-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SLCkok59/DHBySfrpxg4Xcj8Yy8eRsFptjxM4wYZHEVCj4MILJsKUryq0eEEZDvd uZD/PkxVfvDWXlumTjNdAA== 0001104659-06-035742.txt : 20060517 0001104659-06-035742.hdr.sgml : 20060517 20060517165116 ACCESSION NUMBER: 0001104659-06-035742 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060517 DATE AS OF CHANGE: 20060517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERNATIONAL RECTIFIER CORP /DE/ CENTRAL INDEX KEY: 0000316793 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 951528961 STATE OF INCORPORATION: DE FISCAL YEAR END: 0629 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-07935 FILM NUMBER: 06849637 BUSINESS ADDRESS: STREET 1: 233 KANSAS ST CITY: EL SEGUNDO STATE: CA ZIP: 90245 BUSINESS PHONE: 3107268000 10-Q/A 1 a06-12026_210qa.htm AMENDMENT TO QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q/A

 

(MARK ONE)

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

 

 

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2005

 

COMMISSION FILE NUMBER:

 

1-7935

 

International Rectifier Corporation

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

DELAWARE

 

95-1528961

(STATE OR OTHER JURISDICTION OF

 

(IRS EMPLOYER IDENTIFICATION

INCORPORATION OR ORGANIZATION)

 

NUMBER)

 

 

 

233 KANSAS STREET

 

 

EL SEGUNDO, CALIFORNIA

 

90245

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

 

(ZIP CODE)

 

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:  (310) 726-8000

 

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  ý    NO  o

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN ACCELERATED FILER, OR A NON-ACCELERATED FILER. SEE DEFINITION OF “ACCELERATED FILER AND LARGE ACCELERATED FILER” IN RULE 12B-2 OF THE EXCHANGE ACT. (CHECK ONE):

 

LARGE ACCELERATED FILER  ý

 

ACCELERATED FILER  o

 

NON-ACCELERATED FILER  o

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES  o    NO  ý

 

THERE WERE 70,933,810 SHARES OF THE REGISTRANT’S COMMON STOCK, PAR VALUE $1.00 PER SHARE, OUTSTANDING ON FEBRUARY 3, 2006.

 

 



 

Table of Contents

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

Financial Statements

 

 

 

 

 

Unaudited Consolidated Statements of Income for the Three and Six Months Ended December 31, 2005 and 2004

 

 

 

 

 

Unaudited Consolidated Statements of Comprehensive Income for the Three and Six Months Ended December 31, 2005 and 2004

 

 

 

 

 

Unaudited Consolidated Balance Sheets as of December 31, 2005 and June 30, 2005

 

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2005 (Restated) and 2004

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

 

 

 

 

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

ITEM 4.

Controls and Procedures

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

ITEM 1A.

Risk Factors

 

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

ITEM 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

ITEM 6.

Exhibits

 

 

2



 

EXPLANATORY NOTE

 

This amendment to our Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2005, initially filed with the Securities and Exchange Commission on February 10, 2006, is being filed to reflect the restatement of our unaudited consolidated statement of cash flows for the six months ended December 31, 2005, to correct an error in the classification of the excess tax benefits generated from the exercise of stock options. As more fully described in Note 1, “Certain Accounting Policies”, of the Notes to the unaudited consolidated financial statements, the excess tax benefits from stock options exercised that was previously reported in the consolidated statement of cash flows as an operating activity has been restated to correctly present it as a financing activity.

 

Generally, no attempt has been made in this Form 10-Q/A to modify or update other disclosures presented in the original report on Form 10-Q except as required to reflect the effects of the restatement. This Form 10-Q/A generally does not reflect events occurring after the filing of the original Form 10-Q or modify or update those disclosures affected by subsequent events. Information not affected by the restatement is unchanged and reflects the disclosures made at the time of the original filing of the Form 10-Q, including any amendments to those filings. The following items have been amended as a result of the restatement:

 

                  Part I, Item 1, Financial Information;

 

                  Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations;

 

                  Part I, Item 4, Controls and Procedures; and

 

                  Part II, Item 6, Exhibits.

 

Our Chief Executive Officer and Chief Financial Officer have also reissued certifications required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

 

3



 

PART I. FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements.

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

(In thousands except per share amounts)

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

278,811

 

$

298,560

 

$

551,383

 

$

610,785

 

Cost of sales

 

167,237

 

169,179

 

328,915

 

347,967

 

Gross profit

 

111,574

 

129,381

 

222,468

 

262,818

 

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

46,148

 

40,863

 

91,315

 

87,278

 

Research and development expense

 

27,238

 

27,691

 

52,450

 

53,056

 

Amortization of acquisition-related intangible assets

 

1,432

 

1,457

 

2,885

 

2,896

 

Impairment of assets, restructuring and severance charges

 

3,060

 

6,831

 

7,353

 

13,522

 

Other expense, net

 

1,040

 

690

 

1,165

 

656

 

Interest (income) expense, net

 

(800

)

650

 

(2,353

)

2,366

 

Income before income taxes

 

33,456

 

51,199

 

69,653

 

103,044

 

Provision for income taxes

 

9,200

 

11,685

 

19,155

 

25,950

 

Net income

 

$

24,256

 

$

39,514

 

$

50,498

 

$

77,094

 

 

 

 

 

 

 

 

 

 

 

Net income per common share – basic

 

$

0.34

 

$

0.59

 

$

0.72

 

$

1.16

 

 

 

 

 

 

 

 

 

 

 

Net income per common share – diluted

 

$

0.34

 

$

0.55

 

$

0.70

 

$

1.07

 

 

 

 

 

 

 

 

 

 

 

Average common shares outstanding – basic

 

70,816

 

66,929

 

70,567

 

66,723

 

 

 

 

 

 

 

 

 

 

 

Average common shares and potentially dilutive securities outstanding – diluted

 

71,602

 

76,490

 

71,663

 

76,098

 

 

The accompanying notes are an integral part of these statements.

 

4



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

(In thousands)

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

24,256

 

$

39,514

 

$

50,498

 

$

77,094

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(8,198

)

23,406

 

(13,334

)

23,544

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) on available-for-sale securities, net of tax effect of ($6,920), $1,724, ($5,232) and $7,246, respectively

 

11,783

 

(2,937

)

8,911

 

(12,337

)

Unrealized holding gains (losses) on foreign currency forward contract, net of tax effect of ($80), $1,723, ($235) and $1,246, respectively

 

136

 

(2,933

)

399

 

(2,122

)

Less: Reclassification adjustments of net losses on available-for-sale securities and foreign currency forward contract

 

(7

)

336

 

(30

)

552

 

Other comprehensive income (loss)

 

3,714

 

17,872

 

(4,054

)

9,637

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

27,970

 

$

57,386

 

$

46,444

 

$

86,731

 

 

The accompanying notes are an integral part of these statements.

 

5



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

 

December 31,

 

June 30,

 

 

 

2005

 

2005(1)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

273,697

 

$

359,978

 

Short-term cash investments

 

303,186

 

278,157

 

Trade accounts receivable, less allowance for doubtful accounts

 

159,149

 

158,510

 

Inventories, net

 

209,118

 

177,560

 

Short-term deferred income taxes

 

31,228

 

34,784

 

Prepaid expenses and other receivables

 

59,829

 

53,387

 

 

 

 

 

 

 

Total current assets

 

1,036,207

 

1,062,376

 

Long-term cash investments

 

341,525

 

302,585

 

Property, plant and equipment, net

 

517,189

 

488,204

 

Goodwill

 

151,714

 

152,457

 

Acquisition-related intangible assets, net

 

32,338

 

35,354

 

Long-term deferred income taxes

 

73,279

 

76,158

 

Other assets

 

121,203

 

106,410

 

 

 

 

 

 

 

Total assets

 

$

2,273,455

 

$

2,223,544

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Bank loans

 

$

2,678

 

$

18,168

 

Long-term debt, due within one year

 

48

 

163

 

Accounts payable

 

70,996

 

81,893

 

Accrued salaries, wages and commissions

 

36,008

 

33,344

 

Other accrued expenses

 

88,731

 

91,328

 

 

 

 

 

 

 

Total current liabilities

 

198,461

 

224,896

 

Long-term debt, less current maturities

 

539,255

 

547,259

 

Other long-term liabilities

 

23,742

 

26,186

 

Long-term deferred income taxes

 

6,850

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

70,872

 

69,826

 

Capital contributed in excess of par value of shares

 

886,499

 

854,045

 

Retained earnings

 

485,643

 

435,145

 

Accumulated other comprehensive income

 

62,133

 

66,187

 

 

 

 

 

 

 

Total stockholders’ equity

 

1,505,147

 

1,425,203

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

2,273,455

 

$

2,223,544

 

 

The accompanying notes are an integral part of these statements.

 


(1) The consolidated balance sheet as of June 30, 2005 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

 

6



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Six Months Ended

 

 

 

December 31,

 

 

 

2005

 

2004

 

 

 

(As Restated)

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

50,498

 

$

77,094

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

40,048

 

34,158

 

Amortization of acquisition-related intangible assets

 

2,885

 

2,896

 

Stock compensation expense

 

1,402

 

410

 

Unrealized (gains) losses on swap transactions

 

(1,287

)

518

 

Deferred income taxes

 

7,415

 

(9,425

)

Tax benefits from options exercised

 

8,382

 

5,381

 

Excess tax benefits from options exercised

 

(4,264

)

 

Change in operating assets and liabilities, net

 

(56,729

)

(11,834

)

 

 

 

 

 

 

Net cash provided by operating activities

 

48,350

 

99,198

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Additions to property, plant and equipment

 

(75,980

)

(68,575

)

Proceeds from sale of property, plant and equipment

 

298

 

115

 

Acquisition of business

 

 

(39,633

)

Sale or maturities of cash investments

 

233,134

 

163,825

 

Purchase of cash investments

 

(300,857

)

(136,304

)

Change in other investing activities, net

 

(1,859

)

(6,405

)

Net cash used in investing activities

 

(145,264

)

(86,977

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

(Repayments) proceeds from short-term debt, net

 

(15,236

)

1,264

 

Repayments of capital lease obligations, net

 

 

(114

)

Proceeds from exercise of stock options and stock purchase plan

 

24,504

 

16,770

 

Excess tax benefits from options exercised

 

4,264

 

 

Other, net

 

(5,966

)

579

 

 

 

 

 

 

 

Net cash provided by financing activities

 

7,566

 

18,499

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

3,067

 

4,960

 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

(86,281

)

35,680

 

Cash and cash equivalents, beginning of period

 

359,978

 

339,024

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

273,697

 

$

374,704

 

 

The accompanying notes are an integral part of these statements.

 

7



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2005

 

1.                           Certain Accounting Policies

 

Basis of Consolidation

 

The consolidated financial statements include the accounts of International Rectifier Corporation and its subsidiaries (“the Company”), which are located in North America, Europe and Asia. Intercompany transactions have been eliminated in consolidation.

 

The consolidated financial statements included herein are unaudited; however, they contain all normal recurring adjustments which, in the opinion of the Company’s management, are necessary to state fairly the consolidated financial position of the Company at December 31, 2005, and the consolidated results of operations and the consolidated cash flows for the three and six months ended December 31, 2005 and 2004. The results of operations for the three and six months ended December 31, 2005 are not necessarily indicative of the results to be expected for the full year.

 

The accompanying unaudited consolidated financial statements should be read in conjunction with the Annual Report on Form 10-K for the fiscal year ended June 30, 2005.

 

The Company operates on a 52-53 week fiscal year under which the three months ended December 2005 and 2004 consisted of 13 weeks ending January 1, 2006 and January 2, 2005, respectively. For ease of presenting the accompanying consolidated financial statements, the fiscal December quarter-end for all periods presented is shown as December 31. Fiscal June 2005 year-end presented is shown as June 30. Fiscal 2006 will consist of 52 weeks ending July 2, 2006.

 

Certain reclassifications have been made to the December 31, 2004 (i) cash flows from investing activities, (ii) net decrease in cash and cash equivalents, and (iii) ending cash and cash equivalents, as a result of reclassification of auction rate securities (“ARS”) from cash and cash equivalents to short-term investments. Previously, the Company’s investments in ARS were recorded in cash and cash equivalents rather than short-term cash investments. The Company reclassified ARS from cash and cash equivalents to short-term investments because the underlying instruments have maturity dates exceeding ninety days. As a result of the reclassifications, the Company’s consolidated cash flows were affected as follows:

 

                  net cash used for the purchase of cash investments decreased by $74.1 million for the six months ended December 31, 2004; and

 

                  net change in cash and cash equivalents increased by $74.1 million for the six months ended December 31, 2004.

 

8



 

The reclassifications had no impact on the Company’s total current assets, stockholders’ equity, cash flows provided by operating activities or total consolidated results reported in any period presented. At December 31, 2005 and June 30, 2005, the Company had no investments in these securities.

 

Restatement of Consolidated Statement of Cash Flows

 

The Company has restated the consolidated statement of cash flows for the six months ended December 31, 2005 to correct an error in the classification of the excess tax benefits generated from the exercise of stock options. Previously, the Company classified the excess tax benefits from options exercised in cash flows from operating activities rather than as a cash flow from financing activity as required by Statement of Financial Accounting Standard No. 123(R), “Share-Based Payment,” which the Company adopted as of the beginning of its fiscal year 2006 in July 2005. The restatement had no impact on the Company’s statement of cash flows for the six months ended December 31, 2004. The restatement also had no impact on the Company’s overall net change in cash and cash equivalents, the unaudited consolidated statements of income, the unaudited consolidated statements of comprehensive income, or the unaudited consolidated balance sheet for any of the periods presented.

 

A summary of the effects of the restatement is as follows:

 

 

 

Six Months Ended

 

 

 

December 31,

 

 

 

2005

 

Net cash provided by operating activities as previously reported

 

$

52,614

 

Restatement of the excess tax benefits from options exercised

 

(4,264

)

Restated net cash provided by operating activities

 

$

48,350

 

 

 

 

 

Net cash provided by financing activities as previously reported

 

$

3,302

 

Restatement of the excess tax benefits from options exercised

 

4,264

 

Restated net cash provided by financing activities

 

$

7,566

 

 

2.                           Net Income Per Common Share

 

Net income per common share - basic is computed by dividing net income available to common stockholders (the numerator) by the weighted average number of common shares outstanding (the denominator) during the period. The computation of net income per common share - diluted is similar to the computation of net income per common share - basic except that the denominator is increased to include the number of additional common shares that would have been outstanding for the exercise of stock options using the treasury stock method and the conversion of the Company’s convertible subordinated notes using the if-converted method. The Company’s use of the treasury stock method reduces the gross number of dilutive shares by the number of shares purchasable from the proceeds of the options assumed to be exercised. The Company’s use of the if-converted method increases reported net income by the interest expense related to the convertible subordinated notes when computing net income per common share – diluted.

 

The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three and six months ended December 31, 2005 and 2004 (in thousands except per share amounts):

 

9



 

 

 

Net Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

Three months ended December 31, 2005:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

24,256

 

70,816

 

$

0.34

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options and restricted stock units

 

 

786

 

 

Net income per common share – diluted

 

$

24,256

 

71,602

 

$

0.34

 

 

Three months ended December 31, 2004:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

39,514

 

66,929

 

$

0.59

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options and restricted stock units

 

 

2,122

 

(0.01

)

Conversion of subordinated notes

 

2,312

 

7,439

 

(0.03

)

Net income per common share – diluted

 

$

41,826

 

76,490

 

$

0.55

 

 

Six months ended December 31, 2005:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

50,498

 

70,567

 

$

0.72

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options and restricted stock units

 

 

1,096

 

(0.02

)

Net income per common share – diluted

 

$

50,498

 

71,663

 

$

0.70

 

 

10



 

 

 

Net Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Six months ended December 31, 2004:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

77,094

 

66,723

 

$

1.16

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options and restricted stock units

 

 

1,936

 

(0.04

)

Conversion of subordinated notes

 

4,698

 

7,439

 

(0.05

)

Net income per common share – diluted

 

$

81,792

 

76,098

 

$

1.07

 

 

The conversion effect of the Company’s outstanding convertible subordinated notes into 7,439,000 shares of common stock was not included in the computation of diluted income per share for the three and six months ended December 31, 2005, since such effect would have been anti-dilutive.

 

3.                           Cash and Investments

 

The Company classifies all highly liquid investments purchased with original or remaining maturities of ninety days or less at the date of purchase as cash equivalents. The cost of these investments approximates fair value.

 

The Company invests excess cash in marketable securities consisting primarily of commercial paper, corporate notes, corporate bonds and U.S. government securities. At December 31, 2005 and June 30, 2005, all of the Company’s marketable securities are classified as available-for-sale. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, unrealized gains and losses on these investments are included in accumulated other comprehensive income, a separate component of stockholders’ equity, net of any related tax effect. Realized gains and losses and declines in value considered to be other than temporary are included in interest (income) expense, net. At December 31, 2005 and June 30, 2005, no investment was in a material loss position for greater than one year.

 

Cash, cash equivalents and cash investments as of December 31, 2005 and June 30, 2005 are summarized as follows (in thousands):

 

 

 

December 31,

 

June 30,

 

 

 

2005

 

2005

 

Cash and cash equivalents

 

$

273,697

 

$

359,978

 

Short-term cash investments

 

303,186

 

278,157

 

Long-term cash investments

 

341,525

 

302,585

 

Total cash, cash equivalents and cash investments

 

$

918,408

 

$

940,720

 

 

11



 

Available-for-sale securities as of December 31, 2005 are summarized as follows (in thousands):

 

Short-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

126,406

 

$

 

$

(794

)

$

(794

)

$

125,612

 

U.S. government and agency obligations

 

169,932

 

1

 

(367

)

(366

)

169,566

 

Other debt

 

8,010

 

 

(2

)

(2

)

8,008

 

Total short-term cash investments

 

$

304,348

 

$

1

 

$

(1,163

)

$

(1,162

)

$

303,186

 

 

Long-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

132,137

 

$

3

 

$

(1,098

)

$

(1,095

)

$

131,042

 

U.S. government and agency obligations

 

151,063

 

1

 

(798

)

(797

)

150,266

 

Other debt

 

60,629

 

9

 

(421

)

(412

)

60,217

 

Total long-term cash investments

 

$

343,829

 

$

13

 

$

(2,317

)

$

(2,304

)

$

341,525

 

 

Available-for-sale securities as of June 30, 2005 are summarized as follows (in thousands):

 

Short-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

179,372

 

$

6

 

$

(1,477

)

$

(1,471

)

$

177,901

 

U.S. government and agency obligations

 

99,728

 

 

(576

)

(576

)

99,152

 

Other debt

 

1,105

 

 

(1

)

(1

)

1,104

 

Total long-term cash investments

 

$

280,205

 

$

6

 

$

(2,054

)

$

(2,048

)

$

278,157

 

 

Long-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
(Loss) Gain

 

Market
Value

 

Corporate debt

 

$

124,727

 

$

249

 

$

(355

)

$

(106

)

$

124,621

 

U.S. government and agency obligations

 

116,082

 

239

 

(134

)

105

 

116,187

 

Other debt

 

61,765

 

131

 

(119

)

12

 

61,777

 

Total long-term cash investments

 

$

302,574

 

$

619

 

$

(608

)

$

11

 

$

302,585

 

 

12



 

The Company holds as strategic investments the common stock of two publicly-traded Japanese companies, one of which is Nihon Inter Electronics Corporation (“Nihon”), a related party as further disclosed in Note 16. The Company accounts for these available-for-sale investments under SFAS No. 115. These stocks are traded on the Tokyo Stock Exchange. The market values of the equity investments at December 31, 2005 and June 30, 2005 were $84.4 million and $71.2 million, respectively, compared to their purchased cost of $24.2 million. Mark-to-market gains (losses), net of tax, of $11.8 million and ($2.9) million for the three months ended December 31, 2005 and 2004, respectively, and $8.9 million and ($12.3) million for the six months ended December 31, 2005 and 2004, respectively, were included in accumulated other comprehensive income, a separate component of equity.

 

The amortized cost and estimated fair value of cash investments at December 31, 2005, by contractual maturity, are as follows (in thousands):

 

 

 

Amortized
Cost

 

Estimated
Fair Value

 

Due in 1 year or less

 

$

169,586

 

$

168,528

 

Due in 1-2 years

 

243,872

 

242,735

 

Due in 2-5 years

 

200,764

 

199,770

 

Due after 5 years

 

33,955

 

33,678

 

Total cash investments

 

$

648,177

 

$

644,711

 

 

Cash investments with contractual maturity greater than one year for which the Company has the intent and ability to hold for less than one year are classified as short-term investments.

 

Gross realized gains were $0.01 million and $0.02 million for the three and six months ended December 31, 2005, respectively, and gross realized losses were ($0.1) and ($0.4) million for the three and six months ended December 31, 2005, respectively. Gross realized gains were $0.01 million and $0.02 million for the three and six months ended December 31, 2004, respectively, and gross realized losses were ($0.02) and ($0.08) million for the three and six months ended December 31, 2004, respectively. The cost of marketable securities sold is determined by the weighted average cost method.

 

4.                           Derivative Financial Instruments

 

Foreign Currency Risk

 

The Company conducts business on a global basis in several foreign currencies, and is primarily exposed to fluctuations with the British Pound Sterling, the Euro and the Japanese Yen. Considering its foreign currency risks, the Company has the greatest exposure to the Japanese Yen, since it has significant Yen-based revenues without the Yen-based manufacturing costs. The risk of the Company’s revenues in the European currencies is partially offset by the cost of manufacturing goods in the European currencies.

 

13



 

The Company has established a foreign-currency hedging program using foreign exchange forward contracts, including the Forward Contract described below, to hedge certain foreign currency transaction exposures. To protect against reductions in value and volatility of future cash flows caused by changes in currency exchange rates, it has established revenue, expense and balance sheet hedging programs. Currency forward contracts and local Yen and Euro borrowings are used in these hedging programs. The Company’s hedging programs reduce, but do not always eliminate, the impact of currency exchange rate movements.

 

In March 2001, the Company entered into a five-year foreign exchange forward contract (the “Forward Contract”) for the purpose of reducing the effect of exchange rate fluctuations on forecasted intercompany purchases by the Company’s subsidiary in Japan. The Company has designated the Forward Contract as a cash flow hedge under which mark-to-market adjustments are recorded in accumulated other comprehensive income, a separate component of stockholders’ equity, until the forecasted transactions are recorded in earnings. Under the terms of the Forward Contract, the Company is required to exchange 1.2 billion yen for $11.0 million on a quarterly basis from June 2001 to March 2006. At December 31, 2005, one payment of 1.2 billion yen remained to be swapped in March 2006, at a forward exchange rate of 109.32 yen per U.S. dollar. The market value of the forward contract was $0.7 million and $0.1 million at December 31, 2005 and June 30, 2005, respectively. Mark-to-market gains (losses), included in other comprehensive income, net of tax, were $0.1 million and ($2.9) million for the three months ended December 31, 2005 and 2004, respectively, and $0.4 million and ($2.1) million for the six months ended December 31, 2005 and 2004, respectively. At December 31, 2005, based on effectiveness tests comparing forecasted transactions through the Forward Contract expiration date to its cash flow requirements, the Company does not expect to incur a material charge to income as a result of the Forward Contract during the next three months through its maturity.

 

The Company had approximately $109.6 million and $75.9 million in notional amounts of forward contracts not designated as accounting hedges under SFAS No. 133 at December 31, 2005 and June 30, 2005, respectively. Net realized and unrealized foreign-currency net gains recognized in earnings were less than $1 million for the three and six months ended December 31, 2005 and 2004.

 

Interest Rate Risk

 

In December 2001, the Company entered into an interest rate swap transaction (the “Transaction”) with an investment bank, JP Morgan Chase Bank (the “Bank”), to modify the Company’s effective interest payable with respect to $412.5 million of its $550 million outstanding convertible debt (the “Debt”) (see Note 9, “Bank Loans and Long-Term Debt”). In April 2004, the Company entered into an interest rate swap transaction (the “April 2004 Transaction”) with the Bank to modify the effective interest payable with respect to the remaining $137.5 million of the Debt. The Company will receive from the Bank fixed payments equal to 4.25 percent of the notional amount, payable on January 15 and July 15. In exchange, the Company will pay to the Bank floating rate payments based upon the London InterBank Offered Rate (“LIBOR”) multiplied by the notional amount. At the inception of the Transaction, interest rates were lower than that of the Debt and the

 

14



 

Company believed that interest rates would remain lower for an extended period of time. The variable interest rate paid since the inception of the swaps has averaged 2.68 percent, compared to a coupon of 4.25 percent on the Debt. This arrangement increased (decreased) interest expense by $0.8 million and ($2.5) million, for the three months ended December 31, 2005 and 2004, respectively, and ($0.1) million and ($4.7) million for the six months ended December 31, 2005 and 2004, respectively.

 

Accounted for as fair value hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, the mark-to-market adjustments of the Transaction and April 2004 Transaction were offset by the mark-to-market adjustments on the Debt, resulting in no material impact to earnings. The market value of the Transaction was a liability of $5.8 million and $0.3 million at December 31, 2005 and June 30, 2005, respectively. The market value of the April 2004 Transaction was a liability of $4.7 million and $3.4 million at December 31, 2005 and June 30, 2005, respectively.

 

Both Transactions terminate on July 15, 2007 (“Termination Date”), subject to certain early termination provisions. On or after July 18, 2004 and prior to July 14, 2007, if the ten-day average closing price of the Company’s common stock equals or exceeds $77.63, both transactions will terminate.

 

In support of the Company’s obligation under the two transactions, the Company is required to obtain irrevocable standby letters of credit in favor of the Bank, totaling $7.5 million plus a collateral requirement for the Transaction and the April 2004 Transaction, as determined periodically. At December 31, 2005, $17.0 million in letters of credit were outstanding related to both transactions.

 

The Transaction and the April 2004 Transaction qualify as fair value hedges under SFAS No. 133. To test effectiveness of the hedge, regression analysis is performed quarterly comparing the change in fair value of the two transactions and the Debt. The fair values of the Transaction, the April 2004 Transaction and the Debt are calculated quarterly as the present value of the contractual cash flows to the expected maturity date, where the expected maturity date is based on probability-weighted analysis of interest rates relating to the five-year LIBOR curve and the Company’s stock prices. For the three and six months ended December 31, 2005 and 2004, the hedges were highly effective and therefore, the ineffective portion did not have a material impact on earnings.

 

In April 2002, the Company entered into an interest rate contract (the “Contract”) with an investment bank, Lehman Brothers (“Lehman”), to reduce the variable interest rate risk of the Transaction. The notional amount of the Contract is $412.0 million, representing approximately 75 percent of the Debt. Under the terms of the Contract, the Company has the option to receive a payout from Lehman covering its exposure to LIBOR fluctuations between 5.5 percent and 7.5 percent for any four designated quarters. The market value of the Contract at December 31, 2005 and June 30, 2005, was $0.2 million and $0.1 million, respectively, and was included in other long-term assets. Mark-to-market (losses) gains of ($0.05) million and ($0.3) million, for the three months ended December 31, 2005 and 2004, respectively, and $0.1 million and ($0.6) million, for the six months ended December 31, 2005 and 2004, respectively, were charged to interest expense.

 

15



 

5.                           Inventories

 

Inventories are stated at the lower of cost (principally first-in, first-out) or market. Inventories are reviewed for excess and obsolescence based upon demand forecast within a specific time horizon and reserves are established accordingly. Inventories at December 31, 2005 and June 30, 2005 were comprised of the following (in thousands):

 

 

 

December 31,

 

June 30,

 

 

 

2005

 

2005

 

Raw materials

 

$

37,907

 

$

33,328

 

Work-in-process

 

94,260

 

82,802

 

Finished goods

 

76,951

 

61,430

 

 

 

 

 

 

 

Total inventories

 

$

209,118

 

$

177,560

 

 

6.                           Goodwill and Acquisition-Related Intangible Assets

 

The Company accounts for goodwill and acquisition-related intangible assets in accordance with SFAS No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets”. The Company classifies the difference between the purchase price and the fair value of net assets acquired at the date of acquisition as goodwill. The Company classifies intangible assets apart from goodwill if the assets have contractual or other legal rights or if the assets can be separated and sold, transferred, licensed, rented or exchanged. Depending on the nature of the assets acquired, the amortization period may range from four to twelve years for those acquisition-related intangible assets subject to amortization.

 

The Company evaluates the carrying value of goodwill and acquisition-related intangible assets, including the related amortization period, in the fourth quarter of each fiscal year. In evaluating goodwill and intangible assets not subject to amortization, the Company completes the two-step goodwill impairment test as required by SFAS No. 142. The Company identified its reporting units and determined the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units, in order to assess goodwill for impairment. A reporting unit is the lowest level of the Company for which there is discrete information and whose results are regularly reviewed by the Company.

 

In the first of a two-step impairment test, the Company determined the fair value of these reporting units using a discounted cash flow valuation model. The Company compared the discounted cash flows for the reporting unit to its carrying value. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is considered not impaired and no further testing is required. If the fair value does not exceed the carrying value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any. The second step compared the implied fair value of the reporting unit with the carrying amount of that goodwill. Based on its annual impairment test in the fourth quarter

 

16



 

of fiscal year ended June 30, 2005, the Company determined that goodwill was not impaired.

 

At December 31, 2005 and June 30, 2005 acquisition-related intangible assets included the following (in thousands):

 

 

 

 

 

December 31, 2005

 

June 30, 2005

 

 

 

Amortization
Periods
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Acquisition-related intangible assets:

 

 

 

 

 

 

 

 

 

 

 

Complete technology

 

4 – 12

 

$

36,601

 

$

(13,225

)

$

36,665

 

$

(11,859

)

Distribution rights and customer lists

 

5 – 12

 

15,454

 

(8,029

)

15,667

 

(7,243

)

Intellectual property and other

 

5 – 12

 

7,313

 

(5,776

)

7,313

 

(5,189

)

Total acquisition-related intangible assets

 

 

 

$

59,368

 

$

(27,030

)

$

59,645

 

$

(24,291

)

 

As of December 31, 2005, estimated amortization expense for the next five years is as follows (in thousands): remainder of fiscal 2006: $1,840; fiscal 2007: $2,899; fiscal 2008: $2,527; fiscal 2009: $2,489, fiscal 2010: $2,489 and fiscal 2011: $1,710.

 

The carrying amount of goodwill by business segment as of December 31, 2005, is as follows (in thousands):

 

 

 

December 31, 2005

 

Energy-Saving Products

 

$

70,310

 

Aerospace and Defense

 

45,765

 

Computing and Communications

 

28,803

 

Non-Aligned Products

 

3,575

 

Intellectual Property

 

3,261

 

 

 

 

 

Total goodwill

 

$

151,714

 

 

As of December 31, 2005 and June 30, 2005, $43.3 million of goodwill is deductible for income tax purposes.

 

The changes in the carrying amount of goodwill for the period ended December 31, 2005 and June 30, 2005 are as follows (in thousands):

 

 

 

Goodwill

 

Balance, June 30, 2004

 

$

139,919

 

New acquisitions

 

12,958

 

Foreign exchange impact

 

(420

)

 

 

 

 

Balance, June 30, 2005

 

$

152,457

 

Purchase price adjustment

 

406

 

Foreign exchange impact

 

(1,149

)

 

 

 

 

Balance, December 31, 2005

 

$

151,714

 

 

During the fiscal year ended June 30, 2005, the Company acquired the specialty silicon epitaxial services business from Advanced Technology Materials, Inc. for

 

17



 

$39.6 million, of which $12.5 million was allocated to goodwill. The goodwill was assigned to the Computing and Communications, Energy-Saving Products and Intellectual Property segments based on revenue. During the six months ended December 31, 2005, the Company concluded the physical inventory of ATMI’s fixed assets and determined that the purchased cost of the assets should be reduced by $1.1 million. The Company reallocated ATMI’s purchase price and increased goodwill by $1.1 million accordingly. Also during the six months ended December 31, 2005, as described in Note 10, “Impairment of Assets, Restructuring and Severance”, the Company determined that approximately $0.7 million of severance liability associated with the TechnoFusion acquisition was excess. The Company reduced TechnoFusion purchased goodwill by $0.7 million accordingly.

 

7.                           Other long-term assets

 

Other long-term assets at December 31, 2005 and June 30, 2005 were comprised of the following (in thousands):

 

 

 

December 31,

 

June 30,

 

 

 

2005

 

2005

 

Available-for-sale equity investments

 

$

84,420

 

$

71,224

 

Other long-term assets

 

36,783

 

35,186

 

 

 

 

 

 

 

Total other long-term assets

 

$

121,203

 

$

106,410

 

 

8.                           Other accrued expenses

 

Other accrued expenses at December 31, 2005 and June 30, 2005 were comprised of the following (in thousands):

 

 

 

December 31,

 

June 30,

 

 

 

2005

 

2005

 

Accrued taxes

 

$

38,590

 

$

46,704

 

Accrued interest

 

11,929

 

9,289

 

Other accrued expenses

 

38,212

 

35,335

 

 

 

 

 

 

 

Total accrued expenses

 

$

88,731

 

$

91,328

 

 

18



 

9.                           Bank Loans and Long-Term Debt

 

A summary of the Company’s long-term debt and other loans at December 31, 2005 and June 30, 2005 is as follows (in thousands):

 

 

 

December 31,

 

June 30,

 

 

 

2005

 

2005

 

Convertible subordinated notes at 4.25% due in 2007 ($550,000 principal amount, plus accumulated fair value adjustment of ($11,419) and ($3,360) at December 31, 2005 and June 30, 2005, respectively)

 

$

538,581

 

$

546,640

 

Other loans and capitalized lease obligations

 

2,199

 

782

 

Debt, including current portion of long-term debt ($48 and $163 at December 31, 2005 and June 30, 2005, respectively)

 

540,780

 

547,422

 

Foreign revolving bank loans at rates from 1.38% to 3.88%

 

1,201

 

18,168

 

 

 

 

 

 

 

Total debt

 

$

541,981

 

$

565,590

 

 

In July 2000, the Company sold $550 million principal amount of 4.25 percent Convertible Subordinated Notes due 2007. The interest rate is 4.25 percent per year on the principal amount, payable in cash in arrears semi-annually on January 15 and July 15. The notes are subordinated to all of the Company’s existing and future debt. The notes are convertible into shares of the Company’s common stock at any time on or before July 15, 2007, at a conversion price of $73.935 per share, subject to certain adjustments. The Company may redeem any of the notes, in whole or in part, subject to certain call premiums on or after July 18, 2004, as specified in the notes and related indenture agreement. In December 2001 and April 2004, the Company entered into two transactions with JP Morgan Chase Bank for $412.5 million and $137.5 million in notional amounts, respectively, which had the effect to the Company of converting the interest rate to variable and requiring that the convertible notes be marked to market (see Note 4, “Derivative Financial Instruments”).

 

In November 2003, the Company entered into a three-year syndicated multi-currency revolving credit facility, led by BNP Paribas, expiring in November 2006 (the “Facility”). The Facility provides a credit line of $150 million of which up to $150 million may be used for standby letters of credit. The Facility bears interest at (i) local currency rates plus (ii) a margin between 0.75 percent and 2.0 percent for base rate advances and a margin of between 1.75 percent and 3.0 percent for euro-currency rate advances. Other advances bear interest as set forth in the credit agreement. The annual commitment fee for the Facility is subject to a leverage ratio as determined by the credit agreement and was 0.375 percent of the unused portion of the total facility at each period-end. The Company pledged as collateral shares of certain of its subsidiaries. The Facility also contains certain financial and other covenants, with which the Company was in compliance at December 31, 2005. At December 31, 2005, the Company had $1.2 million borrowings and $21.4 million letters of credit outstanding under the Facility. At June 30, 2005, the Company had $17.1 million borrowings and $16.4 million letters of credit outstanding under the Facility. Of the letters of credit outstanding, $17.0

 

19



 

million and $12.0 million were related to the interest rate swap transactions (see Note 4) at December 31, 2005 and June 30, 2005, respectively.

 

At December 31, 2005, the Company had $166.5 million in total revolving lines of credit, of which $22.6 million had been utilized, consisting of $21.4 million in letters of credit and $1.2 million in foreign revolving bank loans, which are included in the table above.

 

10.                     Impairment of Assets, Restructuring and Severance

 

During fiscal 2003 second quarter ended December 31, 2002, the Company announced its restructuring initiatives. Under these initiatives, the goal was to reposition the Company to better fit the market conditions and de-emphasize its commodity business. The Company’s restructuring plan included consolidating and closing certain manufacturing sites, upgrading equipment and processes in designated facilities and discontinuing production in a number of others that cannot support more advanced technology platforms or products within its Focus Product segments. The Company also planned to lower overhead costs across its support organizations. The Company has substantially completed these restructuring activities as of December 31, 2005. The Company expects to complete the remaining activities, primarily the closing of a fabrication line at El Segundo, California by fiscal year end 2006.

 

Total charges associated with the December 2002 initiatives are expected to be approximately $273 million. These charges will consist of approximately $218 million for asset impairment, plant closure and other charges, $6 million of raw material and work-in-process inventory, and $49 million for severance-related costs.

 

For the three months ended December 31, 2005, the Company recorded $3.1 million in total restructuring-related charges, consisting of: $2.1 million for plant closure and relocation costs and other impaired assets charges, and $1.0 million for severance costs. For the six months ended December 31, 2005, the Company recorded $7.4 million in total restructuring-related charges, consisting of: $5.1 million for plant closure and relocation costs and other impaired assets charges, and $2.3 million for severance costs. For the three months ended December 31, 2004, the Company recorded $6.8 million in total restructuring-related charges, consisting of: $5.6 million for plant closure and relocation costs and other impaired assets charges, and $1.2 million for severance costs. For the six months ended December 31, 2004, the Company recorded $13.5 million in total restructuring-related charges, consisting of: $10.5 million for plant closure and relocation costs and other impaired assets charges, and $3.0 million for severance costs.

 

Restructuring-related costs were charged as incurred in accordance with SFAS No. 146, “Accounting for the Costs Associated with Exit or Disposal Activities”. Asset impairments were calculated in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”. In determining the asset groups, the Company grouped assets at the lowest level for which independent identifiable cash flows were available. In determining whether an asset was impaired the Company evaluated undiscounted future cash flows and other factors such as changes in strategy and technology. The undiscounted cash flows from the Company’s initial

 

20



 

analyses were less than the carrying amount for certain of the asset groups, indicating impairment losses. Based on this, the Company determined the fair value of these asset groups using the present value technique, by applying a discount rate to the estimated future cash flows that was consistent with the rate used when analyzing potential acquisitions.

 

As of December 31, 2005, the Company had recorded $268.7 million in total charges, consisting of: $215.2 million for asset impairment, plant closure costs and other charges, $6.0 million for raw material and work-in-process inventory charges, and $47.5 million for severance-related costs. Components of the $215.2 million asset impairment, plant closure and other charges included the following items:

 

                  As the Company emphasizes more advanced generation planar products, it expects the future revenue stream from its less advanced facilities in Temecula, California to decrease significantly. These facilities had a net book value of $138.3 million and were written down by $77.7 million. It is expected that these facilities will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.

 

                  As the Company emphasizes more advanced generation trench products, it expects the future revenue stream from its less advanced facility in El Segundo, California to decrease significantly. This facility had a net book value of $59.5 million and was written down by $57.2 million. This facility had significantly reduced production as of fiscal year ended June 30, 2003, and is used primarily for research and development activities.

 

                  As the Company emphasizes more advanced generation Schottky products, it expects the future revenue stream from its less advanced facility in Borgaro, Italy to decrease significantly. This facility had a net book value of $20.5 million and was written down by $13.5 million. It is expected that this facility will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.

 

                  The Company restructured its manufacturing activities in Europe. Based on a review of its Swansea, Wales facility, a general-purpose module facility, the Company determined in the December 2002 quarter that this facility would be better suited to focus only on automotive applications. The general-purpose module assets at this facility, with a net book value of $13.6 million, were written down by $8.2 million. In addition, the Company has completed the move of its manufacturing activities from its automotive facility in Krefeld, Germany to its Swansea, Wales and Tijuana, Mexico facilities as of September 30, 2005. The Company has also moved the production from its Venaria, Italy facility to its Borgaro, Italy and Mumbai, India facilities, which was completed as of December 31, 2003. The Company stopped manufacturing products at its Oxted, England facility as of September 30, 2003.

 

                  The Company has eliminated the manufacturing of its non-space military products in its Santa Clara, California facility as of July 31, 2004. Currently,

 

21



 

subcontractors handle the Company’s non-space qualified products previously manufactured in this facility. The Company has also transitioned the assembly and test of non-space Power Components from its Leominster, Massachusetts facility to its Tijuana, Mexico facility as of December 31, 2005. Associated with these reductions in manufacturing activities, certain assets with a net book value of $4.0 million were written down by $2.0 million.

 

                  $56.6 million in other miscellaneous items were charged, including $47.8 million in relocation costs and other impaired asset charges and $8.8 million in contract termination and settlement costs.

 

As a result of the restructuring initiatives, certain raw material and work-in-process inventories were impaired, including products that could not be completed in other facilities, materials that were not compatible with the processes used in the alternative facilities, and materials such as gases and chemicals that could not readily be transferred. Based on these factors the Company wrote down these inventories, with a carrying value of $98.2 million, by $6.0 million. The Company had disposed of $1.1 million and $0.2 million of these inventories, for the three months ended December 31, 2005 and 2004, respectively, and $1.1 million and $0.7 million for the six months ended December 31, 2005 and 2004, respectively, which did not materially impact gross margin. As of December 31, 2005, $0.1 million of these inventories remained to be disposed.

 

As of December 31, 2005, the Company has recorded $47.5 million in severance-related charges:  $42.4 million in severance termination costs related to approximately 1,200 administrative, operating and manufacturing positions, and $5.1 million in pension termination costs at its manufacturing facility in Oxted, England. The severance charges associated with the elimination of positions, which included the persons notified to date, had been and will continue to be recognized over the future service period, as applicable, in accordance with SFAS No. 146. The Company measured the total termination benefits at the communication date based on the fair value of the liability as of the termination date. A change resulting from a revision to either the timing or the amount of estimated cash over the future service period will be measured using the credit-adjusted risk-free rate that was used to initially measure the liability. The cumulative effect of the change will be recognized as an adjustment to the liability in the period of the change.

 

During fiscal 2002, the Company had recorded an estimated $5.1 million in severance costs associated with the acquisition of TechnoFusion GmbH in Krefeld, Germany. In fiscal 2003, the Company finalized its plan and determined that total severance would be approximately $10 million, and accordingly, the Company adjusted purchased goodwill by $4.8 million. The Company communicated the plan and the elimination of approximately 250 positions primarily in manufacturing to its affected employees at that time. The Company has completed the restructuring of its Krefeld facility as of December 31, 2005, and determined that $0.7 million of the severance reserve was excess. Accordingly, the Company decreased TechnoFusion purchased goodwill by $0.7 million.

 

22



 

The following summarizes the Company’s accrued severance liability related to the June 2001 restructuring, the TechnoFusion acquisition and the December 2002 restructuring plan for the six months ended December 31, 2005 and the fiscal year ended June 30, 2005. Severance activity related to the elimination of 29 administrative and operating personnel as part of the previously reported restructuring in the fiscal quarter ended June 30, 2001, is also disclosed. The remaining June 2001 severance relates primarily to certain legal accruals associated with that restructuring, which will be paid or released as the outcome is determined (in thousands):

 

 

 

June
2001
Restructuring

 

December
2002
Restructuring

 

TechnoFusion
Severance
Liability

 

Total
Severance
Liability

 

Accrued severance, June 30, 2004

 

$

697

 

$

7,180

 

$

6,067

 

$

13,944

 

Costs incurred or charged to “impairment of assets, restructuring and severance charges”

 

 

8,677

 

 

8,677

 

Costs paid

 

(326

)

(7,810

)

(3,770

)

(11,906

)

Foreign exchange impact

 

 

77

 

(190

)

(113

)

Accrued severance, June 30, 2005

 

$

371

 

$

8,124

 

$

2,107

 

$

10,602

 

Costs incurred or charged to “impairment of assets, restructuring and severance”

 

 

2,245

 

 

2,245

 

Purchase price adjustment

 

 

 

(708

)

(708

)

Costs paid

 

(90

)

(3,858

)

(684

)

(4,632

)

Foreign exchange impact

 

 

(14

)

(40

)

(54

)

Accrued severance, December 31, 2005

 

$

281

 

$

6,497

 

$

675

 

$

7,453

 

 

11.                     Segment and Geographic Information

 

Revenue for the three and six months ended December 31, 2005 and 2004, by the three broad product categories, are as follows (in thousands):

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Power Management ICs and Advanced Circuit Devices

 

$

198,892

 

$

164,488

 

$

374,037

 

$

331,064

 

Power Components

 

43,018

 

90,137

 

98,106

 

192,929

 

Power Systems

 

26,827

 

33,398

 

58,726

 

66,236

 

Total product revenue

 

268,737

 

288,023

 

530,869

 

590,229

 

Intellectual Property

 

10,074

 

10,537

 

20,514

 

20,556

 

Total consolidated revenue

 

$

278,811

 

$

298,560

 

$

551,383

 

$

610,785

 

 

23



 

Segment results for the three months ended December 31, 2005 and 2004, are as follows (in thousands except percentages):

 

 

 

December 31,
2005

 

December 31,
2004

 

Business Segment

 

Revenue

 

Gross
Profit

 

Revenue

 

Gross
Profit

 

Computing and Communications

 

$

95,178

 

41.5

%

$

101,843

 

44.7

%

Energy-Saving Products

 

75,577

 

47.9

 

74,210

 

55.3

 

Aerospace and Defense

 

34,400

 

50.0

 

32,183

 

42.6

 

Intellectual Property

 

10,074

 

100.0

 

10,537

 

100.0

 

Subtotal Focus Products

 

215,229

 

47.8

 

218,773

 

50.7

 

 

 

 

 

 

 

 

 

 

 

Commodity Products

 

39,542

 

16.6

 

52,482

 

26.6

 

Non-Aligned Products

 

24,040

 

8.5

 

27,305

 

16.9

 

Subtotal Non-Focus Products

 

63,582

 

13.5

 

79,787

 

23.3

 

Consolidated total

 

$

278,811

 

40.0

%

$

298,560

 

43.3

%

 

Segment results for the six months ended December 31, 2005 and 2004, are as follows (in thousands except percentages):

 

 

 

December 31,
2005

 

December 31,
2004

 

Business Segment

 

Revenue

 

Gross
Profit

 

Revenue

 

Gross
Profit

 

Computing and Communications

 

$

184,818

 

41.6

%

$

207,835

 

44.2

%

Energy-Saving Products

 

147,963

 

50.1

 

147,360

 

54.5

 

Aerospace and Defense

 

63,801

 

47.1

 

64,460

 

41.9

 

Intellectual Property

 

20,514

 

100.0

 

20,556

 

100.0

 

Subtotal Focus Products

 

417,096

 

48.3

 

440,211

 

49.9

 

 

 

 

 

 

 

 

 

 

 

Commodity Products

 

81,693

 

18.0

 

112,006

 

28.9

 

Non-Aligned Products

 

52,594

 

11.8

 

58,568

 

18.3

 

Subtotal Non-Focus Products

 

134,287

 

15.6

 

170,574

 

25.3

 

Consolidated total

 

$

551,383

 

40.3

%

$

610,785

 

43.0

%

 

Product revenue from unaffiliated customers is based on the location in which the sale originated. The Company includes in long-lived assets all long-term assets excluding long-term cash investments, long-term deferred income taxes, goodwill and acquisition-related intangibles.

 

24



 

Geographic information for the Company on an aggregate basis, for the three months ended December 31, 2005 and 2004, is presented below (in thousands):

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

73,748

 

$

89,900

 

$

148,357

 

$

181,877

 

Asia

 

136,416

 

132,267

 

266,045

 

272,954

 

Europe

 

58,573

 

65,856

 

116,467

 

135,398

 

 

 

 

 

 

 

 

 

 

 

Total product revenue

 

268,737

 

288,023

 

530,869

 

590,229

 

Unallocated royalties

 

10,074

 

10,537

 

20,514

 

20,556

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

278,811

 

$

298,560

 

$

551,383

 

$

610,785

 

 

 

 

December 31,
2005

 

June 30,
2005

 

Long-Lived Assets

 

 

 

 

 

North America, primarily United States

 

$

369,555

 

$

347,892

 

Asia

 

32,269

 

23,598

 

Europe

 

236,568

 

223,124

 

 

 

 

 

 

 

Total

 

$

638,392

 

$

594,614

 

 

No single original equipment manufacturer (“OEM”), customer, distributor or subcontract manufacturer accounted for more than ten percent of the Company’s consolidated revenue for the three and six months ended December 31, 2005 and 2004. No customer accounted for more than ten percent of the Company’s accounts receivable at December 31, 2005 and June 30, 2005.

 

For its Focus Product segments as a whole, the Company primarily sells direct to OEM customers. However, in the Computing and Communications segment, two distributors, individually accounting for greater than ten percent of segment revenue, accounted for approximately 27 percent and 29 percent of revenue for the three and six months ended December 31, 2005, respectively. In the Aerospace and Defense segment, one distributor accounted for approximately 13 percent of revenue for the three and six months ended December 31, 2005. No single OEM customer, distributor or subcontract manufacturer accounted for more than ten percent of the Company’s other Focus Product segment revenues for the three or six months ended December 31, 2005.

 

In the Commodity Product segment, one distributor accounted for approximately 12 percent and 14 percent of revenue for the three and six months ended December 31, 2005, respectively. In the Non-Aligned Product segment, two OEM customers and one distributor, individually accounting for greater than ten percent of segment revenue, accounted for approximately 45 percent and 44 percent of revenue for the three and six months ended December 31, 2005, respectively.

 

25



 

12.                     Stock-Based Compensation

 

For the three and six months ended December 31, 2005, equity-based compensation awards were granted under one of two stock option plans:  the 1997 Employee Stock Incentive Plan (“1997 Plan”) and the 2000 Incentive Plan (“2000 Plan”). Options granted before November 22, 2004, generally became exercisable in annual installments of 25 percent beginning on the first anniversary date, and expire after seven years. Options granted after November 22, 2004, generally became exercisable in annual installments of 33 percent beginning on the first anniversary date, and expire after five years.

 

Under the 1997 Plan, options to purchase shares of the Company’s common stock may be granted to the Company’s employees and consultants. In addition, other stock-based awards (e.g., restricted stock units (“RSUs”), SARs and performance shares) may be granted. During the three and six months ended December 31, 2005 and 2004, non-qualified options and RSUs were issued under the 1997 Plan. As noted below, on November 22, 2004, the Company’s stockholders approved an amendment to the 2000 Plan to increase the authorized number of shares from 7,500,000 to 12,000,000, at which point no awards may be granted under the 1997 Plan.

 

Under the 2000 Plan, options to purchase shares of the Company’s common stock and other stock-based awards may be granted to the Company’s employees, consultants, officers and directors. The terms of the 2000 Plan were substantially similar to those under the 1997 Plan. On November 22, 2004, the Company’s shareholders approved an amendment to the 2000 Plan which increased the authorized number of shares to be granted from 7,500,000 to 12,000,000. The amendment changed the options expiration term on future grants to five years, and contained certain limitations on the maximum number of shares that may be awarded to an individual. No awards may be granted under the 2000 Plan after August 24, 2014. As of December 31, 2005, there were 4,124,348 shares available for future grants.

 

The following table summarizes the stock option activities for the six months ended December 31, 2005 (in thousands except per share price data):

 

 

 

Shares

 

Weighted
Average
Option
Exercise
Price Per
Share

 

Weighted
Average
Grant Date
Fair
Value Per
Share

 

Aggregate
Intrinsic
Value

 

Outstanding, June 30, 2005

 

13,558

 

$

38.01

 

 

$

149,290

 

Granted

 

627

 

$

47.19

 

$

13.02

 

 

Exercised

 

(1,046

)

$

23.43

 

 

$

23,142

 

Expired or canceled

 

(242

)

$

44.02

 

 

 

Outstanding, December 31, 2005

 

12,897

 

$

39.51

 

 

$

34,503

 

 

26



 

The following table summarizes the RSU activities for the six months ended December 31, 2005 (in thousands except per share price data):

 

 

 

Shares

 

Weighted
Average
Grant Date
Fair
Value Per
Share

 

Outstanding, June 30, 2005

 

24

 

 

Granted

 

6

 

$

48.10

 

 

 

 

 

 

 

Outstanding, December 31, 2005

 

30

 

 

 

The following table summarizes the non-vested stock option and RSU activities for the six months ended December 31, 2005 (in thousands):

 

 

 

Stock
Options

 

Restricted
Stock Units

 

Non-vested shares, June 30, 2005

 

137

 

24

 

Granted

 

627

 

6

 

 

 

 

 

 

 

Non-vested shares, December 31, 2005

 

764

 

30

 

 

The following table summarizes the stock options and RSUs outstanding at December 31, 2005, and related weighted average price and life information (in thousands except year and price data):

 

 

 

December 31, 2005

 

 

 

Outstanding

 

Exercisable

 

Range of Exercise
Price per Share

 

Number
Outstanding

 

Weighted
Average
Remaining
Life (Years)

 

Weighted
Average
Exercise
Price

 

Number
Exercisable

 

Weighted
Average
Exercise
Price

 

 

 

 

 

 

 

 

 

 

 

 

 

  $0.00 to $15.38

 

484

 

3.19

 

$

11.09

 

454

 

$

11.82

 

$15.62 to $25.35

 

1,976

 

3.47

 

$

20.62

 

1,975

 

$

20.62

 

$26.00 to $35.90

 

1,512

 

5.43

 

$

33.93

 

1,474

 

$

33.92

 

$36.39 to $45.87

 

6,475

 

4.40

 

$

42.77

 

6,457

 

$

42.77

 

$46.50 to $54.69

 

1,512

 

4.60

 

$

50.53

 

811

 

$

52.44

 

$55.31 to $63.88

 

968

 

4.91

 

$

61.99

 

968

 

$

61.99

 

 

 

12,927

 

4.39

 

$

39.51

 

12,139

 

$

39.11

 

 

Additional information relating to the stock option plans, including employee stock options and RSUs, at December 31, 2005 and June 30, 2005 is as follows (in thousands):

 

 

 

December 31,
2005

 

June 30,
2005

 

 

 

 

 

 

 

Options exercisable

 

12,139

 

13,422

 

Options available for grant

 

4,124

 

4,632

 

Total reserved common stock shares for stock option plans

 

17,052

 

18,214

 

 

27



 

Beginning in the fiscal year 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”) on a modified prospective transition method to account for its employee stock options. Under the modified prospective transition method, fair value of new and previously granted but unvested equity awards are recognized as compensation expense in the income statement, and prior period results are not restated. As a result of the adoption, for the three months ended December 31, 2005, the Company’s income from continuing operations, which is the same as income before income taxes, decreased by $0.8 million, net income was decreased by $0.6 million, and basic and diluted earnings per share were negatively impacted by $0.01. For the six months ended December 31, 2005, the Company’s income from continuing operations decreased by $1.2 million, net income was decreased by $0.8 million, and basic and diluted earnings per share were negatively impacted by $0.01. In addition, cash flows from operating and financing activities decreased and increased, respectively, by $4.3 million for the six months ended December 31, 2005, reflecting the proper classification of the excess tax benefits from options exercised from an operating to a financing activity (see Note 1, “Certain Accounting Policies”).

 

The adoption of SFAS No. 123(R) did not affect the stock-based compensation associated with the Company’s RSUs, which were already based on the market price of the stock at date of grant and recognized over the service period. Stock-compensation expense attributable to the RSUs were $0.1 million and $0.2 million for the three months ended December 31, 2005 and 2004, respectively, and $0.2 million and $0.4 million for the six months ended December 31, 2005 and 2004, respectively.

 

For the three and six months ended December 31, 2005, stock-based compensation expense associated with the Company’s stock options and restricted stock units recognized in the income statement is as follows (in thousands):

 

 

 

December 31, 2005

 

 

 

Three Months
Ended

 

Six Months
Ended

 

Selling and administrative expense

 

$

619

 

$

938

 

Research and development expense

 

231

 

365

 

Cost of sales

 

61

 

99

 

 

 

 

 

 

 

Total stock-based compensation expense

 

$

911

 

$

1,402

 

 

 

For the three and six months ended December 31, 2004, stock-based compensation expense associated with the Company’s restricted stock units recognized in the income statement is as follows (in thousands):

 

 

 

December 31, 2004

 

 

 

Three Months
Ended

 

Six Months
Ended

 

 

 

 

 

 

 

Selling and administrative expense

 

$

124

 

$

207

 

Research and development expense

 

105

 

175

 

Cost of sales

 

17

 

28

 

 

 

 

 

 

 

Total stock-based compensation expense

 

$

246

 

$

410

 

 

28



 

The total unrecognized compensation expense for outstanding stock options and RSUs was $7.5 million as of December 31, 2005, and will be recognized, in general, over three years. The weighted average number of years to recognize the compensation expense is 1.6 years. The fair value of the options associated with the above compensation expense for the three and six months ended December 31, 2005, was determined at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

 

 

December 31,
2005

 

December 31,
2004

 

 

 

 

 

 

 

Expected life

 

3.5 years

 

5.0 years

 

Risk free interest rate

 

3.9%

 

3.9%

 

Volatility

 

30.0%

 

75.0%

 

Dividend yield

 

0.0%

 

0.0%

 

 

In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB No. 107”) that provided the Staff’s views regarding valuation of share-based payment pursuant to SFAS No. 123(R). With respect to volatility, SAB No. 107 clarified that there is not a particular method of estimating volatility and to the extent that the Company has traded financial instruments from which it can derive the implied volatility, it may be appropriate to use only implied volatility in its assumptions. The Company has certain financial instruments that are publicly traded from which it can derive the implied volatility. Therefore, beginning in January 2005, the Company has used implied volatility for valuing its stock options, whereas previously, it had used historical volatility. The Company believes implied volatility is a better indicator of expected volatility because it is generally reflective of both historical volatility and expectations of how future volatility will differ from historical volatility.

 

SAB No. 107 also provided certain “simplified” method for determining expected life in valuing stock options. To the extent that an entity cannot rely on its historical exercise data to determine the expected life, SAB No. 107 has prescribed a simplified “plain-vanilla” formula. Subsequent to the 2000 Plan amendments on November 22, 2004, the Company issued stock options having five-year expiration with generally a three-year annual vesting term, whereas, prior to then, the Company granted stock options having seven or ten-year expiration with generally a four or five-year annual vesting term. Therefore, beginning in January 2005, the Company has applied SAB No. 107 “plain-vanilla” method for determining the expected life, whereas previously, it had used historical exercise data to determine the expected life.

 

29



 

Had the Company accounted for stock-based compensation plans using the fair value based accounting method described by SFAS No. 123 for the periods prior to fiscal year 2006, the Company’s diluted net income per common share–basic and diluted for the three and six months ended December 31, 2004, would have approximated the following (in thousands except per share data):

 

 

 

December 31, 2004

 

 

 

Three Months
Ended

 

Six Months
Ended

 

 

 

 

 

 

 

Net income

 

$

39,514

 

$

77,094

 

Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax

 

(12,796

)

(26,039

)

Pro forma net income

 

$

26,718

 

$

51,055

 

 

 

 

 

 

 

Net income per common share–basic, as reported

 

$

0.59

 

$

1.16

 

Net income per common share–basic, pro forma

 

$

0.40

 

$

0.77

 

 

 

 

 

 

 

Net income per common share–diluted, as reported

 

$

0.55

 

$

1.07

 

Net income per common share–diluted, pro forma

 

$

0.38

 

$

0.73

 

 

On April 17, 2005, the Company accelerated the vesting of all then outstanding equity awards, including employee stock options and restricted stock units, primarily to avoid recognizing in its income statement approximately $108 million in associated compensation expense in future periods, of which approximately $60 million would have been recognized in fiscal year 2006 upon the adoption of SFAS No. 123(R). As a result of the accelerated vesting, the Company recorded $6.0 million in non-cash compensation charge in the fourth quarter of fiscal year 2005, of which $3.9 million is related to the excess of the intrinsic value over the fair market value of the Company’s stock on the acceleration date of those options that would have been forfeited or expired unexercised had the vesting not been accelerated, and $2.1 million is related to the recognition of outstanding RSUs, including $0.3 million for the excess of the intrinsic value over the fair market value of the Company’s stock on the acceleration date.  In determining the forfeiture rates of the stock options, the Company reviewed the unvested options’ original life, time remaining to vest and whether these options were held by officers and directors of the Company.  The compensation charge is adjusted in future period financial results as actual forfeitures are realized. For the three and six months ended December 31, 2005, there were no material changes in actual forfeitures from estimates.

 

13.       Environmental Matters

 

Federal, state, foreign and local laws and regulations impose various restrictions and controls on the storage, use and discharge of certain materials, chemicals and gases used in semiconductor manufacturing processes. The Company does not believe that compliance with such laws and regulations as now in effect will have a material adverse effect on the Company’s results of operations, financial position or cash flows.

 

30



 

However, under some of these laws and regulations, the Company could be held financially responsible for remedial measures if properties are contaminated or if waste is sent to a landfill or recycling facility that becomes contaminated. Also, the Company may be subject to common law claims if it releases substances that damage or harm third parties. The Company cannot make assurances that changes in environmental laws and regulations will not require additional investments in capital equipment and the implementation of additional compliance programs in the future, which could have a material adverse effect on the Company’s results of operations, financial position or cash flows, as could any failure by the Company to comply with environmental laws and regulations.

 

The Company and Rachelle Laboratories, Inc. (“Rachelle”), a former operating subsidiary of the Company that discontinued operations in 1986, were each named a potentially responsible party (“PRP”) in connection with the investigation by the United States Environmental Protection Agency (“EPA”) of the disposal of allegedly hazardous substances at a major superfund site in Monterey Park, California (“OII Site”). Certain PRPs who settled certain claims with the EPA under consent decrees filed suit in Federal Court in May 1992 against a number of other PRPs, including the Company, for cost recovery and contribution under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”). IR has settled all outstanding claims that have arisen against it out of the OII Site. No claims against Rachelle have been settled. The Company has taken the position that none of the wastes generated by Rachelle were hazardous.

 

Counsel for Rachelle received a letter dated August 2001 from the U.S. Department of Justice, directed to all or substantially all PRPs for the OII Site, offering to settle claims against such parties for all work performed through and including the final remedy for the OII Site. The offer required a payment from Rachelle in the amount of approximately $9.3 million in order to take advantage of the settlement. Rachelle did not accept the offer.

 

In as much as Rachelle has not accepted the settlement, the Company cannot predict whether the EPA or others would attempt to assert an action for contribution or reimbursement for monies expended to perform remedial actions at the OII Site. The Company cannot predict the likelihood that the EPA or such others would prevail against Rachelle in any such action. It remains the position of Rachelle that its wastes were not hazardous. The Company’s insurer has not accepted liability, although it has made payments for defense costs for the lawsuit against the Company. The Company has made no accrual for potential loss, if any; however, an adverse outcome could have a material adverse effect on the Company’s results of operations and cash flows.

 

The Company received a letter in June 2001 from a law firm representing UDT Sensors, Inc. relating to environmental contamination (chlorinated solvents such as trichlorethene) assertedly found in UDT’s properties in Hawthorne, California. The letter alleges that the Company operated a manufacturing business at that location in the 1970’s and/or 1980’s and that it may have liability in connection with the claimed contamination. The Company has made no accrual for any potential losses since there has been no assertion of specific facts on which to form the basis for determination of liability.

 

31



 

14.       Litigation

 

In June 2000, the Company filed suit in Federal District Court in Los Angeles, California against IXYS Corporation, alleging infringement of its key U.S. patents 4,959,699; 5,008,725 and 5,130,767. The suit sought damages and other relief customary in such matters. The Federal District Court entered a permanent injunction, effective on June 5, 2002, barring IXYS from making, using, offering to sell or selling in, or importing into the United States, MOSFETs (including IGBTs) covered by the Company’s U.S. patents 4,959,699; 5,008,725 and/or 5,130,767. In August 2002, the Court of Appeals for the Federal Circuit stayed that injunction, pending appeal on the merits. In that same year, following trial on damages issues, a Federal District Court jury awarded the Company $9.1 million in compensatory damages. The Federal District Court subsequently tripled the damages, increasing the award from $9.1 million to approximately $27.2 million, and ruled that the Company is entitled to an additional award of reasonable attorney’s fees for a total monetary judgment of about $29.5 million. In March 2004, the U.S. Court of Appeals for the Federal Circuit reversed the summary judgment granted the Company by the Federal District Court in Los Angeles of infringement by IXYS of the Company’s U.S. patents 4,959,699; 5,008,725 and 5,130,767. The Federal Circuit reversed in part and vacated in part infringement findings of the District Court, granted IXYS the right to present certain affirmative defenses, and vacated the injunction against IXYS entered by the District Court. The ruling by the Federal Circuit had the effect of vacating the damages judgment obtained against IXYS. The Federal Circuit affirmed the District Court’s rulings in the Company’s favor regarding the validity and enforceability of the three Company patents. Following remand, a federal court jury in Los Angeles, California held on September 15, 2005, that IXYS elongated octagonal MOSFETs and IGBTs infringed the Company’s 4,959,699 patent but did not infringe the Company’s 5,008,725 and 5,130,767 patents. On October 6, 2005 the jury awarded the Company $6.2 million in damages. Further proceedings are required in the trial court before final judgment can be entered. The Company anticipates that IXYS will appeal the judgment. No amount has been recognized in the income statement from the pending litigation for the three and six months ended December 31, 2005.

 

15.       Income Taxes

 

The Company’s effective tax provision for the three months ended December 31, 2005 and 2004 was 27.5 percent and 22.8 percent, respectively, and 27.5 percent and 25.2 percent for the six months ended December 31, 2005 and 2004, respectively, rather than the U.S. federal statutory tax provision of 35 percent as a result of lower statutory tax rates in certain foreign jurisdictions, the benefit of foreign tax credits and research and development credits, partially offset by state taxes and certain foreign losses without foreign tax benefit.

 

In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004”, which introduces a limited time 85 percent dividends received deduction on the repatriation of certain foreign earnings to a U.S. tax payer (“repatriation provision”), provided certain criteria are met. The Company

 

32



 

is currently evaluating the range of possible amounts of unremitted earnings that may be repatriated as a result of the repatriation provision; the related range of income tax effects of such repatriation cannot be reasonably estimated at this time.

 

16.                     Related Party Transactions

 

As discussed in Note 3, the Company holds as strategic investment common stock of Nihon Inter Electronics Corporation (“Nihon”), a related party. At December 31, 2005 and June 30, 2005, the Company owned approximately 17.5 percent of the outstanding shares of Nihon. As previously reported, the Company’s Chief Financial Officer was the Chairman of the Board of Nihon until June 28, 2005. In addition, two managers of the Company’s Japan subsidiary are directors of Nihon. Although the Company has two positions on the Board of Directors of Nihon as of December 31, 2005, it does not exercise significant influence, and accordingly, the Company records its interest in Nihon based on readily determinable market values in accordance with SFAS No. 115 (see Note 3, “Cash and Investments”).

 

17.       Stock Repurchase Program

 

On November 1, 2005, the Company’s Board of Directors authorized and the Company announced a stock repurchase program, under which up to $100 million of the Company’s common shares may be repurchased without prior notice, through block trades or otherwise. The Company intends that any shares repurchased will be held as treasury shares that may be used for general corporate purposes. From the date of the repurchase through the following thirty days, no amounts under the Company’s $150 million credit facility will be available. Shares repurchased will be paid with the Company’s existing cash and cash investments. As of December 31, 2005, no shares had been repurchased under the program.

 

33



 

ITEM 2.                                     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and notes to consolidated financial statements included elsewhere in this Form 10-Q. Except for historic information contained herein, the matters addressed in this Item 2 constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements may be identified by the use of terms such as “anticipate,” “believe,” “expect,” “intend,” “project,” “will,” and similar expressions. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed under the heading “Statement of Caution Under the Private Securities Litigation Reform Act of 1995” and elsewhere in this Quarterly Report on Form 10-Q, that could cause actual results to differ materially from those anticipated by the Company. We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes.

 

Restatement of Statement of Cash Flows

 

As discussed in Note 1 of Notes to the unaudited consolidated financial statements, we have corrected the classification of the excess tax benefits generated from options exercised of $4.3 million for the six months ended December 31, 2005 to present the tax benefits from options exercised as cash flows from financing activities rather than operating activities in our consolidated statement of cash flows, as required by Statement of Financial Accounting Standards No. 123(R), “Shared-Based Payment,” which we adopted as of the beginning of our fiscal year 2006 in July 2005. The correction had no impact on our overall net change in cash and cash equivalents, the unaudited consolidated statements of income, the unaudited consolidated statements of comprehensive income, or the unaudited consolidated balance sheet for any of the periods presented.

 

Overview of Results of Operations for the Three Months Ended December 31, 2005

 

We report our results in six segments: Computing and Communications (“C&C”), Energy-Saving Products (“ESP”), Aerospace and Defense (“A&D”), Intellectual Property (“IP”), Commodity Products (“CP”) and Non-Aligned Products (“NAP”). We include our C&C, ESP, A&D and IP segments in our Focus Product group, and our CP and NAP segments in our Non-Focus Product group.

 

For the three months ended December 31, 2005, consolidated revenue was $278.8 million, compared to $298.6 million for the prior year three months ended December 31, 2004. Focus Product revenue was $215.2 million (77.2 percent of revenue) for the three months ended December 31, 2005, compared to $218.8 million (73.3 percent of revenue) for the three months ended December 31, 2004. Non-Focus Product revenue was $63.6 million (22.8 percent of revenue) for the three months ended December 31, 2005, compared to $79.8 million (26.7 percent of revenue) for the three months ended December 31, 2004. Current period revenues were adversely affected by price pressure on certain of our Power Components and capacity constraints in our C&C segment. Capacity utilization was above 95 percent for the three months ended December 31, 2005.

 

Revenue as a percentage of total product revenue based on sales location were approximately 27 percent, 51 percent and 22 percent for United States, Asia and Europe, respectively, for the three months ended December 31, 2005, and 31 percent,

 

34



 

46 percent and 23 percent for United States, Asia and Europe, respectively, for the three months ended December 31, 2004.

 

For the three months ended December 31, 2005, gross profit margin was 40.0 percent, compared to 43.3 percent for the prior year three months ended December 31, 2004. Gross profit margin for our Focus Products was 47.8 percent for the three months ended December 31, 2005, compared to 50.7 percent for the three months ended December 31, 2004. Gross profit margin for our Non-Focus Products was 13.5 percent for the three months ended December 31, 2005, compared to 23.3 percent for the three months ended December 31, 2004. The gross profit margin decline across our Focus and Non-Focus Products reflected primarily price declines on certain of our Power Components, sale of a lower-margin product mix, and profit sharing and employee stock option expense. We expect our overall Company gross margin for the three months ended March 31, 2006 to be flat, plus or minus one percentage point, compared to the three months ended December 31, 2005, tempered by costs associated with the ramp of our Newport, Wales facility.

 

Inventory increased by $15.3 million for the three months ended December 31, 2005 from September 30, 2005, of which $13.1 million was work-in-process and raw material inventory. The increase in work-in-process and raw material inventory positions us to better support our growing backlog. Orders for the three months ended December 31, 2005, increased by 17 percent from the immediately preceding three months ended September 30, 2005, reflecting end-market demand for servers, appliances, digital TVs and game stations.

 

In the March 2006 quarter, for our Focus Product segments, we expect C&C revenue to reflect end-market demand for servers, dual-core notebook platforms and new consumer programs including game stations. In the ESP segment, we expect end-market demand for energy-efficient appliances to be strong with the start of the new model year. In our A&D segment, we expect an increase in A&D revenue mainly due to seasonal increases in demand for certain military programs. For our Non-Focus Product segments, we continue to manage our exposure to Commodity Products and review our Non-Aligned Products. We have announced that we plan to enter into agreements for the Non-Aligned Product divestitures by the end of the June 2006 quarter.

 

As of December 31, 2005, we have substantially completed our restructuring activities previously announced in 2002 and 2003. We expect to complete the remaining activities, primarily the closing of a fabrication line at El Segundo, California by fiscal year end 2006. For the three months ended December 31, 2005, we recorded $3.1 million in total restructuring-related charges, consisting of: $2.1 million for asset impairment, plant closure costs and other charges and $1.0 million for severance-related costs. We estimate that total charges associated with the restructuring will be approximately $273 million. These charges will consist of approximately $218 million for asset impairment, plant closure costs and other charges, $6 million of raw material and work-in-process inventory, and approximately $49 million for severance-related charges. Of the $273 million in total charges, we expect cash charges to be approximately $110 million. As of December 31, 2005, we have realized annualized savings of approximately $80 million from the restructuring activities, with approximately 70 percent of that savings affecting cost of goods sold.

 

35



 

During the three months ended December 31, 2005, we spent $39.0 million in capital expenditures, of which $13.2 million was at the Newport, Wales’s facility. We began production at this facility during the quarter ended December 31, 2005.

 

We adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”) that became effective for us in the fiscal first quarter ended September 30, 2005. SFAS No. 123(R) required that we recognize the fair value of equity awards granted to our employees as compensation expense in the income statement over the requisite service period. For the three months ended December 31, 2005, we recognized $0.8 million in stock-based compensation expense associated with employee stock options as a result of the adoption of SFAS No. 123(R), which lowered our basic and diluted earnings per share by $0.01.

 

During the three months ended December 31, 2005, operating activities generated cash flows of $38.6 million. Cash flows from operating activities decreased by $0.2 million for the three months ended December 31, 2005, reflecting the proper classification of the excess tax benefits from options exercised from an operating to a financing activity (see Note 1, “Certain Accounting Policies”). Our cash, cash equivalents and cash investments totaled $918.4 million at December 31, 2005. Additionally, we have $143.9 million in unused credit facilities.

 

Our $550 million convertible subordinated notes are due in July 2007. We anticipate that these notes will be refinanced through public or private offerings of debt or equity, or be paid down with our existing cash and cash investments.

 

On November 1, 2005, our Board of Directors authorized and we announced a stock repurchase program, under which up to $100 million of our common shares may be repurchased without prior notice, through block trades or otherwise. We intend that any shares repurchased will be held as treasury shares that may be used for general corporate purposes. As of December 31, 2005, no shares had been repurchased under the program.

 

36



 

Results of Operations for the Three and Six Months Ended December 31, 2005 Compared with the Three and Six Months Ended December 31, 2004

 

The following table sets forth certain items as a percentage of revenue (in millions except percentages):

 

 

 

Three Months Ended
December 31,

 

Six Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

Revenue

 

$

278.8

 

100.0

%

$

298.6

 

100.0

%

$

551.4

 

100.0

%

$

610.8

 

100.0

%

Cost of sales

 

167.2

 

60.0

 

169.2

 

56.7

 

328.9

 

59.7

 

348.0

 

57.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

111.6

 

40.0

 

129.4

 

43.3

 

222.5

 

40.3

 

262.8

 

43.0

 

Selling and administrative expense

 

46.1

 

16.5

 

40.9

 

13.7

 

91.3

 

16.6

 

87.3

 

14.3

 

Research and development expense

 

27.2

 

9.8

 

27.7

 

9.3

 

52.5

 

9.5

 

53.0

 

8.7

 

Amortization of acquisition-related intangible assets

 

1.4

 

0.5

 

1.5

 

0.5

 

2.8

 

0.5

 

2.9

 

0.4

 

Impairment of assets, restructuring and severance charges

 

3.1

 

1.1

 

6.8

 

2.3

 

7.4

 

1.3

 

13.5

 

2.2

 

Other expense, net

 

1.1

 

0.4

 

0.7

 

0.2

 

1.2

 

0.2

 

0.7

 

0.1

 

Interest (income) expense, net

 

(0.8

)

(0.3

)

0.6

 

0.2

 

(2.4

)

(0.4

)

2.4

 

0.4

 

Income before income taxes

 

33.5

 

12.0

 

51.2

 

17.1

 

69.7

 

12.6

 

103.0

 

16.9

 

Provision for income taxes

 

9.2

 

3.3

 

11.7

 

3.9

 

19.2

 

3.5

 

25.9

 

4.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

24.3

 

8.7

%

$

39.5

 

13.2

%

$

50.5

 

9.1

%

$

77.1

 

12.6

%

 

Revenue and Gross Margin

 

For the three months ended December 31, 2005, consolidated revenue decreased by 6.6 percent from the prior year three months ended December 31, 2004. For the six months ended December 31, 2005, consolidated revenue decreased by 9.7 percent from the prior year three months ended December 31, 2004. Revenue for the three and six months ended December 31, 2005 was lower than the prior year, primarily due to the combination of price pressure on certain of our Power Components and capacity constraints in our Computing and Communications segment. Capacity utilization remained above 95 percent for the three months ended December 31, 2005.

 

Gross profit margin was 40.0 percent and 40.3 percent for the three and six months ended December 31, 2005, respectively, compared to 43.3 percent and 43.0 percent for the three and six months ended December 31, 2004, respectively. The gross profit margin decline reflected primarily price pressure on certain of our Power Components, sale of a lower-margin product mix, and profit sharing and employee stock option expense. In general, our wafer manufacturing facilities serve all business units as necessary and their operating costs are reflected in the segments’ cost of revenue on the basis of product cost. Manufacturing overhead and variances are specifically

 

37



 

allocated to the segments as appropriate, and general overhead are allocated based on the percentage of total revenue.

 

Revenue as a percentage of total product revenue based on sales location were approximately 27 percent, 51 percent and 22 percent for United States, Asia and Europe, respectively, for the three months ended December 31, 2005, and 28 percent, 50 percent and 22 percent for United States, Asia and Europe, respectively, for the six months ended December 31, 2005. Revenue as a percentage of total product revenue based on sales location were approximately 31 percent, 46 percent and 23 percent for United States, Asia and Europe, respectively, for the three months ended December 31, 2004, and 31 percent, 46 percent and 23 percent for United States, Asia and Europe, respectively, for the six months ended December 31, 2004.

 

Focus Product revenue for the three months ended December 31, 2005 was $215.2 million (77.2 percent of revenue), compared to $218.8 million (73.3 percent of revenue) for the three months ended December 31, 2004. Focus Product revenue for the six months ended December 31, 2005 was $417.1 million (75.6 percent of revenue), compared to $440.2 million (72.1 percent of revenue) for the six months ended December 31, 2004. Non-Focus Product revenue for the three months ended December 31, 2005 was $63.6 million (22.8 percent of revenue), compared to $79.8 million (26.7 percent of revenue) for the three months ended December 31, 2004. Non-Focus Product revenue for the six months ended December 31, 2005 was $134.3 million (24.4 percent of revenue), compared to $170.6 million (27.9 percent of revenue) for the six months ended December 31, 2004. Current period revenues were adversely affected by price pressure on certain of our Power Components and capacity constraints in our C&C segment.

 

Gross profit margin for our Focus Products was 47.8 percent for the three months ended December 31, 2005, compared to 50.7 percent for the three months ended December 31, 2004. Gross profit margin for our Non-Focus Products was 13.5 percent for the three months ended December 31, 2005, compared to 23.3 percent for the three months ended December 31, 2004. The gross profit margin decline across our Focus and Non-Focus Products reflected primarily price declines on certain of our Power Components, sale of a lower-margin product mix, and profit sharing and employee stock option expense.

 

Total inventory increased by $15.3 million for the three months ended December 31, 2005 from September 30, 2005, of which $13.1 million was work-in-process and raw material inventory. The increase in work-in-process and raw material inventory positions us to better support our growing backlog. Orders for the three months ended December 31, 2005, increased by 17 percent from the prior three months ended September 30, 2005, reflecting end-market demand for servers, appliances, digital TVs and game stations.

 

38



 

Revenue and gross margin by business segments for the three and six months ended December 31, 2005, are as follows (in thousands except percentages):

 

 

 

Three Months Ended

 

 

 

December 31, 2005

 

December 31, 2004

 

Business Segment

 

Revenue

 

Percentage
of Total
Revenue

 

Gross
Margin

 

Revenue

 

Percentage
of Total
Revenue

 

Gross
Margin

 

Computing and Communications

 

$

95,178

 

34.2

%

41.5

%

$

101,843

 

34.1

%

44.7

%

Energy-Saving Products

 

75,577

 

27.1

 

47.9

 

74,210

 

24.9

 

55.3

 

Aerospace and Defense

 

34,400

 

12.3

 

50.0

 

32,183

 

10.8

 

42.6

 

Intellectual Property

 

10,074

 

3.6

 

100.0

 

10,537

 

3.5

 

100.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subtotal Focus Products

 

215,229

 

77.2

 

47.8

 

218,773

 

73.3

 

50.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Products

 

39,542

 

14.2

 

16.6

 

52,482

 

17.6

 

26.6

 

Non-Aligned Products

 

24,040

 

8.6

 

8.5

 

27,305

 

9.1

 

16.9

 

Subtotal Non-Focus Products

 

63,582

 

22.8

 

13.5

 

79,787

 

26.7

 

23.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated total

 

$

278,811

 

100.0

%

40.0

%

$

298,560

 

100.0

%

43.3

%

 

 

 

Six Months Ended

 

 

 

December 31, 2005

 

December 31, 2004

 

Business Segment

 

Revenue

 

Percentage
of Total
Revenue

 

Gross
Margin

 

Revenue

 

Percentage
of Total
Revenue

 

Gross
Margin

 

Computing and Communications

 

$

184,818

 

33.5

%

41.6

%

$

207,835

 

34.0

%

44.2

%

Energy-Saving Products

 

147,963

 

26.8

 

50.1

 

147,360

 

24.1

 

54.5

 

Aerospace and Defense

 

63,801

 

11.6

 

47.1

 

64,460

 

10.6

 

41.9

 

Intellectual Property

 

20,514

 

3.7

 

100.0

 

20,556

 

3.4

 

100.0

 

Subtotal Focus Products

 

417,096

 

75.6

 

48.3

 

440,211

 

72.1

 

49.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity Products

 

81,693

 

14.8

 

18.0

 

112,007

 

18.3

 

28.9

 

Non-Aligned Products

 

52,594

 

9.6

 

11.8

 

58,568

 

9.6

 

18.3

 

Subtotal Non-Focus Products

 

134,287

 

24.4

 

15.6

 

170,575

 

27.9

 

25.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated total

 

$

551,383

 

100.0

%

40.3

%

$

610,786

 

100.0

%

43.0

%

 

Computing and Communications (“C&C”)

 

Our Computing and Communication segment is comprised of our Power Management ICs, Advanced Circuit Devices, including iPowirTM multi-chip modules and DirectFETTM solutions, and Power Components (primarily MOSFET Power Components) that address servers and high-end desktops, notebooks, communications networking, and digitally-oriented consumer products like game consoles. Our C&C products are also used in digital television, liquid crystal displays (“LCDs”), portable handheld devices and cellular phones.

 

39



 

C&C revenue for the three months ended December 31, 2005, declined by $6.7 million (6.5 percent), compared to the three months ended December 31, 2004. C&C revenue for the six months ended December 31, 2005, declined by $23.0 million (11.1 percent) compared to the six months ended December 31, 2004. The revenue decline primarily reflected price pressures on certain of our MOSFET Power Components and product mix. Additionally, C&C revenue was inhibited by capacity constraints. We started production on our new eight-inch sub-micron wafer fabrication facility in Newport, Wales in the December 2005 quarter to help address our capacity limitations.

 

Gross margin for C&C was 41.5 percent and 44.7 percent for the three months ended December 31, 2005 and 2004, respectively, and 41.6 percent and 44.2 percent for the six months ended December 31, 2005 and 2004, respectively. The gross margin decline reflected primarily profit sharing and employee stock options expense and some price declines on our MOSFET Power Components.

 

In the March 2006 quarter, we expect C&C revenue to reflect end-market demand for servers, dual-core notebook platforms and new consumer programs including game stations.

 

Energy-Saving Products (“ESP”)

 

Our Energy-Saving Product segment is comprised of our Power Management ICs, Advanced Circuit Devices and Power Components (primarily HEXFET and IGBT Power Components) that provide solutions for variable speed motion control in energy-saving appliances (such as washing machines, refrigerators and air conditioners), and industrial systems (such as fans, pumps and compressors), advanced lighting products (including fluorescent lamps, high intensity discharge (“HID”) lamps, cold cathode fluorescent (“CCFL”) tubes and light emitting diodes (“LED”) lighting), advanced automotive solutions (primarily diesel injection, electric-gasoline hybrid and electric power steering systems), and consumer applications (for example, plasma TVs and digital-audio units).

 

ESP revenue for the three months ended December 31, 2005, increased by $1.4 million (1.8 percent) compared to the three months ended December 31, 2004. ESP revenue for the six months ended December 31, 2005, increased by $0.6 million (0.4 percent) compared to the six months ended December 31, 2004. The revenue increase was primarily attributable to higher sales of our Power Management ICs, partially offset by a decline in our Power Component business.

 

Gross margin for ESP was 47.9 percent and 55.3 percent for the three months ended December 31, 2005 and 2004, respectively, and 50.1 percent and 54.5 percent for the six months ended December 31, 2005 and 2004, respectively. The gross margin decline primarily reflected price declines on our automotive Power Components, sale of a lower-margin product mix, and profit sharing and employee stock options expense. In addition, gross margin was impacted by the cost associated with the ramp of our Newport, Wales facility.

 

In the March 2006 quarter, we expect end-market demand for energy-efficient appliances to be strong with the start of the new model year.

 

40



 

Aerospace and Defense (“A&D”)

 

The Aerospace and Defense segment is comprised of advanced power management solutions, such as radiation-hardened power management modules, radiation-hardened Power Components, and other high-reliability Power Components that address power management requirements in satellites, launch vehicles, aircrafts, ships, submarines and other defense and high-reliability applications.

 

A&D revenue for the three months ended December 31, 2005, increased by $2.2 million (6.9 percent) from the three months ended December 31, 2004. Revenue for the six months ended December 31, 2005, declined by $0.7 million (1.0 percent) from the six months ended December 31, 2004. The A&D revenue increase for the three months ended primarily reflected a delayed shipment from the prior September 2005 quarter.

 

Gross margin for the A&D segment increased to 50.0 percent for the three months ended December 31, 2005, from 42.6 percent in the three months ended December 31, 2004, and to 47.1 percent for the six months ended December 31, 2005, from 41.9 percent for the six months ended December 31, 2004. The gross margin improvement reflected primarily sale of a higher-margin product mix, manufacturing efficiencies and restructuring cost savings, partially offset by profit sharing and employee stock option expense.

 

In the March 2006 quarter, we expect an increase in A&D revenue mainly due to seasonal increases in demand for certain military programs.

 

Intellectual Property (“IP”)

 

The Intellectual Property segment reports our royalty income from licensing our intellectual property to third parties, which may include claims settlement from successful defense of our licenses. Our licensed MOSFET patents expire between 2005 and 2010, with the broadest remaining in effect until 2007 and 2008. We continue to commit to research and development to generate new patents and other intellectual property and concentrate on incorporating our technologies into our Focus Products.

 

IP revenue was $10.1 million and $10.5 million for the three months ended December 31, 2005 and 2004, respectively, and $20.5 million and $20.6 million for the six months ended December 31, 2005 and 2004, respectively.

 

Commodity Products (“CP”)

 

The Commodity Product segment is comprised primarily of older-generation Power Components that are sold with margins generally below our strategic targets and are typically commodity in nature. These products have widespread use throughout the power management product industry and are often complementary to many of our Focus Products offerings or allow us to provide a full range of customer or application offerings. We often offer these products to take advantage of cross-selling opportunities with our other product families.

 

For the three months ended December 31, 2005, CP revenue was $39.5 million, down 24.7 percent from $52.5 million for the three months ended December 31, 2004. For the six months ended December 31, 2005, CP revenue was $81.7 million, down 27.1

 

41



 

percent from $112.0 million for the six months ended December 31, 2004. In line with our strategy, we continue to manage our exposure to Commodity Products.

 

Gross margin for CP was 16.6 percent and 26.6 percent for the three months ended December 31, 2005 and 2004, respectively, and 18.0 percent and 28.9 percent for the six months ended December 31, 2005 and 2004, respectively. The gross margin decline reflected primarily price pressures, profit sharing and employee stock option expense.

 

Non-Aligned Products (“NAP”)

 

The Non-Aligned Product segment includes businesses, product lines or products that we are targeting for realignment, whether by divestiture or otherwise. We plan to support our Non-Aligned Products to the extent we believe appropriate, to manage, maintain or increase their value. Currently, product lines reported in this segment include certain modules, rectifiers, diodes and thyristors used in the automotive, industrial, welding and motor control applications.

 

Non-Aligned Product revenue was $24.0 million in the three months ended December 31, 2005, decreasing 12.0 percent from $27.3 million in the three months ended December 31, 2004, and $52.6 million in the six months ended December 31, 2005, decreasing 10.2 percent from $58.6 million in the six months ended December 31, 2004. The revenue decline primarily reflected reduced production due in part to component shortages and product mix.

 

Gross margin for our NAP segment was 8.5 percent and 16.9 percent for the three months ended December 31, 2005 and 2004, respectively, and 11.8 percent and 18.3 percent for the six months ended December 31, 2005 and 2004, respectively, reflecting primarily sale of a lower-margin product mix.

 

Selling and Administrative Expense

 

For the three and six months ended December 31, 2005, selling and administrative expense was $46.1 million (16.5 percent of revenue) and $91.3 million (16.6 percent of revenue), compared to $40.9 million (13.7 percent of revenue) and $87.3 million (14.3 percent of revenue) for the three and six months ended December 31, 2004, respectively. Selling and administrative expense increased primarily reflecting profit sharing and employee stock options expense in the current year. In addition, we also increased spending on employee benefits, Sarbanes-Oxley Rule 404 compliance, customer, intellectual property and claims support in the current three and six months ended December 31, 2005, as compared to the comparable prior year periods. The selling and administrative expense ratio increased primarily reflecting a lower revenue base in the current year.

 

Research and Development Expenses

 

For the three and six months ended December 31, 2005, research and development expense was $27.2 million (9.8 percent of revenue) and $52.5 million (9.5 percent of revenue), respectively, compared to $27.7 million (9.3 percent of revenue) and $53.0 million (8.7 percent of revenue), for the three and six months ended December 31,

 

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2004, respectively. Research and development expense primarily reflected our continued development activities on our Focus Products.

 

Impairment of Assets, Restructuring and Severance

 

During fiscal 2003 second quarter ended December 31, 2002, we announced our restructuring initiatives. Under our restructuring initiatives, our goal was to reposition us to better fit the market conditions and de-emphasize the commodity business. Our restructuring plan included consolidating and closing certain manufacturing sites, upgrading equipment and processes in designated facilities and discontinuing production in a number of others that cannot support more advanced technology platforms or products. We also planned to lower overhead costs across our support organizations. We have substantially completed these restructuring activities as of December 31, 2005. We expect to complete the remaining activities, primarily the closing of a fabrication line at El Segundo, California by fiscal year end 2006.

 

We estimate that total charges associated with the restructuring will be approximately $273 million. These charges will consist of approximately $218 million for asset impairment, plant closure costs and other charges, $6 million of raw material and work-in-process inventory, and approximately $49 million for severance. Of the $273 million in total charges, we expect cash charges to be approximately $110 million. As of December 31, 2005, we have realized annualized savings of approximately $80 million from the restructuring activities, with approximately 70 percent of that savings affecting cost of goods sold.

 

For the three months ended December 31, 2005, we recorded $3.1 million in total restructuring-related charges, consisting of: $2.1 million for plant closure costs and relocation costs and other impaired asset charges, and $1.0 million for severance-related costs. For the six months ended December 31, 2005, we recorded $7.4 million in total restructuring related charges, consisting of: $5.1 million for plant closure and relocation costs and other impaired assets charges and $2.3 million for severance costs. For the three months ended December 31, 2004, we recorded $6.8 million in total restructuring-related charges, consisting of: $5.6 million for plant closure and relocation costs and other impaired asset charges, and $1.2 million for severance-related costs. For the six months ended December 31, 2004, we recorded $13.5 million in total restructuring-related charges consisting of: $10.5 million for plant closure and relocation costs and other impaired assets charges, and $3.0 million for severance costs.

 

Restructuring-related costs were measured in accordance with SFAS No. 146, “Accounting for the Costs Associated with Exit or Disposal Activities”. Asset impairments were calculated in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. In determining the asset groups, we grouped assets at the lowest level for which independent identifiable cash flows information was available. In determining whether an asset was impaired we evaluated undiscounted future cash flows and other factors such as changes in strategy and technology. The undiscounted cash flows from our initial analyses were less than the carrying amount for certain of the asset groups, indicating impairment losses. Based on this, we determined the fair value of these asset groups using the present value technique, by applying a discount rate to the estimated future cash flows that is consistent with the rate used when analyzing potential acquisitions.

 

43



 

As of December 31, 2005, we had recorded $268.7 million in total charges, consisting of: $215.2 million for asset impairment, plant closure costs and other charges, $6.0 million for raw material and work-in-process inventory charges, and $47.5 million for severance-related costs. Components of the $215.2 million asset impairment, plant closure and other charges included the following items:

 

                  As we emphasize more advanced generation planar products, we expect the future revenue stream from our less advanced facilities in Temecula, California to decrease significantly. These facilities had a net book value of $138.3 million and were written down by $77.7 million. It is expected that these facilities will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.

 

                  As we emphasize more advanced generation trench products, we expect the future revenue stream from our less advanced facility in El Segundo, California to decrease significantly. This facility had a net book value of $59.5 million and was written down by $57.2 million. This facility had significantly reduced production as of fiscal year ended June 30, 2003, and is being used primarily for research and development activities.

 

                  As we emphasize more advanced generation Schottky products, we expect the future revenue stream from our less advanced facility in Borgaro, Italy to decrease significantly. This facility had a net book value of $20.5 million and was written down by $13.5 million. It is expected that this facility will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.

 

                  We are restructuring our manufacturing activities in Europe. Based on a review of our Swansea, Wales facility, a general-purpose module facility, we determined in the December 2002 quarter that this facility would be better suited to focus only on automotive applications. The general-purpose assembly assets in this facility, with a net book value of $13.6 million, were written down by $8.2 million. In addition, we have completed the move of our manufacturing activities at our automotive facility in Krefeld, Germany to our Swansea, Wales and Tijuana, Mexico facilities as of September 30, 2005. We have also moved the production from our Venaria, Italy facility to our Borgaro, Italy and Mumbai, India facilities, which was completed as of December 31, 2003. We stopped manufacturing activities in our Oxted, England facility as of September 30, 2003.

 

                  We have eliminated the manufacturing of our non-space military products in our Santa Clara, California facility as of July 31, 2004. Currently, subcontractors handle our non-space qualified products formerly manufactured in this facility. We have also transitioned the assembly and test of non-space Power Components from our Leominster, Massachusetts facility to our Tijuana, Mexico facility as of December 31, 2005. Associated with this reduction in manufacturing activities, certain assets with a net book value of $4.0 million were written down by $2.0 million.

 

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                  $56.6 million in other miscellaneous items were charged, including $47.8 million in relocation costs and other impaired asset charges and $8.8 million in contract termination and settlement costs.

 

As a result of the restructuring initiatives, certain raw material and work-in-process inventories were impaired, including products that could not be completed in other facilities, materials that were not compatible with the processes used in the alternative facilities, and materials such as gases and chemicals that could not readily be transferred. Based on these factors we wrote down these inventories, with a carrying value of $98.2 million, by $6.0 million. We disposed of $1.1 million and $0.2 million of these inventories, for the three and six months ended December 31, 2005 and 2004, respectively, of these inventories, which did not materially impact gross margin. As of December 31, 2005, $0.1 million of these inventories remained to be disposed.

 

Our restructuring activities are expected to result in severance charges of approximately $49 million through June 2006. Below is a table of approximate severance charges by major activity and location:

 

Location

 

Activity

 

Amount

 

 

 

 

 

 

 

El Segundo, California

 

Close manufacturing facilities

 

$

10 million

 

Santa Clara, California and Leominster, Massachusetts

 

Eliminate certain manufacturing activities

 

4 million

 

Oxted, England

 

Close manufacturing facility

 

9 million

 

Venaria, Italy

 

Move manufacturing to India and discontinue certain products

 

11 million

 

Company-wide

 

Realign business processes

 

15 million

 

 

 

 

 

 

 

Total

 

 

 

$

49 million

 

 

To date, of the $49 million noted above, we have recorded $47.5 million in severance-related charges: $42.4 million in severance termination costs related to approximately 1,200 administrative, operating and manufacturing positions, and $5.1 million in pension termination costs at our manufacturing facility in Oxted, England. The severance charges associated with the elimination of positions, which included the 1,200 persons notified to date, had been and will continue to be recognized over the future service period, as applicable, in accordance with SFAS No. 146, “Accounting for the Costs Associated with Exit or Disposal Activities”. We measured the total termination benefits at the communication date based on the fair value of the liability as of the termination date. A change resulting from a revision to either the timing or the amount of estimated cash over the future service period will be measured using the credit-adjusted risk-free rate that was used to initially measure the liability. The cumulative effect of the change will be recognized as an adjustment to the liability in the period of the change.

 

In fiscal 2002, we had recorded an estimated $5.1 million in severance costs associated with the acquisition of TechnoFusion GmbH in Krefeld, Germany. In fiscal 2003, we finalized our plan and determined that total severance would be approximately $10 million, and accordingly, we adjusted purchased goodwill by $4.8 million. We communicated the plan and the elimination of approximately 250 positions primarily in manufacturing to our affected employees at that time. We have completed the restructuring of our Krefeld facility as of December 31, 2005, and determined that $0.7

 

45



 

million of the severance reserve was excess. Accordingly, we decreased TechnoFusion purchased goodwill by $0.7 million.

 

The following summarizes our accrued severance liability related to the June 2001 restructuring, the TechnoFusion acquisition and the December 2002 restructuring plan for the three months ended December 31, 2005 and the fiscal year ended June 30, 2005. Severance activity related to the elimination of 29 administrative and operating personnel as part of the previously reported restructuring in the fiscal quarter ended June 30, 2001, is also disclosed. The remaining June 2001 severance relates primarily to certain legal accruals associated with that restructuring, which will be paid or released as the outcome is determined (in thousands):

 

 

 

June
2001
Restructuring

 

December
2002
Restructuring

 

TechnoFusion
Severance
Liability

 

Total
Severance
Liability

 

Accrued severance, June 30, 2004

 

$

697

 

$

7,180

 

$

6,067

 

$

13,944

 

Costs incurred or charged to “impairment of assets, restructuring and severance charges”

 

 

8,677

 

 

8,677

 

Costs paid

 

(326

)

(7,810

)

(3,770

)

(11,906

)

Foreign exchange impact

 

 

77

 

(190

)

(113

)

 

 

 

 

 

 

 

 

 

 

Accrued severance, June 30, 2005

 

$

371

 

$

8,124

 

$

2,107

 

$

10,602

 

Costs incurred or charged to “impairment of assets, restructuring and severance”

 

 

2,245

 

 

2,245

 

Purchase price adjustment

 

 

 

(708

)

(708

)

Costs paid

 

(90

)

(3,858

)

(684

)

(4,632

)

Foreign exchange impact

 

 

(14

)

(40

)

(54

)

Accrued severance, December 31, 2005

 

$

281

 

$

6,497

 

$

675

 

$

7,453

 

 

Other Income and Expenses

 

Other expense was $1.1 million and $0.7 million for the three months ended December 31, 2005 and 2004, respectively, and $1.2 million and $0.7 million for the six months ended December 31, 2005 and 2004, respectively.

 

Interest Income and Expenses

 

Interest income was $7.8 million and $3.8 million for the three months ended December 31, 2005 and 2004, respectively, and $14.9 million and $7.2 million for the six months ended December 31, 2005 and 2004, respectively, reflecting higher prevailing interest rates on higher average cash and cash investment balance in the current year.

 

Interest expense was $7.0 million and $4.5 million for the three months ended December 31, 2005 and 2004, respectively, and $12.6 million and $9.6 million for the six months ended December 31, 2005 and 2004, respectively, primarily reflecting higher effective interest rate payable on our $550 million convertible subordinated notes outstanding, partially offset by higher income from the mark-to-market adjustments on our interest rate swaps (see Notes 4, “Derivative Financial Instruments” and 9, “Bank

 

46



 

Loans and Long-Term Debt” of the Notes to the unaudited consolidated financial statements, regarding the modification of the effective interest payable on our convertible notes).

 

Income Taxes

 

Our effective tax provision for the three months ended December 31, 2005 and 2004 was 27.5 percent and 22.8 percent, respectively, and 27.5 percent and 25.2 for the six months ended December 31, 2005 and 2004, respectively, rather than the U.S. federal statutory tax provision of 35 percent, as a result of lower statutory tax rates in certain foreign jurisdictions, the benefit of foreign tax credits and research and development credits, partially offset by state taxes and certain foreign losses without foreign tax benefits.

 

In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004”, which introduces a limited time 85 percent dividends received deduction on the repatriation of certain foreign earnings to a U.S. tax payer (“repatriation provision”), provided certain criteria are met. We are currently evaluating the range of possible amounts of unremitted earnings that may be repatriated as a result of the repatriation provision; the related range of income tax effects of such repatriation cannot be reasonably estimated at this time.

 

Liquidity and Capital Resources

 

At December 31, 2005, we had cash and cash equivalent balances of $273.7 million and cash investments in marketable debt securities of $644.7 million. We also have $143.9 million in unused credit facilities. Our investment portfolio consists of available-for-sale fixed-income, principally investment-grade securities as of December 31, 2005.

 

For the six months ended December 31, 2005, cash provided by operating activities was $48.4 million compared to $99.2 million in the comparable prior year six months ended December 31, 2004. Cash flows from operating activities decreased by $4.3 million for the six months ended, reflecting the proper classification of the excess tax benefits from options exercised from an operating to a financing activity (see Note 1, “Certain Accounting Policies”). Depreciation and amortization adjusted cash flows from operations by $42.9 million. Changes in operating assets and liabilities decreased cash by $56.7 million during the six months ended December 31, 2005. The increase in working capital reflected the increase in our inventory balance as a result of the build up of inventory to support our backlog, the timing of accounts and other receivable collections, taxes and other accrued expense payments.

 

For the six months ended December 31, 2005, cash used in investing activities was $145.3 million. We purchased $300.9 million and sold $233.1 million of cash investments. Certain prior year’s amounts have been reclassified to conform to the current-year presentation. Auction rate securities are now classified as available-for-sale securities and reported as short-term cash investments instead of cash and cash equivalents, for all periods presented. For the six months ended December 31, 2004, proceeds from the sale of auction rate securities reduced net cash used in investing activities by $74.1 million.

 

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During the six months ended December 31, 2005, we spent $76.0 million in capital expenditures, of which $27.1 million was at the Newport, Wales facility. As of December 31, 2005, demand for our Focus Products exceeded our worldwide capacity. To help address our capacity limitations, we started production at our new facility in Newport, Wales in the December 2005 quarter. Purchase order commitments for capital expenditures were $31.7 million as of December 31, 2005. We intend to fund capital expenditures and working capital requirements through cash and cash equivalents on hand, anticipated cash flows from operations and available credit facilities.

 

Financing activities for the six months ended December 31, 2005 provided $7.6 million. Cash flows from financing activities increased by $4.3 million for the six months ended, reflecting the proper classification of the excess tax benefits from options exercised a financing activity (see Note 1, “Certain Accounting Policies”). Proceeds from the exercise of employee stock options and stock participation plan contributed $24.5 million while repayments of short-term debt decreased cash by $15.3 million. As of December 31, 2005, we had revolving, equipment and foreign credit facilities of $166.6 million, against which $22.6 million had been used. As discussed in Note 4 of the unaudited consolidated financial statements, we are required to obtain irrevocable standby letters of credit in favor of JP Morgan Chase Bank, for $7.5 million plus the collateral requirement for the interest rate swap transactions, as determined periodically. At December 31, 2005, $17.0 million in letters of credit were outstanding related to the transactions. The collateral requirement of the transactions may be adversely affected by an increase in the five-year LIBOR curve, a decrease in our stock price, or both. We cannot predict what the collateral requirement of the transactions and the letter of credit requirement will be over time. To illustrate the potential impact, had a 10 percent increase in the five-year LIBOR curve and a 10 percent decrease in our stock price occurred at the close of the fiscal quarter ended December 31, 2005, our letter of credit commitment would have increased by $3.8 million to $20.8 million. We do not have any off-balance sheet arrangements as of December 31, 2005.

 

On November 1, 2005, our Board of Directors authorized and we announced a stock repurchase program, under which up to $100 million of our common shares may be repurchased without prior notice, through block trades or otherwise. Any shares repurchased will be paid with our existing cash and cash investments. As of December 31, 2005, we have not repurchased any shares.

 

Our $550 million convertible subordinated notes are due in July 2007. We anticipate that these notes will be refinanced through public or private offerings of debt or equity, or be paid down with our existing cash and cash investments.

 

We believe that our current cash and cash investment balances, cash flows from operations and borrowing capacity, including unused amounts under the $150 million Credit Facility as discussed in Note 9 of the unaudited consolidated financial statements, will be sufficient to meet our operations in the next twelve months. Although we believe that our current financial resources will be sufficient for normal operating activities, we may also consider the use of funds from other external sources, including, but not limited to, public or private offerings of debt or equity.

 

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Recent Accounting Pronouncements

 

In November 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) on Statement of Financial Accounting Standard (“SFAS”) No. 115-1 and SFAS No. 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS No. 115-1”), which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss.  FSP FAS No. 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.  FSP FAS No. 115-1 is effective for reporting periods beginning after December 15, 2005.  Our adoption of FSP FAS No. 115-1 will not have a material impact on our results of operations or financial condition.

 

On October 18, 2005, the FASB issued FASB Staff Position on SFAS No. 123(R)-2 (“FSP FAS No. 123(R)-2”). FSP FAS No. 123(R)-2 provides guidance on the application of grant date as defined in SFAS No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). As a practical accommodation, in determining the grant date of an award, assuming all other criteria in the grant date definition have been met, FSP FAS No. 123(R)-2 provides that a mutual understanding of the key terms and conditions of an award to an individual employee shall be presumed to exist at the date the award is approved in accordance with the relevant corporate governance requirements (that is, by the Board or management with the relevant authority) if both of the following conditions are met:

 

a. The award is a unilateral grant and, therefore, the recipient does not have the ability to negotiate the key terms and conditions of the award with the employer.

 

b. The key terms and conditions of the award are expected to be communicated to an individual recipient within a relatively short time period(1) from the date of approval.

 

The guidance in FSP FAS No. 123(R)-2 is effective upon initial adoption of SFAS No. 123(R) or if an entity has adopted SFAS No. 123(R) prior to the issuance of this FSP and did not apply the provisions of FSP FAS No. 123(R)-2, this FSP will be effective in the first reporting period after October 18, 2005, the date the FSP was posted to the FASB website. We have applied the provisions under FSP FAS No. 123(R)-2 in accounting for our equity awards as of July 4, 2005, the start of our fiscal year 2006.

 

Critical Accounting Estimates

 

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. Information with respect to our critical accounting policies which we believe could have the most significant effect on our reported results and require subjective or complex judgments is contained in Item 7, Management’s Discussion and Analysis of Financial Condition and

 

49



 

Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2005.

 

Effective in the first fiscal quarter ended September 30, 2005, in July 2005, we adopted the provisions of Statement of Financial Accounting Standards No. 123 “Share-Based Payment” (“SFAS No. 123R”) to account for stock-based compensation. Under SFAS No. 123R, we estimate the fair value of stock options granted using the Black-Scholes option pricing model. The fair value for awards that are expected to vest is then amortized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. The amount of expense attributed is based on estimated forfeiture rate, which is revised as information is updated. This option pricing model requires the input of highly subjective assumptions, including the expected volatility of our common stock and an option’s expected life. The financial statements include amounts that are based on our best estimates and judgments.

 

Statement of Caution Under the Private Securities Litigation Reform Act of 1995

 

This Quarterly Report on Form 10-Q includes some statements and other information that are not historical facts but are “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995. The materials presented can be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “estimate,” “expect,” “may,” “should,” “view,” or “will” or the negative or other variations thereof. We caution that such statements are subject to a number of uncertainties, and actual results may differ materially. Factors that could affect our actual results include those set forth below under Part II, Item 1A, “Risk Factors” and other uncertainties disclosed in our reports filed from time to time with the Securities and Exchange Commission. Unless required by law, we undertake no obligation to publicly update or revise any forward looking statements, to reflect new information, future events or otherwise.

 

ITEM 3.     Quantitative and Qualitative Disclosures about Market Risk

 

We are exposed to various risks, including fluctuations in interest and foreign currency rates. In the normal course of business, we also face risks that are either non-financial or non-quantifiable. Such risks principally include country risk, credit risk and legal risk and are not discussed or quantified in the following analyses, as well as risks set forth under the heading “Factors that May Affect Future Results” in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended June 30, 2005.

 

Interest Rate Risk

 

Our financial assets and liabilities subject to interest rate risk are cash investments, convertible debt, credit facilities and interest rate swaps. Our primary objective is to preserve principal while maximizing yield without significantly increasing risk. At December 31, 2005, we evaluated the effect that near-term changes in interest rates would have had on these transactions. A change of as much as ten percent in the London InterBank Offered Rate (“LIBOR”) would have had a favorable impact of

 

50



 

approximately $0.3 million and $0.7 million on net interest income/expense for the three and six months ended December 31, 2005, since the interest income on our cash and cash investments would have outweighed additional interest expense on our outstanding debt.  For our interest rate contract with Lehman Brothers, an increase of ten percent in interest rates would have had a favorable impact of $0.6 million, and a decrease of ten percent in interest rates would have had an adverse impact of ($0.1) million, on net interest income/expense. These changes would not have had a material impact on our results of operations, financial position or cash flows.

 

In December 2001, we entered into an interest rate swap transaction (the “Transaction”) with JP Morgan Chase Bank (the “Bank”), to modify our effective interest payable with respect to $412.5 million of our $550 million outstanding convertible debt (the “Debt”) (see Notes 4, “Derivative Financial Instruments,” and 9, “Bank Loans and Long-Term Debt”). At the inception of the Transaction, interest rates were lower than that of the Debt and we believed that interest rates would remain lower for an extended period of time. In April 2004, we entered into an interest rate swap transaction (the “April 2004 Transaction”) with the Bank to modify the effective interest payable with respect to the remaining $137.5 million of the Debt. The variable interest rate we have paid since the inception of the swap has averaged 2.68 percent, compared to a coupon of 4.25 percent on the Debt. For the three months ended December 31, 2005 and 2004, this arrangement increased (decreased) interest expense by $0.8 million and ($2.5) million, respectively, and ($0.1) million and ($4.7) million for the six months ended December 31, 2005 and 2004, respectively.

 

Accounted for as fair value hedges under SFAS No. 133, the mark-to-market adjustments of the two Transactions were offset by the mark-to-market adjustments on the Debt, resulting in no material impact to earnings. To measure the effectiveness of the hedge relationship, we used a regression analysis. To evaluate the relationship of the fair value of the two transactions and the changes in fair value of the Debt attributable to changes in the benchmark rate, we discounted the estimated cash flows by the LIBOR swap rate that corresponds to the Debt’s expected maturity date. In addition, our ability to call the Debt was considered in assessing the effectiveness of the hedging relationship. For those years that were projected to include at least a portion of redemption of the convertible debentures, we employed a valuation model known as a Monte Carlo simulation. This simulation allowed us to project probability-weighted contractual cash flows discounted at the LIBOR swap rate that corresponded to the Debt’s expected maturity date. The market value of the December 2001 Transaction was a liability of $5.8 million and $0.3 million at December 31, 2005 and June 30, 2005, respectively. The market value of the April 2004 Transaction was a liability of $4.7 million and $3.4 million at December 31, 2005 and June 30, 2005, respectively.

 

In April 2002, we entered into an interest rate contract (the “Contract”) with an investment bank, Lehman Brothers (“Lehman”), to reduce the variable interest rate risk of the Transaction. The notional amount of the Contract is $412.0 million, representing approximately 75 percent of the Debt. Under the terms of the Contract, we have the option to receive a payout from Lehman covering our exposure to LIBOR fluctuations between 5.5 percent and 7.5 percent for any four designated quarters. The market value of the Contract at December 31, 2005 and June 30, 2005, respectively, was $0.2 million and $0.1 million, respectively, and was included in other long-term assets. Mark-to-market (losses) gains of ($0.05) million and ($0.3) million for the three months ended December 31, 2005 and 2004, respectively, and $0.1 million and ($0.6) million, for the

 

51



 

six months ended December 31, 2005 and 2004, respectively, were charged to interest expense.

 

Foreign Currency Risk

 

We conduct business on a global basis in several foreign currencies and have currency exposure related primarily to the British Pound Sterling, the Euro and the Japanese Yen. Considering our foreign currency risks, we have the greatest exposure to the Japanese Yen, since we have significant Yen-based revenue without the Yen-based manufacturing costs. The risk of our revenues in the European currencies is partially offset by the cost of manufacturing goods in the European currencies.

 

We have established a foreign-currency hedging program using foreign exchange forward contracts, including the Forward Contract described below, to hedge certain foreign currency transaction exposures. To protect against reductions in value and volatility of future cash flows caused by changes in currency exchange rates, we have established revenue, expense and balance sheet hedging programs. Currency forward contracts and local Yen and Euro borrowings are used in these hedging programs. Our hedging programs reduce, but do not always eliminate, the impact of currency exchange rate movements. We considered an adverse near-term change in exchange rates of ten percent for the British Pound Sterling, the Euro and the Japanese Yen. Such a change, after taking into account our derivative financial instruments and offsetting positions, would have resulted in an annualized adverse impact on income before taxes of less than $1 million for the three and six months ended December 31, 2005 and 2004.

 

In March 2001, we entered into a five-year foreign exchange forward contract (the “Forward Contract”) for the purpose of reducing the effect of exchange rate fluctuations on forecasted intercompany purchases by our subsidiary in Japan. We have designated the Forward Contract as a cash flow hedge under which mark-to-market adjustments are recorded in accumulated other comprehensive income of stockholders’ equity, until the forecasted transactions are recorded in earnings. Under the terms of the Forward Contract, we are required to exchange 1.2 billion Yen for $11.0 million on a quarterly basis from June 2001 to March 2006. At December 31, 2005, one quarterly payment of 1.2 billion Yen remained to be swapped at a forward exchange rate of 109.32 Yen per U.S. dollar. The market value of the forward contract was $0.7 million and $0.1 million at December 31, 2005 and June 30, 2005, respectively, and was included in other long-term assets. Mark-to-market gains (losses), included in other comprehensive income, net of tax, were $0.1 million and ($2.9) million for the three months ended December 31, 2005 and 2004, respectively, and $0.4 million and ($2.1) million for the six months ended December 31, 2005 and 2004, respectively. At December 31, 2005, based on effectiveness tests comparing forecasted transactions through the Forward Contract expiration date to its cash flow requirements, we do not expect to incur a material charge to income during the next three months through its maturity.

 

We had approximately $109.6 million and $75.9 million in notional amounts of forward contracts not designated as accounting hedges under SFAS No. 133 at December 31, 2005 and June 30, 2005, respectively. Net realized and unrealized foreign-currency gains recognized in earnings were less than $1 million for the three and six months ended December 31, 2005 and 2004.

 

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ITEM 4.     CONTROLS AND PROCEDURES

 

(a)          Evaluation of disclosure controls and procedures

 

The term “disclosure controls and procedures” refers to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized and reported, within required time periods. Our management, with the participation of our Chief Executive Officer, Alexander Lidow, and Chief Financial Officer, Michael P. McGee, carried out an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b).

 

In our Quarterly Reports on Form 10-Q for the fiscal quarter ended December 31, 2005, previously filed on February 10, 2006, we originally reported that our disclosure controls and procedures were effective as of each of December 31, 2005. As further discussed in Note 1 to the Company’s consolidated financial statements included in Item 1 of this Quarterly Report, we have restated the financial statements, specifically the statement of cash flows, included in this Form 10-Q/A to reflect the amended correct classification of the excess tax benefits from stock options exercised as cash flows from financing activities rather than operating activities for the six months ended December 31, 2005. In light of the restatement, we have reassessed the effectiveness of our disclosure controls and procedures as of December 31, 2005 and have concluded that our disclosure controls and procedures were not effective, at the reasonable assurance level, as of December 31, 2005 due to the material weakness discussed below.

 

Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.

 

(b)         Material weakness in internal control over financial reporting

 

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A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

 

As of December 31, 2005, we did not maintain effective controls over the preparation, review and presentation of our consolidated statements of cash flows. Specifically, the controls were not effective to ensure that cash flows from the excess tax benefits from stock option exercised were presented as cash flows from financing activities in the consolidated statements of cash flows in accordance with generally accepted accounting principles. This control deficiency resulted in the restatement of our interim consolidated financial statements for the first and second quarter of fiscal 2006. In addition, this control deficiency could result in a misstatement of our cash flows from operating activities and cash flows from financing activities that would result in a material misstatement to our annual or interim consolidated statements of cash flows that would not be prevented or detected. Accordingly, we have determined that this control deficiency constitutes a material weakness.

 

Plan for remediation of material weakness

 

During the fourth quarter of fiscal 2006, we are implementing enhanced procedures and controls which include improved training and review processes to ensure proper preparation, review, presentation and disclosure of amounts included in our consolidated statement of cash flows.

 

(c)          Changes in internal controls

 

There was no change in our internal controls during the fiscal second quarter 2006 that has materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II.                                                OTHER INFORMATION

 

ITEM 1A.                                            Risk Factors

 

Changes in end-market demand or downturns in the highly cyclical semiconductor industry could affect our operating results and the value of our business.

 

We may experience significant changes in our profitability as a result of variations in sales, changes in product mix sought by customers, seasonality, price competition for orders and the costs associated with the introduction of new products and start-up of new facilities and additional capacity lines. The markets for our products depend on continued demand with the product technological platforms and in the mix we plan for and produce in the information technology, consumer, industrial, aerospace and defense and automotive markets. Changes in the demand mix, needed technologies and these end markets may adversely affect our ability to match our products, inventory and capacity to meet customer demand and could adversely affect our operating results and financial condition.

 

In addition, the semiconductor industry is highly cyclical and the value of our business may decline during the down portion of these cycles. We have experienced these conditions in our business in the recent past and we cannot predict when we may experience such downturns in the future. Future downturns in the semiconductor industry, or any failure of the industry to recover fully from its recent downturns could seriously impact our revenue and harm our business, financial condition and results of operations. Although markets for our semiconductors appear stable, we cannot assure you that they will continue to be stable or that our markets will not experience renewed, possibly more severe and prolonged, downturns in the future.

 

Consumer and/or corporate spending for the end-market applications which incorporate our products may be reduced due to increased oil prices or otherwise.

 

Our revenue and gross margin guidance is dependent on a certain level of consumer and/or corporate spending for the specific mix of products we produce and have the capacity to produce. If our projections of these expenditures fail to materialize, or materialize in a mix different from that for which we anticipate and build inventory, whether due to reduced consumer or corporate spending from increased oil prices or otherwise, our revenue and gross margin could be adversely impacted.

 

We maintain backlog of customer orders that is subject to cancellation, reduction or delay in delivery schedules, which may result in lower than expected revenue.

 

With certain exceptions related to products within our Aerospace and Defense and Non-Aligned Product segments, we manufacture primarily pursuant to purchase orders for current delivery or to forecast, rather than pursuant to long-term supply contracts. The semiconductor industry is subject to rapid changes in customer outlooks or unexpected build ups of inventory in the supply channel as a result of shifts in end-market demand generally or in the mix of that demand. Accordingly, many of these purchase orders or forecasts may be revised or canceled without penalty. As a result, we must commit resources to the manufacturing of products, and a specific mix of products, without any advance purchase commitments from customers. Our inability to sell products after we devote significant resources to build them could have a material adverse effect on our

 

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levels of inventory (the value of our inventory), our revenue and our operating results generally.

 

We build and maintain inventory in order to meet our historic and projected needs, but cannot guarantee that our inventory will be adequate to meet our needs or will be usable at a future date.

 

At the end of fiscal quarter ended December 31, 2005, we reported net inventories of approximately $209 million. We build and maintain inventory in order to meet our historic and projected needs, but cannot guarantee that the inventory we build will be adequate or the right mix of products to meet market demand. If we do not project and build the proper mix and amount of inventory, our revenue and gross margin may be adversely affected. Additionally, if we produce or have produced inventory that does not meet current or future demand, we may determine at some point that certain of the inventory may only be sold at a discount or may not be sold at all, resulting in the reduction in the carrying value of our inventory and a material adverse effect on our financial condition and operating results.

 

The semiconductor business is highly competitive and increased competition could adversely affect the price of our products and otherwise reduce the value of an investment in our company.

 

The semiconductor industry, including the sectors in which we do business, is highly competitive. Competition is based on price, product performance, technology platform, product availability, quality, reliability and customer service. Price pressures often emerge as competitors attempt to gain a greater market share by lowering prices or by offering a more desirable technological solution. Pricing and other competitive pressures can adversely affect our revenue and gross margin, and hence, our profitability. We also compete in various markets with companies of various sizes, many of which are larger and have greater financial and other resources than we have, and thus they may be better able to withstand adverse economic or market conditions. In addition, companies not currently in direct competition with us may introduce competing products in the future.

 

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Failure to timely complete our expansion plans for our wafer fabrication facility could adversely affect our revenue growth and ability to achieve our margin targets.

 

We are operating in the mid to high 90s percent of our worldwide semiconductor fabrication and assembly/module manufacturing capacities, without taking into account subcontract or foundry capacity. We are also expanding our most advanced wafer fabrication facility in Newport, Wales to provide additional capacity to support the growth of our Focus Products. We have started production on certain of such new facilities during the December 2005 quarter, and expect to complete our expansion of that facility in about calendar year 2006. If we fail to timely execute on those plans in advance of demand for our products, that failure could adversely affect our revenue growth and ability to achieve our margin targets. We cannot assure you that we will complete our plans timely, that the ramp-up of the expanded facilities will occur effectively and without error or delay, or that sufficient third party sources would be available to satisfy our ability to meet customer demand. Even if we fully execute and implement our plans, we cannot guarantee that we will have sufficient worldwide semiconductor fabrication and assembly/module manufacturing capacities to meet demand and there may be other unforeseen factors that could adversely impact our operating results.

 

Delays in initiation of production at new facilities, implementing new production techniques or resolving problems associated with technical equipment malfunctions could adversely affect our manufacturing efficiencies.

 

Our manufacturing efficiency has been and will be an important factor in our future profitability, and we may not be able to maintain or increase our manufacturing efficiency. Our manufacturing and testing processes are complex, require advanced and costly equipment and are continually being modified in our efforts to improve yields and product performance. Difficulties in the manufacturing process can lower yields. Technical or other problems could lead to production delays, order cancellations and lost revenue. In addition, any problems in achieving acceptable yields, construction delays, or other problems in upgrading or expanding existing facilities, building new facilities, problems in bringing other new manufacturing capacity to full production or changing our process technologies, could also result in capacity constraints, production delays and a loss of future revenue and customers. Our operating results also could be adversely affected by any increase in fixed costs and operating expenses related to increases in production capacity if net sales in the appropriate mix do not increase proportionately, or in the event of a decline in demand for some or all of our products.

 

If we are unable to implement our business strategy, our revenue and profitability may be adversely affected.

 

Our future financial performance and success are largely dependent on our ability to implement our business strategy successfully of transforming our business to one led by our Focus Products and succeeding on our plans to restructure our company. We cannot assure you that we will continue to successfully implement our business strategy or that implementing our strategy will sustain or improve our results of operations.

 

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The failure to execute on our plans to divest or discontinue product lines that are not consistent with our business objectives, and replace those revenues with higher-margin product sales could adversely affect our operating results.

 

We have announced the divestiture, discontinuation or change in business model of certain of our Non-Focus Products (and, may divest discontinue or charge the business model for others) that are not consistent with our business objectives or margin targets. Our plan is to replace the divested or discontinued revenues with (or change the business model to achieve) higher-margin product sales and target gross margin of greater 50 percent. We cannot assure you that we will complete our plans or achieve our target gross margin, timely or at all. Additionally, we have announced that we plan to enter into agreements with respect to certain divestitures by the end of June 2006. As a number of factors, among those factors controlled by third parties, affect our ability to complete those plans, we cannot assure you that we can achieve our target dates or complete such plans at all.

 

The activities involved with the divestiture, discontinuation and re-alignment of product sales could involve changes to various aspects of our business which could have a material adverse effect on our profitability to an extent we have not anticipated. Even if we fully execute and implement our plans, there may be unforeseen factors that could have a material adverse impact on our operating results.

 

The failure to implement and complete our restructuring programs and accomplish planned cost reductions could adversely affect our business.

 

In December 2002, we announced a number of restructuring initiatives. Our goal was to reposition our company to better fit the market conditions, de-emphasize our commodity business and accelerate the move to what we categorize as our proprietary products, which refer to our Power Management ICs, Advanced Circuit Devices, and Power Systems. The restructuring includes consolidating and closing certain manufacturing sites, upgrading equipment and processes in designated facilities and discontinuing production in a number of others that cannot support more advanced technology platforms or products. The restructuring also includes lowering overhead costs across our support organization. We cannot assure you that these restructuring initiatives will achieve their goals, accomplish the cost reductions planned, or be accomplished within our expectations as to the amount of charges to be taken in connection with that activity. Additionally, because our restructuring activities involve changes to many aspects of our business, the activities could adversely affect productivity and sales to an extent we have not anticipated. Even if we fully execute and implement these restructuring activities, and they generate the anticipated cost savings, there may be other unforeseen factors that could result in the amount of charges to be taken in connection with our restructuring activities or otherwise adversely impact our profitability and business.

 

Our products may be found to be defective and, as a result, product claims may be asserted against us, which may harm our business and our reputation with our customers and significantly adversely affect our results and financial condition.

 

Our products are typically sold at prices that are significantly lower than the cost of the equipment or other goods in which they are incorporated. Although we maintain rigorous quality control systems, we shipped large quantities of semiconductor devices in 2005 to a wide range of customers around the world, in a variety of high profile and

 

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critical applications, and continue to do so. In the ordinary course of our business we receive warranty claims for some of these products that are defective, or that do not perform to published specifications. Since a defect or failure in our products could give rise to failures in the end products that incorporate them (and consequential claims for damages against our customers from their customers depending on applicable law and contract), we often need to defend against claims for damages that are disproportionate to the revenue and profit we receive from the products involved. In addition, our ability to reduce such liabilities may be limited by the laws or the customary business practices of the countries where we do business. Even in cases where we do not believe we have legal liability for such claims, we may choose to pay for them to retain a customer’s business or goodwill or to settle claims to avoid protracted litigation. Our results of operations and business would be adversely affected as a result of a significant alleged quality or performance issues in our products, if we are required or choose to pay for the damages that result. In addition, in our Aerospace and Defense segment, we are sometimes subject to government procurement regulations and other laws that could result in costly investigations and other legal proceedings as a consequence of allegedly defective products or other actions. Although we currently have product liability and other types of insurance, we have certain deductibles and exclusions to such policies and may not have sufficient insurance coverage. We also may not have sufficient resources to satisfy all possible product liability or other types of product claims. In addition, any perception that our products are defective would likely result in reduced sales of our products, loss of customers and harm to our business and reputation.

 

While we attempt to monitor the credit worthiness of our customers, we may from time to time be at risk due to the adverse financial condition of one or more customers.

 

We have established procedures for the review and monitoring of the credit worthiness of our customers and/or significant amounts owing from customers. However, from time to time, we may find that despite our efforts one or more of our customers become insolvent or face bankruptcy proceedings (Delphi, one of our largest customers, is currently one such customer). Such events could have an adverse effect on our operating results if our receivables applicable to that customer become uncollectible in whole or in part, or if our customers’ financial situation result in reductions in whole or in part of our ability to continue to sell our products or services to such customers at the same levels or at all.

 

If some original equipment manufacturers (“OEMs”) do not design our products into their equipment, a portion of our revenue may be adversely affected.

 

A “design win” from a customer does not guarantee future sales to that customer. We also are unable to guarantee that we will be able to convert design wins into sales for the life of any particular program, or at all, or that the revenue from such wins would be significant. We also cannot guarantee that we will achieve the same level of design wins as we have in the past, or at all. Without design wins from OEMs, we would only be able to sell our products to these OEMs as a second source, if at all. Once an OEM designs another supplier’s semiconductor into one of its product platforms, it is more difficult for us to achieve future design wins with that OEM’s product platform because changing suppliers involves significant cost, time, effort and risk. Achieving a design win

 

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with a customer does not ensure that we will receive significant revenue from that customer and we may be unable to convert design wins into actual sales.

 

Corporate investment and expenditures in the Information Technology sector and in Information Technology purchases may not materialize as we have planned.

 

Our revenue and gross margin guidance is dependent on a certain level of corporate investment and expenditures in the Information Technology sector and in Information Technology purchases. If our projections of these expenditures fail to materialize, whether due to increased oil prices, change in market conditions, or otherwise, our revenue and gross margin could be adversely impacted.

 

New technologies could result in the development of new products and a decrease in demand for our products, and we may not be able to develop new products to satisfy changes in demand.

 

Our failure to develop new technologies or react to changes in existing technologies could materially delay our development of new products, which could result in decreased revenue and a loss of market share to our competitors. Rapidly changing technologies and industry standards, along with frequent new product introductions, characterize the semiconductor industry. As a result, we must devote significant resources to research and development. Our financial performance depends on our ability to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. We cannot assure you that we will successfully identify new product opportunities and develop and bring new products to market in a timely and cost-effective manner, or that products or technologies developed by others will not render our products or technologies obsolete or noncompetitive. A fundamental shift in technologies in our product markets could have a material adverse effect on our competitive position within the industry. In addition, to remain competitive, we must continue to reduce die sizes and improve manufacturing yields. We cannot assure you that we can accomplish these goals.

 

Our failure to obtain or maintain the right to use certain technologies may negatively affect our financial results.

 

Our future success and competitive position may depend in part upon our ability to obtain or maintain certain proprietary technologies used in our principal products, which is achieved in part by defending and maintaining the validity of our patents and defending claims by our competitors of intellectual property infringement. We license certain patents owned by others. We have also been notified that certain of our products may infringe the patents of third parties. Although licenses are generally offered in such situations, we cannot eliminate the risk of litigation alleging patent infringement. We are currently a defendant in intellectual property claims and we could become subject to other lawsuits in which it is alleged that we have infringed upon the intellectual property rights of others.

 

Our involvement in existing and future intellectual property litigation could result in significant expense, adversely affect sales of the challenged product or technologies and divert the efforts of our technical and management personnel, whether or not such litigation is resolved in our favor. If any such infringements exist, arise or are claimed in the future, we may be exposed to substantial liability for damages and may need to obtain licenses from the patent owners, discontinue or change our processes or products or

 

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expend significant resources to develop or acquire non-infringing technologies. We cannot assure you that we would be successful in such efforts or that such licenses would be available under reasonable terms. Our failure to develop or acquire non-infringing technologies or to obtain licenses on acceptable terms or the occurrence of related litigation itself could have a material adverse effect on our operating results and financial condition.

 

Our ongoing protection and reliance on our intellectual property assets expose us to risks and continued levels of revenue in our IP segment is subject to our ability to maintain current licenses, licensee and market factors not within our control and our ability to obtain new licenses.

 

We have traditionally relied on our patents and proprietary technologies. Patent litigation settlements and royalty income substantially contribute to our financial results. Enforcement of our intellectual property rights is costly, risky and time-consuming. We cannot assure you that we can successfully continue to protect our intellectual property rights, especially in foreign markets. Our key MOSFET patents expire between 2005 and 2010, although our broadest MOSFET patents expire in 2007 and 2008.

 

Our royalty income is largely dependent on the following factors: the remaining terms of our MOSFET patents; the continuing introduction and acceptance of products that are not covered by our patents; remaining covered under unexpired MOSFET patents; the defensibility and enforceability of our patents; changes in our licensees’ unit sales, prices or die sizes; the terms, if any, upon which expiring license agreements are renegotiated; and our ability to obtain revenue from new licensing opportunities. Market conditions and mix of licensee products, as well as sales of non-infringing devices can significantly adversely affect royalty income. We also cannot guarantee that we can obtain new licenses to offset reductions in royalties from existing licenses. While we try to predict the effects of these factors and efforts, often there are variations or factors that can significantly affect results different from that predicted. Accordingly, we cannot guarantee that our predictions of our IP segment revenue will be consistent with actual results. We also cannot guarantee that our royalty income will continue at levels consistent with prior periods. Any decrease in our royalty income could have a material adverse effect on our operating results and financial condition.

 

Our international operations expose us to material risks.

 

We expect revenue from foreign markets to continue to represent a significant portion of total revenue. We maintain or contract with significant operations in foreign countries. Among others, the following risks are inherent in doing business internationally: changes in, or impositions of, legislative or regulatory requirements, including tax laws in the United States and in the countries in which we manufacture or sell our products; trade restrictions; transportation delays; work stoppages; economic and political instability; and foreign currency fluctuations.

 

In addition, certain of our operations and products are subject to restrictions or licensing under U.S. export laws. If such laws or the implementation of these restrictions change, or if in the course of operating under such laws we become subject to claims, we cannot assure you that such factors would not have a material adverse effect on our financial condition and operating results.

 

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In addition, it is more difficult in some foreign countries to protect our products or intellectual property rights to the same extent as is possible in the United States. Therefore, the risk of piracy or misuse of our technology and products may be greater in these foreign countries. Although we have not experienced any material adverse effect on our operating results as a result of these and other factors, we cannot assure you that such factors will not have a material adverse effect on our financial condition and operating results in the future.

 

Delays in initiation of production at new facilities, implementing new production techniques or resolving problems associated with technical equipment malfunctions could adversely affect our manufacturing efficiencies.

 

Our manufacturing efficiency will be an important factor in our future profitability, and we cannot assure you that we will be able to maintain or increase our manufacturing efficiency to the same extent as our competitors. Our manufacturing processes are highly complex, require advanced and costly equipment and are continuously being modified in an effort to improve yields and product performance. Impurities, defects or other difficulties in the manufacturing process can lower yields.

 

In addition, as is common in the semiconductor industry, we have from time to time experienced difficulty in beginning production at new facilities or in effecting transitions to new manufacturing processes. As a consequence, we have experienced delays in product deliveries and reduced yields. We may experience manufacturing problems in achieving acceptable yields or experience product delivery delays in the future as a result of, among other things, capacity constraints, construction delays, upgrading or expanding existing facilities or changing our process technologies, any of which could result in a loss of future revenue. Our operating results could also be adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity if revenue does not increase proportionately.

 

We have transferred manufacturing from our Krefeld, Germany to our Swansea, Wales and Tijuana, Mexico facilities. We are ramping up our Newport, Wales’s facility, and anticipate transferring our El Segundo manufacturing to the Newport, Wales facility by fiscal year end June 2006. We have experienced some delays and/or technical problems in moving our various facilities. Continued delays and/or technical problems in completing the remaining transfers could lead to increased costs, reduced yields, delays in product deliveries, order cancellations and/or lost revenue.

 

Interruptions, delays or cost increases affecting our materials, parts or equipment may impair our competitive position and our operations.

 

Our manufacturing operations depend upon obtaining adequate supplies of materials, parts and equipment, including silicon, mold compounds and leadframes, on a timely basis from third parties. Our results of operations could be adversely affected if we were unable to obtain adequate supplies of materials, parts and equipment in a timely manner from our third party suppliers or if the costs of materials, parts or equipment increase significantly. From time to time, suppliers may extend lead times, limit supplies or increase prices due to capacity constraints or other factors. We have a limited number of suppliers for some materials, parts and equipment, and any interruption could materially impair our operations.

 

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We manufacture a substantial portion of our wafer product at our Temecula, California and Newport, Wales facilities. Any disruption of operations at those facilities could have a material adverse effect on our business, financial condition and results of operations.

 

Also, some of our products are assembled and tested by third party subcontractors. We do not have any long-term assembly agreements with these subcontractors. As a result, we do not have immediate control over our product delivery schedules or product quality. Due to the amount of time often required to qualify assemblers and testers and the high cost of qualifying multiple parties for the same products, we could experience delays in the shipment of our products if we are forced to find alternative third parties to assemble or test them. Any product delivery delays in the future could have a material adverse effect on our operating results and financial condition. Our operations and ability to satisfy customer obligations could be adversely affected if our relationships with these subcontractors were disrupted or terminated.

 

We must commit resources to product manufacturing prior to receipt of purchase commitments and could lose some or all of the associated investment.

 

We sell products primarily pursuant to purchase orders for current delivery or to forecast, rather than pursuant to long-term supply contracts. Many of these purchase orders or forecasts may be revised or canceled without penalty. As a result, we must commit resources to the manufacturing of products without any advance purchase commitments from customers. Our inability to sell products after we devote significant resources to them could have a material adverse effect on our levels of inventory and our business, financial condition and results of operations.

 

We receive a significant portion of our revenue from a small number of customers and distributors.

 

Historically, a significant portion of our revenue has come from a relatively small number of customers and distributors. The loss or financial failure of any significant customer or distributor, any reduction in orders by any of our significant customers or distributors, or the cancellation of a significant order, could materially and adversely affect our business.

 

We may fail to attract or retain the qualified technical, sales, marketing and managerial personnel required to operate our business successfully.

 

Our future success depends, in part, upon our ability to attract and retain highly qualified technical, sales, marketing and managerial personnel. Personnel with the necessary semiconductor expertise are scarce and competition for personnel with these skills is intense. We cannot assure you that we will be able to retain existing key technical, sales, marketing and managerial employees or that we will be successful in attracting, assimilating or retaining other highly qualified technical, sales, marketing and managerial personnel in the future. If we are unable to retain existing key employees or are unsuccessful in attracting new highly qualified employees, our business, financial condition and results of operations could be materially and adversely affected.

 

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We have acquired and may continue to acquire other companies and may be unable to successfully integrate such companies with our operations.

 

We have acquired several companies over the past few years. We may continue to expand and diversify our operations with additional acquisitions. If we are unsuccessful in integrating these companies with our operations, or if integration is more difficult than anticipated, we may experience disruptions that could have a material adverse effect on our business, financial condition and results of operations.

 

The price of our common stock has fluctuated widely in the past and may fluctuate widely in the future.

 

Our common stock, which is traded on The New York Stock Exchange, has experienced and may continue to experience significant price and volume fluctuations that could adversely affect the market price of our common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in financial results, earnings below analysts’ estimates and financial performance and other activities of other publicly traded companies in the semiconductor industry could cause the price of our common stock to fluctuate substantially. In addition, in recent periods, our common stock, the stock market in general and the market for shares of semiconductor industry-related stocks in particular have experienced extreme price fluctuations which have often been unrelated to the operating performance of the affected companies. Any similar fluctuations in the future could adversely affect the market price of our common stock.

 

Our investments in certain securities expose us to market risks.

 

We invest excess cash in marketable securities consisting primarily of commercial paper, corporate notes, corporate bonds and governmental securities. We also hold as strategic investments the common stock of two publicly-traded Japanese companies, one of which is Nihon Inter Electronics Corporation. The value of these investments is subject to market fluctuations, which if adverse, could have a material adverse effect on our operating results and financial condition.

 

If we fail to maintain an effective system of internal control over financial reporting or discover material weaknesses in our internal control over financial reporting or financial reporting practices, we may not be able to report our financial results accurately or detect fraud, which could harm our business and the trading price of our stock.

 

We have disclosed that we have discovered a material weakness in our internal control over financial reporting. While we are implementing enhanced procedures and controls in our fourth quarter of fiscal 2006 to cure the material weakness and management believes that it will cure such weakness within a reasonable period of time, we cannot assure you that such procedures will timely cure such weakness.

 

Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. We are required to periodically evaluate the effectiveness of the design and operation of our internal controls. These evaluations may result in the conclusion that enhancements, modifications or changes to our internal controls are necessary or desirable. As noted with the disclosed material weakness, while management evaluates the effectiveness of our internal controls on a regular basis, we cannot provide absolute assurance that these controls will always be effective or any assurance that the controls, accounting processes, procedures and underlying assumptions will not be subject to revision. There are also inherent limitations on the effectiveness of internal controls and financial reporting practices, including collusion, management override, and failure of human judgment. Because of this, control procedures and financial reporting practices are designed

 

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to reduce rather than eliminate business risks. If we fail to maintain an effective system of internal control over financial reporting or if, and for as long as, management or our independent registered public accounting firm were to discover material weaknesses in our internal control over financial reporting (or if our system of controls and audits result in a change of practices or new information or conclusions about our financial reporting like the disclosed material weakness), we may be unable to produce reliable financial reports or prevent fraud and it could harm our financial condition and results of operations and result in loss of investor confidence and a decline in our stock price.

 

Large potential environmental liabilities, including those relating to a former operating subsidiary, may adversely impact our financial position.

 

Federal, state, foreign and local laws and regulations impose various restrictions and controls on the discharge of materials, chemicals and gases used in our semiconductor manufacturing processes. In addition, under some laws and regulations, we could be held financially responsible for remedial measures if our properties are contaminated or if we send waste to a landfill or recycling facility that becomes contaminated, even if we did not cause the contamination. Also, we may be subject to common law claims if we release substances that damage or harm third parties. Further, we cannot assure you that changes in environmental laws or regulations will not require additional investments in capital equipment or the implementation of additional compliance programs in the future. Any failure to comply with environmental laws or regulations could subject us to serious liabilities and could have a material adverse effect on our operating results and financial condition.

 

Some of our facilities are located near major earthquake fault lines.

 

Our corporate headquarters, one of our manufacturing facilities, one of our research facility and certain other critical business operations are located near major earthquake fault lines. We could be materially and adversely affected in the event of a major earthquake. Although we maintain earthquake insurance, we can give you no assurance that we have obtained or will maintain sufficient insurance coverage.

 

There can be no assurance that we will have sufficient capital resources to make necessary investments in manufacturing technology and equipment.

 

The semiconductor industry is capital intensive. Semiconductor manufacturing requires a constant upgrading of process technology to remain competitive, as new and enhanced semiconductor processes are developed which permit smaller, more efficient and more powerful semiconductor devices. We maintain certain of our own manufacturing, assembly and test facilities, which have required and will continue to require significant investments in manufacturing technology and equipment. We are also attempting to add the appropriate level and mix of capacity to meet our customers’ future demand. There can be no assurance that we will have sufficient capital resources to make necessary investments in manufacturing technology and equipment. Although we believe that anticipated cash flows from operations, existing cash reserves and other equity or debt financings that we may obtain will be sufficient to satisfy our future capital expenditure requirements, there can be no assurance that this will be the case or that alternative sources of capital will be available to us on favorable terms or at all.

 

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The maturity of our outstanding Convertible Subordinated Notes due in July 2007 may expose us to risks.

 

We have outstanding $550 million in Convertible Subordinated Notes due in July 2007. While we intend to refinance or pay down such notes prior to maturity, if we decide to refinance such notes, in whole or in part, we cannot guarantee that the terms, including interest rate and costs, would be comparable to the current interest rates and costs, and if higher, could adversely affect our future results. Additionally, if we elect in whole or in part to pay down such notes, it would lower the amount of funds we have available for operations or investment.

 

Unforeseen changes in market conditions, tax laws and other factors could impact our judgment about the realizability of our deferred tax assets.

 

We have made certain judgments regarding the realizability of our deferred tax assets. In accordance with SFAS No. 109, “Accounting for Income Taxes”, the carrying value of the net deferred tax assets is based on the belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets, after considering all available positive and negative evidence. If our assumptions and estimates change in the future given unforeseen changes in market conditions, tax laws or other factors, then the valuation allowances established may be increased, resulting in increased income tax expense. Conversely, if we are ultimately able to use all or a portion of the deferred tax assets for which a valuation allowance has been established, then the related portion of the valuation allowance will be released to income as a credit to income tax expense.

 

Final outcomes from the various tax authorities’ audits are difficult to predict and an unfavorable finding may negatively impact our financial results.

 

As is common with corporations of our size, we are from time to time under audit by various taxing authorities. It is often difficult to predict the final outcome or the timing of resolution of any particular tax matter. We have provided certain tax reserves which have been included in the determination of our financial results. However, unpredicted unfavorable settlements may require additional use of cash and negatively impact our financial position or results of operations.

 

Terrorist attacks, such as those that took place on September 11, 2001, or threats or occurrences of other terrorist activities whether in the United States or internationally may affect the markets in which our common stock trades, the markets in which we operate and our profitability.

 

Terrorist attacks, such as those that took place on September 11, 2001, or threats or occurrences of other terrorist or related activities, whether in the United States or internationally, may affect the markets in which our common stock trades, the markets in which we operate and our profitability. Future terrorist or related activities could affect our domestic and international sales, disrupt our supply chains and impair our ability to produce and deliver our products. Such activities could affect our physical facilities or those of our suppliers or customers, and make transportation of our supplies and products more difficult or cost prohibitive. Due to the broad and uncertain effects that terrorist attacks have had on financial and economic markets generally, we cannot provide any estimate of how these activities might affect our future results.

 

66



 

Natural disasters, like those related to Hurricanes Katrina and Wilma, or occurrences of other natural disasters whether in the United States or internationally may affect the markets in which our common stock trades, the markets in which we operate and our profitability.

 

Natural disasters, like those related to Hurricanes Katrina and Wilma, or threats or occurrences of other similar events, whether in the United States or internationally, may affect the markets in which our common stock trades, the markets in which we operate and our profitability. Such events could affect our domestic and international sales, disrupt our supply chains, and impair our ability to produce and deliver our products. While we do not have facilities located near the affected areas, such activities could affect physical facilities, primarily for raw materials and process chemicals and gases of our suppliers or customers, and make transportation of our supplies and products more difficult or cost prohibitive. Due to the broad and uncertain effects that natural events have had on financial and economic markets generally, we cannot provide any estimate of how these activities might affect our future results.

 

67



 

ITEM 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

On November 1, 2005, our Board of Directors authorized a stock repurchase program, under which up to $100 million of our common shares may be repurchased without prior notice, through block trades or otherwise. We intend that any shares repurchased will be held as treasury shares that may be used for general corporate purposes. The following lists the number of the shares purchased under the repurchase program and, as of each month, the number of shares that may yet be repurchased under announced plans (in thousands):

 

Period

 

(a) Total Number of Shares (or Units) Purchased

 

(b) Average Price Paid per Share (or Unit)

 

(c) Total Number of Shares (or Unites) Purchased as part of Publicly Announced Plans or Programs

 

(d) Maximum
Number (or
Approximate Dollar Value) of Shares (or Units) that can be Purchased Under the Plans or Programs

 

 

 

 

 

 

 

 

 

 

 

Month #1 (November 1 to November 30, 2005)

 

0

 

0

 

0

 

$

100 million

 

 

 

 

 

 

 

 

 

 

 

Month #2 (December 1 to December 31, 2005)

 

0

 

0

 

0

 

$

100 million

 

 

68



 

ITEM 4.                  Submission of Matters to a Vote of Security Holders

 

The following matters were submitted to a vote of the Company’s stockholders at its Annual Meeting of Stockholders held on November 21, 2005. All such matters were approved by the Company’s stockholders. Below is a summary of, where applicable, the number of votes cast for, against or withheld, as well as the number of abstentions as to each matter.

 

 

 

Description of Matter

 

For

 

Authority
Withheld

 

 

 

 

 

 

 

 

 

1.

 

Election of Directors

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Alexander Lidow

 

60,343,984

 

2,279,352

 

 

 

Rochus E. Vogt

 

58,758,096

 

3,865,240

 

 

 

 

 

 

For

 

Against

 

Abstentions

 

2.

 

Proposal to amend the Company’s 1984 Stock

 

45,313,529

 

1,474,493

 

218,400

 

 

 

Participation Plan as described in the proxy

 

 

 

 

 

 

 

 

 

materials

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Broker non-votes

 

15,616,914

 

 

 

 

 

 

 

 

 

 

For

 

Against

 

Abstentions

 

3.

 

Ratification of PricewaterhouseCoopersLLP

 

61,634,276

 

925,249

 

66,811

 

 

 

as the Company’s Independent Registered

 

 

 

 

 

 

 

 

 

Public Accounting Firm For Fiscal Year 2006

 

 

 

 

 

 

 

 

69



 

ITEM 6.                  Exhibits

 

Index:

 

3.1                                 Certificate of Incorporation, as Amended to date (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-8 filed with the Commission on July 19, 2005; Registration No. 333-117489)

 

3.2                                 Bylaws, as Amended (incorporated by reference to Exhibit 3.2 to the Company’s quarterly report on Form 10-Q filed with the Commission on November 11, 2005)

 

11.1                           Statement Regarding Computation of Per Share Earnings (incorporated by reference to Note 2, “Net Income Per Common Share”, of the Notes to Unaudited Consolidated Financial Statements contained herein)

 

31.1                           Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2                           Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1                           Certification Pursuant to 18 U.S.C. 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2                           Certification Pursuant to 18 U.S.C. 1350, Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

70



 

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.

 

 

 

INTERNATIONAL RECTIFIER CORPORATION

 

Registrant

 

 

 

 

May 17, 2006

/s/ Michael P. McGee

 

 

Michael P. McGee

 

Executive Vice President,

 

Chief Financial Officer

 

(Duly authorized officer and

 

principal financial and accounting officer)

 

71


EX-31.1 2 a06-12026_2ex31d1.htm EX-31

EXHIBIT 31.1

 

CERTIFICATION

 

I, Alexander Lidow, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of International Rectifier Corporation;

 

2.               Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.               Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.               The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13(a)-15(f) and 15(d)-15(f)) for the registrant and have:

 

(a)          Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b)         Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c)          Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d)         Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.               The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 

(a)          All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b)         Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: May 17, 2006

 

/s/ Alexander Lidow

 

 

Alexander Lidow

 

 

Director and Chief Executive Officer

 

1


EX-31.2 3 a06-12026_2ex31d2.htm EX-31

EXHIBIT 31.2

 

CERTIFICATION

 

I, Michael P. McGee, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of International Rectifier Corporation;

 

2.               Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.               Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.               The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13(a)-15(f) and 15(d)-15(f)) for the registrant and have:

 

(a)          Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b)         Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c)          Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d)         Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.               The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 

(a)          All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b)         Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: May 17, 2006

 

/s/ Michael P. McGee

 

 

Michael P. McGee

 

 

Executive Vice President and

 

 

Chief Financial Officer

 

 

(Principal Financial and Accounting
Officer)

 

1


EX-32.1 4 a06-12026_2ex32d1.htm EX-32

EXHIBIT 32.1

 

CERTIFICATION

PURSUANT TO

18 U.S.C. SECTION 1350

 

The undersigned, Alexander Lidow, the Chief Executive Officer of International Rectifier Corporation (the “Company”), pursuant to 18 U.S.C. §1350, hereby certifies that, to his knowledge:

 

(i)                                     the quarterly report on Form 10-Q of the Company for the fiscal quarter ended December 31, 2005 (the “Report) fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(ii)                                  the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of, and for the periods presented in the Report.

 

Dated: May 17, 2006

 

 

 

 

 

 

/s/ Alexander Lidow

 

Alexander Lidow

 

Director and Chief Executive Officer

 

A signed original of the written statement required by Section 906 has been provided to International Rectifier Corporation and will be furnished to the Securities and Exchange Commission or its staff upon request.

 

1


EX-32.2 5 a06-12026_2ex32d2.htm EX-32

EXHIBIT 32.2

 

CERTIFICATION

PURSUANT TO

18 U.S.C. SECTION 1350

 

The undersigned, Michael P. McGee, the Chief Financial Officer of International Rectifier Corporation (the “Company”), pursuant to 18 U.S.C. §1350, hereby certifies that, to his knowledge:

 

(i)                                     the quarterly report on Form 10-Q of the Company for the fiscal quarter ended December 31, 2005 (the “Report) fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(ii)                                  the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of, and for the periods presented in the Report.

 

Dated: May 17, 2006

 

 

 

 

 

 

/s/ Michael P. McGee

 

Michael P. McGee

 

Executive Vice President and

 

Chief Financial Officer

 

(Principal Financial and Accounting
Officer)

 

A signed original of the written statement required by Section 906 has been provided to International Rectifier Corporation and will be furnished to the Securities and Exchange Commission or its staff upon request.

 

1


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