Service began an
examination of tax returns for fiscal years 1994 through 1996. The examination
is expected to continue through December 1999. Management believes that the
outcome of the examination will not have a material effect on Cypress's
consolidated financial position or results of operations.
Net Income (Loss) and Net Income (Loss) Per Share
-------------------------------------------------
Net income for Q3 1999 was $26.4 million or $0.23 per share on a diluted
basis, compared to a net income of $1.8 million or $0.02 per share, on a diluted
basis for Q3 1998. Net income for the nine-month period ended October 3, 1999
was $43.6 million or $0.40 per share on a diluted basis, compared to a net loss
of $103.2 million or $1.01 per share on a diluted basis for the nine months
ended September 28, 1998.
<PAGE>31
Earnings Before Goodwill
------------------------
Cypress reported basic earnings before goodwill ("EBG") and diluted EBG.
EBG refers to earnings excluding pretax acquisition and restructuring related
charges and credits, in-process research and development costs, transaction
costs and amortization of intangible assets, net of tax. These charges and
credits are excluded from the computation of EBG and are collectively referred
to as goodwill by Cypress. The table below reconciles basic and diluted net
income (loss) per share to basic and diluted earnings (loss) before goodwill per
share, respectively.
Reconciliation of basic net income (loss) per share to basic earnings
(loss) before goodwill:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
----------------------- -----------------------
Oct. 3, Sep. 28, Oct. 3, Sep. 28,
1999 1998 1999 1998
---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C>
Basic net income (loss) per share.................... $ 0.25 $ 0.02 $ 0.42 $ (1.01)
Goodwill net of taxes per share...................... $ 0.01 $ 0.00 $ 0.11 $ 0.00
Restructuring costs (credits) net of taxes per share. $ 0.00 $ 0.00 $ (0.03) $ 0.54
---------- ---------- ---------- ----------
Basic earnings (loss) before goodwill per share...... $ 0.26 $ 0.02 $ 0.50 $ (0.47)
========== ========== ========== ==========
Reconciliation of diluted net income (loss) per share to diluted earnings (loss) before goodwill:
<CAPTION>
Three Months Ended Nine Months Ended
----------------------- -----------------------
Oct. 3, Sep. 28, Oct. 3, Sep. 28,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Diluted net income (loss) per share.................. $ 0.23 $ 0.02 $ 0.40 $ (1.01)
Goodwill net of taxes per share...................... $ 0.01 $ 0.00 $ 0.10 $ 0.00
Restructuring costs (credits) net of taxes per share. $ 0.00 $ 0.00 $ (0.03) $ 0.54
---------- ---------- ---------- ----------
Diluted earnings (loss) before goodwill per share.... $ 0.24 $ 0.02 $ 0.47 $ (0.47)
========== ========== ========== ==========
</TABLE>
<PAGE>32
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Cypress's cash, cash equivalents and short-term investments totaled $202.8
million at October 3, 1999, a $42.2 million increase from the end of fiscal
1998.
During the nine months ended October 3, 1999, Cypress purchased $76.6
million in capital equipment compared to $51.5 million in the same period in
fiscal 1998. Cypress purchased equipment for its domestic wafer fabrication
plants, its test and assembly facility in the Philippines and its San Jose
design and technology groups. Equipment purchased for its fabs is expected to
improve wafer manufacturing capacity and capabilities as Cypress implements new
technologies, including its 0.18- and 0.25-micron processes. A majority of the
equipment purchased was to increase the capacity and capability of Fab 4 located
in Minnesota. Equipment purchased for the Philippines was used to increase
manufacturing capacity and tool certain packaging capabilities. Purchases of
capital equipment for the technology group are expected to enhance and
accelerate research and development capabilities. Capital expenditures for the
remainder of 1999 are expected to be approximately $55.0 million as Cypress
continues its efforts to increase its manufacturing capabilities and capacity
and to enhance its research and development capabilities. Cypress intends to
increase purchase commitments for capital expenditures from upwards of $140.0
million in the fourth quarter of 1999 and into 2000.
During Q1 1999, Cypress filed a registration statement on Form S-3 with the
Securities and Exchange Commission. Under this shelf registration, Cypress can
through March 2001 sell any combination of debt securities, preferred stock and
common stock in one or more offerings up to a total amount of $300.0 million
dollars. Pursuant to the shelf registration, on March 29, 1999, Cypress sold 7.2
million shares of common stock, including 4.7 million shares it was required to
sell to cure a taint to allow the merger with ICW to be accounted for as a
pooling of interests. Cypress received approximately $33.8 million in proceeds,
net of issuance costs, from the sale of these shares. The remaining 2.5 million
shares were sold by selling stockholders. Cypress did not receive any proceeds
from the shares sold by the selling stockholders.
In March 1999, Cypress announced a program whereby all U.S. employees were
offered loans to facilitate the exercise of vested stock options. The loan
program was initiated to reduce the number of tainted shares to allow the merger
with ICW to be accounted for as a pooling of interests. Under the terms of the
program, only options which were vested as of March 1, 1999 and whose exercise
price was less than or equal to $9.75 could qualify for a loan. The loans,
including interest, are due at the earlier of three days following the sale of
the shares,within thirty days of the date the individual ceases to be an
employee of Cypress or 3 years from the grant date of the loan. The loans bear
interest and are secured by Cypress common shares. At October 3, 1999, loans
receivable under this program totaled $7.9 million.
During 1997, Cypress (ICW) entered into an agreement to borrow $2.0 million
from a third party with interest accruing at 6.0% per annum. The loan became due
simultaneously with the merger of Cypress and ICW and was repaid in April 1999.
Also during 1997, Cypress (ICW) issued promissory notes to three significant
customers for $2.0 million, $1.4 million and $0.3 million, bearing interest at
6.0%, 10.0% and 7.5%, respectively and due in October 2000, August 2000 and July
1999, respectively. As of October 3, 1999, a total of $0.8 million was payable
under the notes.
<PAGE>33
In fiscal years 1997 and 1998, the Board of Directors authorized the
repurchase of up to 14.0 million shares of Cypress's common stock. Through
January 3, 1999, 8.1 million shares had been repurchased under this entire
program for $67.5 million. On February 25, 1999, the Board of Directors
terminated the stock repurchase program to cure the tainted shares in order to
allow the merger with ICW to be accounted for as a pooling of interests. The
unsold repurchased shares were and are expected to continue to be used for
option exercises under Cypress's 1994 Stock Option Plan and stock purchases
under the Employee Stock Purchase Plan. During 1998, Cypress reissued 1.8
million shares of common stock under such plans. During the first nine months of
1999, Cypress reissued a total of 8.3 million shares in relation to the stock
offering described above and in conjunction with the 1994 Stock Option Plan and
Employee Purchase Plan. Such shares had been repurchased under the 1997/1998
plan and repurchase programs prior to 1997.
In 1997, Cypress (ICW) established a revolving line of credit with a bank
totaling up to $6.5 million. Cypress (ICW) cancelled this line of credit in June
1999. In July 1996, Cypress established a three-year $100.0 million unsecured
revolving credit facility with Bank of America National Trust and Savings
Association as agent on behalf of certain banks. During 1998, Cypress cancelled
this line of credit.
Cypress believes that existing cash and cash equivalents and cash from
operations will be sufficient to meet present and anticipated working capital
requirements and other cash needs for at least the next twelve months. Cypress's
operating results may be adversely impacted by various risk factors causing
Cypress to raise additional capital through debt or equity financing. Although
additional financing may be required, Cypress may not be able to obtain it at
terms Cypress deems satisfactory, or at all.
FACTORS AFFECTING FUTURE RESULTS
- --------------------------------
Risk Factors
------------
Except for the historical information contained herein, the discussion in
this Form 10-Q report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, including, but not
limited to, statements as to the future operating results and business plans of
Cypress, that involve risks and uncertainties. We use words such as
"anticipate", "believes", "expects", "future", "intends" and similar expressions
to identify forward-looking statements. Our actual results could differ
materially from those anticipated in these forward-looking statements for many
reasons, including the risks described below or elsewhere in this Form 10-Q. If
any of the following risks actually occur, our business, financial condition and
operating results could be materially adversely affected.
<PAGE>34
CYPRESS'S FUTURE OPERATING RESULTS ARE VERY LIKELY TO FLUCTUATE AND
THEREFORE MAY FAIL TO MEET EXPECTATIONS.
Cypress's operating results have varied widely in the past, and may
continue to fluctuate in the future. In addition, our operating results may not
follow any past trends. Our future operating results will depend on many factors
and may fluctuate and fail to meet the expectations of Cypress or others for a
variety of reasons set forth in these Risk Factors. Any downward fluctuation or
failure to meet expectations will likely adversely affect the value of your
investment in our stock. The factors we believe make our results more likely to
fluctuate, and difficult to predict, than results of a typical, non-technology
company our size and age, and which are therefore most likely to produce
departure from expectations, include:
o the intense competitive pricing pressure to which our products are subject,
which can lead to rapid and unexpected declines in average selling prices;
o the complexity of our manufacturing processes and the sensitivity of our
production costs to declines in manufacturing yields, which make yield
problems both possible and costly when they occur;
o the need for constant, rapid new product introductions which present an
ongoing design and manufacturing challenge significantly impacted by even
relatively minor errors, and which may never achieve expected market
demand.
As a result of these or other factors we could fail to achieve our
expectations as to future revenues, gross profit and income from operations.
Also, the performance of the semiconductor industry as a whole is characterized
by cyclical swings in revenue and profitability and these swings may adversely
impact Cypress.
Since we recognize revenues from sales to our domestic distributors only
when these distributors make a sale to customers, we are highly dependent on the
accuracy of their resale estimates. The occurrence of inaccurate estimates also
contributes to the difficulty in predicting our quarterly revenue and results of
operations, particularly in the last month of the quarter.
CYPRESS FACES PERIODS OF INDUSTRY-WIDE SEMICONDUCTOR OVER-SUPPLY WHICH HARM
ITS RESULTS.
The semiconductor industry has historically been characterized by wide
fluctuations in the demand for, and supply of, its products, and these
fluctuations have helped produce many occasions when supply and demand for the
industry's products are not in balance. In the past, our operating results have
been adversely affected by these industry-wide fluctuations in the demand for
semiconductors, which have resulted in under-utilization of our manufacturing
capacity. In some cases, industry downturns with these characteristics have
lasted more than a year. If these cycles continue, they will materially and
adversely affect our business, financial condition and results of operations.
<PAGE>35
CYPRESS'S FINANCIAL RESULTS COULD BE ADVERSELY IMPACTED IF THE MARKETS IN WHICH
IT SELLS ITS PRODUCTS DO NOT GROW.
Cypress's continued success depends in large part on the continued growth
of various electronics industries that use our semiconductors, including the
following industries:
o data communications and telecommunications equipment;
o computers and computer related peripherals;
o automotive electronics;
o industrial controls; and
o customer electronics equipment and military equipment.
A significant portion of our products are incorporated into data
communications and telecommunication end-products. Any decline in the demand for
networking applications, mass storage, telecommunications, cellular base
stations, cellular handsets and other personal communication devices which
incorporate our products could adversely affect our business, financial
condition and operating results. In addition, certain of our products, including
Universal Serial Bus microcontrollers, high-frequency clocks and static RAMs,
are incorporated into computer and computer-related products, which have
historically experienced significant fluctuations in demand. In addition, we may
be materially and adversely affected by slower growth in the other markets in
which we sell our products.
CYPRESS IS AFFECTED BY A GENERAL PATTERN OF PRODUCT PRICE DECLINE AND
FLUCTUATIONS, WHICH CAN ADVERSELY IMPACT OUR BUSINESS.
Even in the absence of an industry downturn, the average selling prices of
our products historically have decreased during the products' lives, and we
expect this trend to continue. In order to offset these average selling price
decreases, we attempt to manufacture the products more cheaply, to generate
greater unit demand to reduce fixed costs per unit and to introduce new, higher
priced products that incorporate advanced features. If our efforts to achieve
these cost reductions, increased unit demand or new product introductions are
not successful or do not occur in a timely manner, or if our newly introduced
products do not gain market acceptance, our business, financial condition and
results of operations could be materially and adversely affected.
In addition to following the general pattern of decreasing average prices
referenced above, the selling prices for certain products, particularly
commodity static RAM products, fluctuate significantly with real and perceived
changes in the balance of supply and demand for these products. Growth in
worldwide supply of static RAMs in recent periods resulted in a decrease in
average selling prices for our products. In the event we are unable to decrease
per unit manufacturing costs faster than the rate at which average selling
prices continue to decline, our business, financial condition and results of
operations will be materially and adversely affected. In addition, we expect our
competitors to invest in new manufacturing capacity and achieve significant
manufacturing yield improvements in the future. These developments could
dramatically increase worldwide supply of static RAM products and associated
downward pressure on pricing.
<PAGE>36
CYPRESS MAY BE UNABLE TO ADEQUATELY PROTECT ITS INTELLECTUAL PROPERTY RIGHTS,
AND MAY FACE SIGNIFICANT EXPENSES AS A RESULT OF ONGOING, OR FUTURE, LITIGATION.
Protection of intellectual property rights is crucial to Cypress, since
that is how we keep others from copying the innovations which are central to our
existing and future products. So although we are not currently, we may become
involved in litigation to enforce our patents or other intellectual property
rights, to protect our trade secrets and know-how, to determine the validity or
scope of the proprietary rights of others, or to defend against claims of
invalidity. This kind of litigation can be expensive, regardless of whether we
win or lose.
Also, Cypress is now and may again become involved in litigation relating
to alleged infringement by us of others' patents or other intellectual property
rights. This kind of litigation is frequently expensive to both the winning
party and the losing party and takes up large amounts of management's time and
attention. In addition, if we lose in this kind of litigation a court could
require us to pay substantial damages and/or royalties, prohibiting us from
using essential technologies. For these and other reasons, this kind of
litigation could have a material adverse effect on our business, financial
condition and results of operations. Also, although we may seek to obtain a
license under a third party's intellectual property rights in order to bring an
end to certain claims or actions asserted against us, we may not be able to
obtain such a license on reasonable terms or at all.
We have entered into technology license agreements with third parties which
give those parties the right to use patents and other technology developed by
us, and which give us the right to use patents and other technology developed by
them. We anticipate that we will continue to enter into these kinds of licensing
arrangements in the future; however, it is possible that licenses we want will
not be available to us on commercially reasonable terms. If we lose existing
licenses to key technology, or are unable to enter into new licenses which we
deem important, it could have a material adverse effect on our business,
financial condition and results of operations.
Because it is critical to our success that we are able to prevent
competitors from copying our innovations, we intend to continue to seek patent,
trade secret and mask work protection for our semiconductor manufacturing
technologies. The process of seeking patent protection can be long and
expensive, and we cannot be certain that any currently pending or future
applications will actually result in issued patents, or that, even if patents
are issued, they will be of sufficient scope or strength to provide meaningful
protection or any commercial advantage to us. Furthermore, others may develop
technologies that are similar or superior to our technology or design around the
patents we own.
We also rely on trade secret protection for our technology, in part through
confidentiality agreements with our employees, consultants and third parties.
However, employees may breach these agreements, and we may not have adequate
remedies for any breach. In any case, others may come to know about or determine
our trade secrets through a variety of methods. In addition, the laws of certain
territories in which we develop, manufacture or sell our products may not
protect our intellectual property rights to the same extent as do the laws of
the United States.
<PAGE>37
CYPRESS'S FINANCIAL RESULTS COULD BE ADVERSELY IMPACTED IF IT FAILS TO
DEVELOP, INTRODUCE AND SELL NEW PRODUCTS OR FAILS TO DEVELOP AND IMPLEMENT NEW
MANUFACTURING TECHNOLOGIES.
Like many semiconductor companies, which frequently operate in a highly
competitive, quickly changing environment marked by rapid obsolescence of
existing products, Cypress's future success depends on its ability to develop
and introduce new products which customers choose to buy. In recent years we
have introduced and sold an average of 131 new products a year, and these
products have been an important source of revenue for us. If we fail to compete
and introduce new product designs in a timely manner or are unable to
manufacture products according to the requirements of these designs (discussed
more below), or if our customers do not successfully introduce new systems or
products incorporating ours, or market demand for our new products does not
exist as anticipated, our business, financial condition and results of
operations could be adversely affected.
For Cypress and many other semiconductor companies, introduction of new
products is a major manufacturing challenge. The new products the market
requires tend to be increasingly complex, incorporating more functions and
operating at greater speed than prior products. Increasing complexity generally
requires smaller features on a chip. This makes manufacturing new generations of
products substantially more difficult than prior products. Ultimately, whether
we can successfully introduce these and other new products depends on our
ability to develop and implement new ways of manufacturing semiconductors. If we
are unable to design, develop, manufacture, market and sell new products
successfully, our business, financial condition and results of operations would
be materially and adversely affected.
INTERRUPTIONS IN THE AVAILABILITY OF RAW MATERIALS CAN ADVERSELY IMPACT
CYPRESS'S FINANCIAL PERFORMANCE.
Cypress's semiconductor manufacturing operations require raw materials that
must meet exacting standards. We generally have available more than one source
of these materials, but there are only a limited number of suppliers capable of
delivering certain raw materials that meet our standards. If we need to use
other companies as suppliers, we would need them to go through a qualification
process. In addition, the raw materials we need for our business could get
harder to obtain as worldwide use of semiconductors increases. Although we have
faced shortages from time to time in the past and on occasion our suppliers have
told us they need more time than expected to fill our orders, to date we have
not experienced any significant interruption in operations as a result of
difficulties in obtaining raw materials for our manufacturing operations.
However, interruption of any raw material source could have a material adverse
effect on our business, financial condition and results of operations.
PROBLEMS IN THE PERFORMANCE OF OTHER COMPANIES CYPRESS HIRES TO PERFORM
CERTAIN MANUFACTURING TASKS CAN ADVERSELY IMPACT CYPRESS'S FINANCIAL
PERFORMANCE.
A high percentage of our products are assembled, packaged and tested at our
manufacturing facility located in the Philippines. We rely on independent
<PAGE>38
subcontractors to assemble, package and test the balance of our products. This
reliance involves certain risks, since we have reduced control over
manufacturing quality and delivery schedules, whether these companies have
adequate capacity to meet our needs and whether or not they discontinue or
phase-out assembly processes we rely on. We cannot be certain that these
subcontractors will continue to assemble, package and test products for us, and
it might be difficult for us to find alternatives if they do not do so.
THE COMPLEX, ESSENTIAL NATURE OF CYPRESS'S MANUFACTURING ACTIVITIES MAKE
THE COMPANY HIGHLY SUSCEPTIBLE TO MANUFACTURING PROBLEMS AND THESE PROBLEMS CAN
HAVE SUBSTANTIAL NEGATIVE IMPACT WHEN THEY OCCUR.
Making semiconductors is a highly complex and precise process, requiring
production in a tightly controlled, clean environment. Even very small
impurities in our manufacturing materials, difficulties in the wafer fabrication
process, defects in the masks used to print circuits on a wafer or other factors
can cause a substantial percentage of wafers to be rejected or numerous chips on
each wafer to be nonfunctional. We may experience problems in achieving an
acceptable success rate in the manufacture of wafers, and the likelihood of
facing such difficulties is higher in connection with the transition to new
manufacturing methods. The interruption of wafer fabrication or the failure to
achieve acceptable manufacturing yields at any of our facilities would have a
material adverse effect on our business, financial condition and results of
operations. We may also experience manufacturing problems in our assembly and
test operations and in the introduction of new packaging materials.
CYPRESS MAY NOT BE ABLE TO USE ALL OF ITS EXISTING OR FUTURE MANUFACTURING
CAPACITY, WHICH CAN NEGATIVELY IMPACT ITS BUSINESS.
Cypress has spent, and expects to continue spending, large amounts of money
to upgrade and increase its wafer fabrication, assembly and test manufacturing
capability and capacity. If we end up not needing this capacity and capability
for any of a variety of reasons, including inadequate demand or a significant
shift in mix of product orders making our existing capacity and capability
inadequate or in excess of actual needs, our fixed costs per semiconductor
produced will increase, which will adversely affect us. In addition, if the need
for more advanced technologies requires accelerated conversion to technologies
capable of manufacturing semiconductors having smaller features, or using larger
wafers, we are likely to face higher operating expenses and the need to
write-off capital equipment made obsolete by the technology conversion, which
could adversely affect our business and results of operations.
CYPRESS'S OPERATIONS AND FINANCIAL RESULTS COULD BE SEVERELY HARMED BY CERTAIN
NATURAL DISASTERS.
Cypress's headquarters and some manufacturing facilities are located near
major earthquake faults. If a major earthquake or other natural disaster occurs,
we could suffer damages that could materially and adversely affect our business,
financial condition and results of operations.
<PAGE>39
CYPRESS'S BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION WILL BE
ADVERSELY IMPACTED IF IT FAILS TO COMPETE IN ITS HIGHLY COMPETITIVE INDUSTRY AND
MARKETS.
The semiconductor industry is intensely competitive. This intense
competition results in a difficult operating environment for most companies in
the industry, including Cypress, marked by erosion of product sale prices over
the lives of each product, rapid technological change, limited product life
cycles and strong domestic and foreign competition in many markets. If we are
not able to compete successfully in this environment, our business, operating
results and financial condition will be adversely affected. A primary cause of
this highly competitive environment is the strengths of our competitors; the
industry consists of major domestic and international semiconductor companies,
many of which have substantially greater financial, technical, marketing,
distribution and other resources than we do. Cypress faces competition from
other domestic and foreign high-performance integrated circuit manufacturers,
many of which have advanced technological capabilities and have increased their
participation in markets that are important to us. Our ability to compete
successfully in a rapidly evolving high performance end of the semiconductor
technology spectrum depends on many factors, including:
o Our success in developing new products and manufacturing technologies;
o The quality and price of our products;
o The diversity of our product lines;
o The cost effectiveness of our design, development, manufacturing and
marketing efforts;
o The pace at which customers incorporate our products into their systems;
and
o The number and nature of our competitors and general economic conditions.
We believe we currently compete effectively in the above areas to the
extent they are within our control; however, given the pace at which events
change in the industry, our current abilities are not a guarantee of future
success.
CYPRESS MUST BUILD SEMICONDUCTORS BASED ON ITS FORECASTS OF DEMAND, AND CAN
END UP WITH LARGE AMOUNTS OF UNSOLD PRODUCT IF ITS FORECASTS ARE WRONG.
Cypress must order materials and build semiconductors based on its existing
orders, which may be cancelled under many circumstances and to a greater extent
on its internal forecasts. As a result, we are very dependent on our forecasts
to predict what we think we will be able to sell. Because our markets are
volatile and subject to rapid technology and price changes, our forecasts may be
wrong, and we may make too many or too few of certain products. Also, our
customers frequently place orders requesting product delivery almost immediately
after the order is made, which makes forecasting customer demand all the more
difficult. The above factors also make it difficult to forecast quarterly
operating results. If we are unable to predict accurately the appropriate amount
of product required to meet customer demand, our business, financial condition
and results of operations could be materially adversely affected.
<PAGE>40
CYPRESS MUST SPEND HEAVILY ON EQUIPMENT TO STAY COMPETITIVE, AND WILL BE
ADVERSELY IMPACTED IF IT IS UNABLE TO SECURE FINANCING FOR SUCH INVESTMENTS.
Semiconductor manufacturers generally must spend heavily on equipment to
maintain or increase manufacturing capacity and capability in order to remain
competitive. In particular, Cypress expects to spend in excess of $100 million
on equipment in 1999 and anticipates significant continuing capital expenditures
in subsequent years. In the past, we have reinvested a substantial portion of
our cash flow from operations in capacity expansion and improvement programs.
However, our cash flows from operations depend primarily on average selling
prices, which have been declining, and the per-unit cost of our products. If we
are unable to decrease costs for our products at a rate at least as fast as the
rate of decline in selling prices for such products, we may not be able to
generate enough cash flow from operations to maintain or increase manufacturing
capability and capacity as necessary. In that case we would need to seek
financing from external sources to satisfy our needs for manufacturing equipment
and, if cash flow from operations declines too much, for operational cash needs
as well. However, such financing may not be available on terms which are
satisfactory to us, in which case our business, financial condition and results
of operations will be adversely impacted.
CYPRESS COMPETES WITH OTHERS TO ATTRACT AND RETAIN KEY PERSONNEL, AND ANY LOSS
OF, OR INABILITY TO ATTRACT, SUCH PERSONNEL WOULD HURT US.
To a greater degree than most non-technology companies, Cypress depends on
the efforts and abilities of certain key management and technical personnel. Our
future success will depend in part upon our ability to retain these personnel,
and to attract and retain other highly qualified personnel, particularly product
design engineers. We compete for such personnel with other companies, academic
institutions, government entities and other organizations. Competition for
personnel such as these is intense throughout the technology industry and we may
not be successful in hiring or retaining new or existing qualified personnel. If
we lose existing qualified personnel or are unable to hire new qualified
personnel as needed, our business, financial condition and results of operations
could be adversely affected.
CYPRESS FACES ADDITIONAL PROBLEMS AND UNCERTAINTIES ASSOCIATED WITH
INTERNATIONAL OPERATIONS THAT COULD ADVERSELY IMPACT IT.
International sales represented 47.7% revenues during the first nine months
of fiscal 1999 and 42.8% of our revenues during the same period in fiscal 1998.
Our offshore assembly and test operations, as well as our international sales,
face risks frequently associated with foreign operations, including:
o currency exchange fluctuations,
o political instability,
o changes in local economic conditions,
o the devaluation of local currencies,
o import and export controls, and
o changes in tax laws, tariffs and freight rates.
To the extent any such risks materialize, our business, financial
condition and results of operations could be materially and adversely
affected.
<PAGE>41
CYPRESS MUST COMPLY WITH MANY DIFFERENT ENVIRONMENTAL REGULATIONS, WHICH CAN BE
EXPENSIVE.
Cypress must comply with many different federal, state and local
governmental regulations related to the storage, use, discharge and
disposal of toxic, volatile or otherwise hazardous chemicals used in its
manufacturing process. This compliance can be expensive. In addition, over
the last several years, the public has paid a great deal of attention to
the potentially negative environmental impact of semiconductor
manufacturing operations. This attention and other factors may lead to
changes in environmental regulations that could force us to purchase
additional equipment or comply with other potentially costly requirements.
If we fail to control the use of, or to adequately restrict the discharge
of, hazardous substances under present or future regulations, we could face
substantial liability or suspension of our manufacturing operations, which
could have a material adverse effect on our business, financial condition
and results of operations.
CYPRESS DEPENDS ON THIRD PARTIES TO TRANSPORT ITS PRODUCTS AND COULD BE HARMED
IF THESE PARTIES EXPERIENCE PROBLEMS.
Cypress relies on independent carriers and freight forwarders to move
its products between manufacturing plants and to its customers. Cypress has
limited control over these parties; however, any transport or delivery
problems because of their errors, or because of unforeseen interruptions in
their activities due to factors such as strikes, political instability,
natural disasters and accidents, could have a materially adverse effect on
our business, financial conditions and results of operations and ultimately
impact our relationship with our customers.
YEAR 2000 READINESS DISCLOSURE
- ------------------------------
In less than three months, most companies will face a potentially
serious problem because many software applications, operational systems and
equipment with embedded chips or processors may not properly recognize or
accurately process calendar dates beginning in the year 2000. The problem
arises because of the prevalent use of two digits to represent the year
2000 in these systems and equipment.
Like many other companies, the year 2000 issue poses a risk for
Cypress. The year 2000 problem could affect our computers, software and
other equipment we use and operate. This could result in system failures
causing disruptions in operations, including among other things,
interruptions in manufacturing, design and process development operations;
temporary disruptions in processing business transactions; and disruptions
in other normal business operations.
Cypress has taken company-wide actions to assess the nature and extent of
work required to prepare its products, systems, equipment and infrastructure for
January 1, 2000. In addition, we have engaged in the process of evaluating our
key suppliers and customers to determine the extent to which our operations are
vulnerable based upon third parties' failure to address their own year 2000
<PAGE>42
issues. These activities represent our ongoing efforts to address the year 2000
problem that we commenced with the implementation of a year 2000-compliant
accounting software system in 1997.
Cypress's president and executive staff have assumed the responsibility of
managing the impact of the year 2000 problem on all aspects of our operations,
including programs for identification, inventory taking, risk assessment and
cost estimates of problems associated with the year 2000; the plans, remediation
effort and testing methodology to correct those problems; and the development of
contingency plans if some of the corrective actions fail to correct the problem
or do not get implemented in a timely manner. These activities, in varying
phases, are currently in process.
As of November 1999, Cypress has completed all of its year 2000 compliance
efforts for our internal business (MIS) systems. An integrated system test for
critical business applications was completed at the end of September 1999. As of
October 1999, Cypress had completed 100% of the compliance efforts related to
the rest of our systems, equipment and infrastructure. Our efforts since the
beginning of fiscal year 1999 shifted in focus from inventory taking and
assessment to remediation, testing and contingency planning activities.
Contingency planning efforts have incorporated Cypress's entire supply chain and
external infrastructure, to ensure plans will be in place to address any
unforeseen year 2000 failures.
Cypress's compliance efforts will continue throughout the remainder of
1999. We continue to monitor systems, processes and suppliers for unanticipated
and previously undiscovered problems. We may discover new information that may
drive us to refine our year 2000 contingency and migration plans and/or launch
remediation and re-testing efforts.
Cypress incurred little cost during 1998 in addressing the year 2000
problem. In 1999 we expect to incur a total of $3.0 million of expense and
capital outlays for remediation, testing and contingency planning efforts.
Through Q3 1999, approximately 95% of planned expenditures have been incurred.
In the event year 2000 issues relating to key customers and suppliers are
not successfully resolved, based on information available to us at present, we
believe that the most reasonably likely worse case scenario is a temporary
disruption in infrastructure service, particularly power and telecommunications,
which could adversely impact supplier deliveries or customer shipments. If
severe disruptions occur in these areas and are not corrected in a timely
manner, a revenue or profit shortfall may result in fiscal year 2000.
Cypress Year 2000 contingency planning efforts are guided by three elements
and specifically expressed in our Year 2000 Mission: (1) Cypress serves its
customers continuously, (2) Cypress maintains continuous employment, and (3)
Cypress increases shareholder value relative to its competitors. The executive
staff of Cypress is directly responsible for developing and approving Cypress's
year 2000 contingency planning efforts, and the team is led by the CEO. The
operating assumption that external infrastructure may be down for up to 2-4
weeks has been used in order to create a suitable framework for contingency
planning efforts, and as a result, Cypress expects to have plans in place to
address any unforeseen year 2000 failures. Our contingency planning efforts will
continue through the end of the year. Many of these activities have already been
documented, implemented and communicated accordingly. A number of business
responses are being actively considered and/or have already been employed for
some segment of our customer/supplier base:
<PAGE>43
o developing second/alternate source suppliers for critical raw materials
and subcontract operations,
o work-in-process inventory "build ahead" in Cypress wafer fab locations,
o finished goods inventory "build ahead" in Cypress/subcontractor assembly
locations,
o increased consignment inventory programs for strategic customers
(up to 3 months on customer premises),
o higher year-end 1999 stocking levels for primary Cypress distributors,
o intersite communication blackouts immediately around the
December 31/January 1 date change in order to minimize the risk of
external system intrusion into Cypress's systems,
o facility "safe state" plans, including plans to preserve equipment and
the controlled environment of manufacturing facilities (i.e.,
temperature and humidity controls) for a period of 7 days using
self-generated power in the event of infrastructure shutdown, and
o early payment/collection as well as delayed payment/collection for
Cypress suppliers, customers and employees.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- ------------------------------------------------------------------
Cypress is exposed to financial market risks, including changes in interest
rates and foreign currency exchange rates. To mitigate these risks, Cypress
utilizes derivative financial instruments. Cypress does not use derivative
financial instruments for speculative or trading purposes.
A majority of Cypress's revenue and capital spending is transacted in U.S.
dollars. However, Cypress does enter into these transactions in other
currencies, primarily Japanese yen and certain other European currencies. To
protect against reductions in value and the volatility of future cash flows
caused by changes in foreign exchange rates, Cypress has established revenue and
balance sheet hedging programs. Cypress's hedging programs reduce, but do not
always eliminate, the impact of foreign currency rate movements. There have been
no significant changes in the market risk disclosures during the nine months
ended October 3, 1999 as compared to the discussion in our 1998 Annual Report on
Form 10-K for the year ended January 3, 1999.
<PAGE>44
PART II. OTHER INFORMATION
--------------------------
ITEM 1 -- LEGAL PROCEEDINGS
- ---------------------------
The information required by this item is included in Part I in Note 10 of Notes
to the Condensed Consolidated Financial Statements.
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
- ------------------------------------------
a. Exhibits
Exhibit 27 -- Financial Data Schedule
b. Reports on Form 8-K
None
<PAGE>45
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.
CYPRESS SEMICONDUCTOR CORORATION
By /s/ T.J. RODGERS
------------------------------
T.J. Rodgers
President and Chief Executive
Officer
By /s/ EMMANUEL HERNANDEZ
------------------------------
Emmanuel Hernandez
Vice President, Finance and
Administration and Chief
Financial Officer
Dated: November 17, 1999
- -------------------------
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated financial statements for the nine months ended October 3, 1999.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-2000
<PERIOD-START> JUL-05-1999
<PERIOD-END> OCT-03-1999
<CASH> 128,876
<SECURITIES> 73,915
<RECEIVABLES> 93,253
<ALLOWANCES> 2,478
<INVENTORY> 79,270
<CURRENT-ASSETS> 398,356
<PP&E> 352,323
<DEPRECIATION> 488,003
<TOTAL-ASSETS> 965,243
<CURRENT-LIABILITIES> 159,817
<BONDS> 160,000
0
0
<COMMON> 1,143
<OTHER-SE> 625,843
<TOTAL-LIABILITY-AND-EQUITY> 965,243
<SALES> 497,611
<TOTAL-REVENUES> 497,611
<CGS> 277,561
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<OTHER-EXPENSES> 95,306
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<INTEREST-EXPENSE> 7,244
<INCOME-PRETAX> 45,900
<INCOME-TAX> 2,319
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<EXTRAORDINARY> 0
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<NET-INCOME> 43,581
<EPS-BASIC> 0.42
<EPS-DILUTED> 0.40
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