-----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, Hnf+zy4pQWsHMD8SJb64nqelaXVfPQP5Q8vug6W7XEw31uP1gBgEWIQWWUvLCuVZ AAiFrUwvqdP1V2CiWcOk6w== 0000891618-01-501746.txt : 20010816 0000891618-01-501746.hdr.sgml : 20010816 ACCESSION NUMBER: 0000891618-01-501746 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010701 FILED AS OF DATE: 20010815 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LSI LOGIC CORP CENTRAL INDEX KEY: 0000703360 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 942712976 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10317 FILM NUMBER: 1714632 BUSINESS ADDRESS: STREET 1: 1551 MCCARTHY BLVD STREET 2: MS D 106 CITY: MILPITAS STATE: CA ZIP: 95035 BUSINESS PHONE: 4084338000 MAIL ADDRESS: STREET 1: 1551 MCCARTHY BLVD STREET 2: MS D 106 CITY: MILPITAS STATE: CA ZIP: 95035 10-Q 1 f75169e10-q.txt FORM 10-Q QUARTER ENDED JULY 1, 2001 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-Q ---------------- (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JULY 1, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ________ COMMISSION FILE NUMBER: 0-11674 LSI LOGIC CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-2712976 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER) 1551 MCCARTHY BOULEVARD MILPITAS, CALIFORNIA 95035 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (408) 433-8000 (REGISTRANT'S TELEPHONE NUMBER) ----------------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] As of August 8, 2001, there were 365,957,004 of the registrant's Common Stock, $.01 par value, outstanding. 2 LSI LOGIC CORPORATION FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001 INDEX
PAGE NO. ------ PART I. FINANCIAL INFORMATION Item 1 Financial Statements Consolidated Balance Sheets -- June 30, 2001 and December 31, 2000 3 Consolidated Statements of Operations -- Three and Six Months Ended June 30, 2001 and 2000 4 Consolidated Statements of Cash Flows -- Six Month Periods Ended June 30, 2001 and 2000 5 Notes to Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 3 Quantitative and Qualitative Disclosures About Market Risk 30 PART II. OTHER INFORMATION Item 1 Legal Proceedings 31 Item 4 Submission of Matters to a Vote of Security Holders 31 Item 5 Other Information 32 Item 6 Exhibits and Reports on Form 8-K 32
2 3 PART I ITEM 1. FINANCIAL STATEMENTS LSI LOGIC CORPORATION CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30, December 31, (In thousands, except per-share amounts) 2001 2000 ----------- ----------- ASSETS Cash and cash equivalents $ 317,909 $ 235,895 Short-term investments 823,796 897,347 Accounts receivable, less allowances of $13,266 and $8,297 301,220 522,729 Inventories 355,680 290,375 Deferred tax assets 54,654 54,552 Prepaid expenses and other current assets 187,033 71,342 ----------- ----------- Total current assets 2,040,292 2,072,240 Property and equipment, net 1,133,926 1,278,683 Goodwill and other intangibles 1,232,184 580,861 Other assets 318,696 265,703 ----------- ----------- Total assets $ 4,725,098 $ 4,197,487 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable $ 183,682 $ 268,215 Accrued salaries, wages and benefits 81,101 87,738 Other accrued liabilities 267,930 181,199 Income tax payable 38,114 88,752 Current portion of long-term obligations 433 1,030 ----------- ----------- Total current liabilities 571,260 626,934 ----------- ----------- Deferred tax liabilities 130,616 130,616 Other long-term obligations 967,359 936,058 ----------- ----------- Total long-term obligations and deferred tax liabilities 1,097,975 1,066,674 ----------- ----------- Commitments and contingencies (Note 11) Minority interest in subsidiaries 5,743 5,742 ----------- ----------- Stockholders' equity: Preferred shares; $.01 par value; 2,000 shares authorized -- -- Common stock; $.01 par value; 1,300,000 shares authorized; 365,250 and 321,523 shares outstanding 3,653 3,215 Additional paid-in capital 2,852,410 1,931,564 Deferred stock compensation (163,211) (163,045) Retained earnings 328,423 672,152 Accumulated other comprehensive income 28,845 54,251 ----------- ----------- Total stockholders' equity 3,050,120 2,498,137 ----------- ----------- Total liabilities and stockholders' equity $ 4,725,098 $ 4,197,487 =========== ===========
See notes to unaudited consolidated financial statements. 3 4 LSI LOGIC CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ----------------------------- (In thousands, except per share amounts) 2001 2000 2001 2000 ----------- ----------- ----------- ----------- Revenues $ 465,219 $ 644,328 $ 982,418 $ 1,259,514 ----------- ----------- ----------- ----------- Costs and expenses: Cost of revenues 284,759 367,978 595,904 722,378 Additional excess inventory charges 108,026 -- 108,026 11,100 Research and development 127,412 86,801 246,179 167,030 Selling, general and administrative 77,480 75,079 156,451 145,319 Acquired in-process research and 77,500 16,333 77,500 16,333 development Restructuring of operations and other non-recurring charges, net 59,839 -- 59,839 2,781 Amortization of non-cash deferred stock compensation(*) 27,840 -- 49,107 -- Amortization of intangibles 43,469 13,820 70,558 25,656 ----------- ----------- ----------- ----------- Total costs and expenses 806,325 560,011 1,363,564 1,090,597 ----------- ----------- ----------- ----------- (Loss)/income from operations (341,106) 84,317 (381,146) 168,917 Interest expense (9,864) (10,323) (19,804) (21,216) Interest income and other, net 3,742 11,507 12,721 18,636 Gain on sale of equity securities -- 15,314 5,302 49,486 ----------- ----------- ----------- ----------- (Loss)/income before income taxes (347,228) 100,815 (382,927) 215,823 (Benefit)/provision for income taxes (34,747) 30,239 (39,198) 59,004 ----------- ----------- ----------- ----------- Net (loss)/income $ (312,481) $ 70,576 $ (343,729) $ 156,819 =========== =========== =========== =========== (Loss)/earnings per share: Basic $ (0.91) $ 0.23 $ (1.03) $ 0.51 =========== =========== =========== =========== Dilutive $ (0.91) $ 0.21 $ (1.03) $ 0.46 =========== =========== =========== =========== Shares used in computing per share amounts: Basic 344,873 308,275 332,728 305,464 =========== =========== =========== =========== Dilutive 344,873 353,120 332,728 351,155 =========== =========== =========== ===========
(*) Amortization of non-cash deferred stock compensation, if not shown separately, of $685, $19,625 and $7,530 would have been included in cost of revenues, research and development and selling, general and administrative expenses respectively for the three months ended June 30, 2001. Amortization of non-cash deferred stock compensation, if not shown separately, of $848, $36,707 and $11,552 would have been included in cost of revenues, research and development and selling, general and administrative expenses, respectively for the six months ended June 30, 2001. See notes to unaudited consolidated financial statements. 4 5 LSI LOGIC CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30, --------------------------- (In thousands) 2001 2000 ---------- ---------- Operating activities: Net (loss)/income $ (343,729) $ 156,819 Adjustments: Depreciation and amortization 243,614 187,798 Amortization of non-cash deferred stock compensation 49,107 -- Acquired in-process research and development 77,500 14,745 Non-cash restructuring charges, net 59,517 2,781 Gain on sale of equity securities (5,302) (49,486) Changes in working capital components, net of assets acquired and liabilities assumed in business combinations: Accounts receivable, net 237,013 (126,135) Inventories, net (54,763) (43,037) Prepaid expenses and other assets (48,477) (51,678) Accounts payable (91,166) (13,237) Accrued and other liabilities (19,349) 53,075 ---------- ---------- Net cash provided by operating activities 103,965 131,645 ---------- ---------- Investing activities: Purchase of debt and equity securities available-for-sale (923,378) (684,199) Maturities and sales of debt and equity securities 941,687 485,534 available-for-sale Purchase of equity securities (10,819) (6,035) Proceeds from sale of stock investments 7,926 45,741 Purchases of property and equipment, net of retirements (125,635) (83,537) Acquisition of companies, net of cash acquired 43,979 (37,565) ---------- ---------- Net cash used in investing activities (66,240) (280,061) ---------- ---------- Financing activities: Proceeds from borrowings -- 500,000 Repayment of debt obligations (869) (375,786) Debt issuance costs -- (15,300) Issuance of common stock, net 44,367 90,166 ---------- ---------- Net cash provided by financing activities 43,498 199,080 ---------- ---------- Effect of exchange rate changes on cash and cash equivalents 791 (6,130) ---------- ---------- Increase in cash and cash equivalents 82,014 44,534 ---------- ---------- Cash and cash equivalents at beginning of period 235,895 250,603 ---------- ---------- Cash and cash equivalents at end of period $ 317,909 $ 295,137 ---------- ----------
See notes to unaudited consolidated financial statements. 5 6 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- BASIS OF PRESENTATION In the opinion of LSI Logic Corporation (the "Company" or "LSI"), the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments, except for additional excess inventory charges, acquired in-process research and development and restructuring and other non-recurring charges as discussed in Notes 2 and 3), necessary to present fairly the financial information included therein. While the Company believes that the disclosures are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. For financial reporting purposes, the Company reports on a 13 or 14 week quarter with a year ending December 31. For presentation purposes, the consolidated financial statements refer to the quarter's calendar month end for convenience. The results of operations for the quarter ended June 30, 2001 are not necessarily indicative of the results to be expected for the full year. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. NOTE 2 -- ACQUISITIONS ACQUISITION OF C-CUBE. On March 26, 2001, the Company signed a definitive merger agreement ("Merger Agreement") to acquire C-Cube Microsystems Inc. ("C-Cube"). In accordance with the Merger Agreement, the Company commenced an exchange offer whereby it offered 0.79 of a share of common stock for each outstanding share of C-Cube common stock. Under the terms of the Merger Agreement, the exchange offer was followed by a merger in which the Company acquired, at the same exchange ratio, the remaining shares of C-Cube common stock not previously acquired in the exchange offer. Upon completion of the merger, the Company assumed all options and warrants to purchase shares of C-Cube common stock and converted them into options and warrants to purchase shares of the Company's common stock. The merger was subject to customary closing conditions, including the tender for exchange of at least a majority of C-Cube's outstanding shares of common stock (including for purposes of the calculation of the majority of shares, certain outstanding options and warrants to purchase C-Cube shares.) The acquisition was effective May 11, 2001. The Company issued approximately 40.2 million shares of its common stock, 10.6 million options and 0.8 million warrants in exchange for the outstanding ordinary shares, options and warrants of C-Cube, respectively. The acquisition is intended to enhance and accelerate the Company's digital video product offerings in the Semiconductor segment. The acquisition was accounted for as a purchase. Accordingly, the results of operations of C-Cube and estimated fair value of assets acquired and liabilities assumed were included in the Company's consolidated financial statements as of May 11, 2001 through the end of the period. 6 7 The components of purchase price are as follows (in thousands):
Fair value of common shares issued $ 752,557 Fair value of options assumed 116,174 Fair value of warrants assumed 8,121 Direct acquisition costs 16,856 ---------- Total purchase price $ 893,708 ==========
The fair value of common shares issued was determined using a price of approximately $18.73, which represents the average closing stock price for the period of two days before and after the announcement of the merger. The fair value of the options and warrants assumed was determined using the Black-Scholes method. The portion of the intrinsic value of unvested options of C-Cube relating to the vesting period following consummation of the transaction has been allocated to deferred stock compensation. The Company calculated the intrinsic value of the unvested options using the closing price of its common stock on the date of consummation of the merger. Deferred stock compensation is included as a component of stockholders' equity and will be amortized over the remaining vesting period of the options. Direct acquisition costs consist of investment banking, legal and accounting fees. The total purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed based on independent appraisals and management estimates as follows (in thousands):
Tangible net assets acquired $ 64,315 Acquired in-process research and development 77,500 Current technology 74,000 Trademarks 20,500 Assembled workforce 36,000 Excess of purchase price over net assets acquired 572,120 ---------- Total purchase price excluding deferred stock compensation 844,435 Deferred stock compensation 49,273 ---------- Total purchase price $ 893,708 ==========
In-process research and development. In connection with the purchase of C-Cube, the Company recorded a $77.5 million charge to in-process research and development. The amount was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed. As of the acquisition date, there were various projects that met the above criteria. The primary projects identified consisted of digital video disc ("DVD"), recordable digital video ("DVD-R"), Consumer Set-Top Box and Cable Modem. The value of the projects identified to be in progress was determined by estimating the future cash flows from the projects once commercially feasible, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value. The net cash flows from the identified projects were based on estimates of revenues, cost of revenues, research and development costs, selling general and administrative costs and applicable income taxes for the projects. The percentage of completion for the projects was determined based on research and development expenses incurred as of May 11, 2001 for the projects as a percentage of total research and development expenses to bring the projects to technological feasibility. The discount rate used was 27.5% for these projects. The development of these projects started in early 1999. As of May 11, 2001, the Company estimated the projects were approximately 84%, 62%, 61% and 69% complete for DVD, DVD-R, Consumer Set-Top Box and Cable Modem, respectively. Development of the technology remains a substantial risk to the Company due to factors including the remaining effort to achieve technological feasibility, rapidly changing customer markets and competitive threats from other companies. Additionally, the value of other intangible assets acquired may become impaired. Useful life of intangible assets. The amount allocated to current technology, trademarks, assembled workforce and excess of purchase price over net assets acquired is being amortized over their estimated weighted average useful life of six years using the straight-line method. 7 8 Pro forma results. The following pro forma summary is provided for illustrative purposes only and is not necessarily indicative of the consolidated results of operations for future periods or that actually would have been realized had the Company and C-Cube been a consolidated entity during the periods presented. The summary combines the results of operations as if C-Cube had been acquired as of the beginning of the periods presented. The summary includes the impact of certain adjustments such as amortization of intangibles and non-cash deferred stock compensation. Additionally, the in-process research and development charge of $77.5 million discussed above has been excluded from the periods presented as it arose from the acquisition of C-Cube. The restructuring and other non-recurring charges of $60 million were included in the pro forma calculation as the charges did not relate to the acquisition of C-Cube (See Note 3 of the Notes.)
SIX MONTHS ENDED JUNE 30, 2001 2000 ------------ ------------ (UNAUDITED) (IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS) ------------------------------- Revenues ..................... $ 1,000,275 $ 1,381,559 Net (loss)/ income ........... $ (324,665) $ 79,064 Basic EPS .................... $ (0.90) $ 0.23 Diluted EPS .................. $ (0.90) $ 0.21
Recent Accounting Pronouncements In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (SFAS 141 and SFAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets." SFAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. SFAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. SFAS 141 and SFAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of SFAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under SFAS 141 will be reclassified to goodwill. Companies are required to adopt SFAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted. The Company will adopt SFAS 142 on January 1, 2002, the beginning of fiscal 2002. In connection with the adoption of SFAS 142, the Company will be required to perform a transitional goodwill impairment assessment. The Company has not yet determined the impact these standards will have on its results of operations and financial position. NOTE 3 -- RESTRUCTURING AND OTHER NON-RECURRING ITEMS The Company recorded approximately $60 million in restructuring and other non-recurring charges during the three months ended June 30, 2001. Total restructuring charges were $52 million and other non-recurring charges were approximately $8 million for the three months ending June 30, 2001. Restructuring: In April of 2001, the Company announced the closure of the Company's Colorado Springs fabrication facility ("the facility") in August of 2001. In May of 2001, the Company entered into a definitive agreement to sell the facility to X-FAB Semiconductor Foundries AG ("X-Fab"), a German corporation. As part of the agreement, the Company agreed to purchase a minimum amount of production wafers and die from the facility for a period of 18 months following the close of the transaction. During the quarter ended June 30, 2001, the Company recorded an impairment charge of $71 million relating to the facility of which approximately $35 million was recorded in cost of sales and $36 million was recorded in restructuring charges. The restructuring charges consisted of fixed asset 8 9 write-downs due to impairment, losses on an operating lease for equipment, severance for approximately 413 employees and other exit costs. On August 1, 2001, the Company announced the termination of the agreement to sell the facility because X-Fab was unable to secure the required funding to close the transaction. The facility is currently scheduled to close in October of 2001. The Company is continuing its efforts to dispose of the facility and estimates that its reserves as of June 30, 2001 are adequate to cover losses associated with the disposal of the facility. The Company reclassified approximately $96 million from property, plant and equipment to other current assets to reflect the intention to dispose of the facility within the next twelve months. The Company recorded approximately $16 million in additional restructuring charges primarily associated with the write-down of fixed assets in the U.S., Japan and Hong Kong that will be disposed of and severance charges for approximately 243 employees in the U.S., Europe and Asia Pacific. The fair value of assets determined to be impaired was the result of independent appraisals and the use of management estimates. Given that current market conditions for the sale of older fabrication facilities and related equipment may continue to deteriorate, there can be no assurance that the company will realize its current net book value for the assets. The Company will reassess the realizability of the carrying value of these assets at the end of each quarter until the assets are sold or otherwise disposed of and additional adjustments may be necessary. The following table sets forth the Company's restructuring reserves as of June 30, 2001:
(In thousands) Restructuring Balance Expense June 30, June 30, 2001 Utilized 2001 ------------- ---------- ---------- Write-down of excess assets(a) $ 22,920 $ (21,513) $ 1,407 Lease terminations and maintenance contracts 14,253 14,253 Other exit costs 7,742 7,742 Payments to employees for severance(b) 6,848 (2,764) 4,084 ---------- ---------- ---------- Total $ 51,763 $ (24,277) $ 27,486 ========== ========== ==========
(a) Amounts utilized in 2001 reflect a write-down of fixed assets in the U.S., Japan and Hong Kong due to impairment. The amounts were accounted for as a reduction of the assets and did not result in a liability. The $1.4 million balance as of June 30, 2001 relates to machinery and equipment decommissioning costs in the U.S. (b) Amounts utilized represent cash payments related to the severance of 230 employees during the second quarter of 2001. Other non-recurring: The Company recorded approximately $8 million in other non-recurring charges associated with the write-down of intangible assets due to impairment. The majority of the intangible assets were originally acquired in the purchase of a division of Neomagic in the second quarter of 2000. On February 22, 2000, the Company entered into an agreement with a third party to outsource certain testing services performed by the Company at its Fremont, California facility. The agreement provided for the sale and transfer of certain test equipment and related peripherals for total proceeds of approximately $10.7 million. The Company recorded a loss of approximately $2.2 million associated with the agreement. In March 2000, the Company recorded approximately $1.1 million of non-cash compensation-related expenses resulting from a separation agreement entered into during the quarter with a former employee and a $0.5 million benefit from the reversal of reserves established in the second quarter of 1999 for merger related expenses in connection with the merger with SEEQ Technology, Inc. ("SEEQ"). 9 10 In the second quarter of 1999, the Company and Silterra Malaysia Sdn. Bhd. (formerly known as Wafer Technology (Malaysia) Sdn. Bhd.) ("Silterra") entered into a technology transfer agreement under which the Company grants licenses to Silterra with respect to certain of the Company's wafer fabrication technologies and provides associated manufacturing training and related services. In exchange, the Company receives cash and equity consideration valued at $120 million over three years for which transfers and obligations of the Company are scheduled to occur. The Company transferred technology to Silterra valued at $6 million for each of the three month periods ended June 30, 2001 and 2000 and $12 million for each of the six month periods ended June 30, 2001 and 2000. The amount was recorded as an offset to the Company's R&D expenses. In addition, the Company provided engineering training with a value of $1 million for each of the three month periods ended June 30, 2001 and 2000, and $2 million for each of the six month periods ended June 30, 2001 and 2000. The amount was recorded as an offset to cost of revenues. NOTE 5 -- INVESTMENTS As of June 30, 2001 and December 31, 2000, the Company held $132 million and $89 million of debt securities, respectively, that were included in cash and cash equivalents and $824 million and $897 million of debt and equity securities, respectively, that were classified as short-term investments on the Company's consolidated balance sheet. Debt securities consisted primarily of U.S. and foreign corporate debt securities, commercial paper, auction rate preferred stock, overnight deposits, certificates of deposit and U.S. government and municipal agency securities. Unrealized holding gains and losses of held-to-maturity securities and available-for-sale debt securities were not significant and accordingly the amortized cost of these securities approximated fair market value at June 30, 2001 and December 31, 2000. Contract maturities of these securities were within one year as of June 30, 2001. Realized gains and losses for held-to-maturity securities and available-for-sale debt securities were not significant for the three month periods ended June 30, 2001 and 2000. As of June 30, 2001 and December 31, 2000, the Company had marketable equity securities with an aggregate carrying value of $50 million and $66 million, respectively, of which all securities were classified as other long-term assets at June 30, 2001 and $60 million were classified as short-term investments on the Company's consolidated balance sheet at December 31, 2000. The remaining balance was included in other long-term assets. As of June 30, 2001, an unrealized gain of $25 million, net of the related tax effect of $13 million, related to these equity securities was included in accumulated other comprehensive income. As of December 31, 2000, an unrealized gain of $31 million, net of the related tax effect of $17 million, on these equity securities was included in accumulated other comprehensive income. During the three month period ended June 30, 2001, the Company did not sell any equity securities. During the six month period ended June 30, 2001, the Company sold equity securities for approximately $8 million in the open market, realizing a pre-tax gain of approximately $5 million. During the three and six month periods ended June 30, 2000, the Company sold equity securities for approximately $16 million and $46 million, respectively, in the open market, realizing a pre-tax gain of approximately $15 million and $42 million, respectively. In addition, the Company realized a pre-tax loss of approximately $7 million associated with a marketable equity investment in a certain technology company during the three months ended June 30, 2001. The 10 11 decline in value of the investment was considered by management to be other than temporary. The Company realized a pre-tax gain of approximately $7 million associated with equity securities of a certain technology company that was acquired by another technology company during the six month period ended June 30, 2000. The Company does not anticipate selling any marketable equity securities in the second half of 2001. NOTE 6 -- DERIVATIVE FINANCIAL INSTRUMENTS The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and 138 as of January 1, 2001. SFAS No. 133 requires that an entity recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow and foreign currency hedges and establishes respective accounting standards for reporting changes in the fair value of the instruments. All of the Company's derivative instruments are recorded at their fair value in other current assets or other accrued liabilities. The transition adjustment upon adoption of SFAS No. 133 was not material. On the date a derivative contract is entered into, the Company designates its derivative as either a hedge of the fair value of a recognized asset or liability ("fair-value" hedge), as a hedge of the variability of cash flows to be received ("cash-flow" hedge), or as a foreign-currency hedge. Changes in the fair value of a derivative that is highly effective, and is designated and qualifies as a fair-value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk (including losses or gains on firm commitments), are recorded in current period earnings. Changes in the fair value of a derivative that is highly effective, and is designated and qualifies as a cash-flow hedge, are recorded in other comprehensive income, until earnings are affected by the variability of the cash flows. Changes in the fair value of derivatives that are highly effective as, and are designated and qualify as a foreign-currency hedge, are recorded in either current period earnings or other comprehensive income, depending on whether the hedge transaction is a fair-value hedge (e.g., a hedge of a firm commitment that is to be settled in a foreign currency) or a cash-flow hedge (e.g., a foreign-currency-denominated forecasted transaction). As of June 30, 2001, the Company had certain foreign currency fair-value and cash-flow hedges outstanding. The Company's derivative instruments at December 31, 2000 were designated as foreign currency fair-value hedges. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair-value, cash-flow or foreign-currency hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of the hedged items. If it were determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company would discontinue hedge accounting prospectively, as discussed below. The Company would discontinue hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated or exercised; (3) the derivative is no longer designated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; (4) the hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designation of the derivative as a hedge instrument is no longer appropriate. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the derivative will continue to be carried on the balance sheet at its fair value, and the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the derivative will continue to be carried on the balance sheet at its fair value, and any asset or liability that was recorded pursuant to recognition of the firm commitment will be removed from 11 12 the balance sheet and recognized as a gain or loss in current-period earnings. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the derivative will be carried as its fair value on the balance sheet, with changes in its fair value recognized in current period earnings. The Company has foreign subsidiaries that operate and sell the Company's products in various global markets. As a result, the Company is exposed to changes in foreign currency exchange rates and interest rates. The Company utilizes various hedge instruments, primarily forward contracts and currency option contracts, to manage its exposure associated with firm intercompany and third-party transactions and net asset and liability positions denominated in non-functional currencies. The Company does not hold derivative financial instruments for speculative or trading purposes. Forward contracts Forward contracts are used to hedge certain cash flows denominated in non-functional currencies. These contracts expire within one to seven month periods and are designated as foreign currency fair-value hedges in accordance with SFAS No. 133. Changes in the fair value of forward contracts due to changes in time value are excluded from the assessment of effectiveness and are recognized in other income and expense. For the three and six months ended June 30, 2001, the change in time value of the forward contracts was not significant. The Company did not record any gains or losses due to hedge ineffectiveness for the three and six month periods ended June 30, 2001. Forward exchange contracts are also used to hedge certain foreign currency denominated assets or liabilities. These derivatives do not qualify for SFAS No. 133 hedge accounting treatment. Accordingly, changes in the fair value of these hedges are recorded immediately in earnings to offset the changes in fair value of the assets or liabilities being hedged. The related gains and losses included in other income and expense was not significant. Option contracts As of June 30, 2001, the Company held purchased currency option contracts that were designated as foreign currency cash-flow hedges of third-party yen revenue exposures. There were no option contracts outstanding as of December 31, 2000. Changes in the fair value of currency option contracts due to changes in time value are excluded from the assessment of effectiveness and are recognized in other income and expense. For the three and six months ended June 30, 2001, the change in option time value was $1.7 million and $3.3 million, respectively. The contracts expire over a six month period. For the three and six months ended June 30, 2001, an amount of $1.3 million was reclassified to revenue. Unrealized gains of $4.9 million were included in accumulated other comprehensive income and will be reclassified to revenue over the next six month period as the forecasted transactions occur. The Company did not record any gains or losses due to hedge ineffectiveness for the three and six month periods ended June 30, 2001. NOTE 7 -- BALANCE SHEET DETAIL
June 30, December 31, (In thousands) 2001 2000 ---------- ---------- Inventories: Raw materials $ 41,060 $ 36,133 Work-in-process 103,311 129,394 Finished goods 211,309 124,848 ---------- ---------- $ 355,680 $ 290,375 ========== ==========
12 13 During the second quarter of 2001, the Company wrote-down certain inventory. This additional excess inventory charge was due to a sudden and significant decrease in forecasted revenue and was calculated in accordance with the Company's policy, which is primarily based on inventory levels in excess of 12-month demand for each specific product and the use of management judgment. NOTE 8 --DEBT
June 30, December 31, (In thousands) 2001 2000 ------------ ------------ 2000 Convertible Subordinated Notes $ 500,000 $ 500,000 1999 Convertible Subordinated Notes 344,935 345,000 Capital lease obligations 1,472 2,341 ------------ ------------ 846,407 847,341 Current portion of long-term debt, capital lease obligations and short-term borrowings (433) (1,030) ------------ ------------ Long-term debt and capital lease obligations $ 845,974 $ 846,311 ============ ============
On March 14, 2001, the Second Amended and Restated Credit Agreement was amended to reduce the total revolving commitment by $165 million from $240 million to $75 million. On the effective date of this reduction, the revolving commitment of each lender was reduced accordingly. On February 18, 2000, the Company issued $500 million of 4% Convertible Subordinated Notes (the "2000 Convertible Notes") due in 2005. The 2000 Convertible Notes are subordinated to all existing and future senior debt, are convertible, at the option of the holder, at any time into shares of the Company's common stock at a conversion price of $70.2845 per share and are redeemable at the Company's option, in whole or in part, at any time on or after February 20, 2003. Each holder of the 2000 Convertible Notes has the right to cause the Company to repurchase all of such holder's convertible notes at 100% of their principal amount plus accrued interest upon the occurrence of certain events and in certain circumstances. Interest is payable semiannually. The Company paid approximately $15.3 million for debt issuance costs related to the 2000 Convertible Notes. The debt issuance costs are being amortized using the interest method. The net proceeds from the 2000 Convertible Notes were used to repay bank debt outstanding with a balance of approximately $380 million as of December 31, 1999. NOTE 9 --RECONCILIATION OF BASIC AND DILUTED (LOSS)/ EARNINGS PER SHARE A reconciliation of the numerators and denominators of the basic and diluted per share amount computations as required by SFAS No. 128 "Earnings Per Share" ("EPS") is as follows: 13 14
Three Months Ended June 30, -------------------------------------------------------------------------------- 2001 2000 -------------------------------------- ------------------------------------ Per-Share Per-Share (In thousands except per share amounts) Loss* Shares+ Amount Income* Shares+ Amount -------- -------- -------- -------- -------- --------- Basic EPS: Net (loss)/ income available to Common stockholders $(312,481) 344,873 $ (0.91) $ 70,576 308,275 $ 0.23 -------- -------- Effect of dilutive securities: Stock options -- -- -- -- 22,837 -- 4 1/4% Convertible Subordinated Notes -- -- -- 2,750 22,008 -- Diluted EPS: Net (loss)/ income available to Common stockholders $(312,481) 344,873 $ (0.91) $ 73,326 353,120 $ 0.21 -------- --------
* Numerator + Denominator Options to purchase approximately 71,395,129 shares were outstanding at June 30, 2001 and were excluded from the computation of diluted shares because of their antidilutive effect on earnings per share for the three months ended June 30, 2001. The exercise price of these options ranged from $0.01 to $72.25 at June 30, 2001. Options to purchase approximately 393,836 shares were outstanding as of June 30, 2000, but were excluded from the computation of diluted shares for the three months ended June 30, 2000 because the exercise price of these options was greater than the average market price of common shares for the three month period then ended. The exercise price of these options ranged from $58.50 to $72.25 at June 30, 2000. For the three months ended June 30, 2001, common equivalent shares of 22,003,317 and interest expense of $2.7 million, net of taxes, associated with the 1999 Convertible Notes were excluded from the calculation of diluted shares because of their antidilutive effect on earnings per share. Common equivalent shares of 7,113,944 and interest expense of $3.7 million, net of taxes, associated with the 2000 Convertible Notes were also excluded from the calculation of diluted shares because of their antidilutive effect on earnings per share. For the three months ended June 30, 2000, common equivalent shares of 7,113,944 and interest expense of $3.8 million, net of taxes, associated with the 2000 Convertible Notes were excluded from the calculation of diluted shares because of their antidilutive effect on earnings per share.
Six Months Ended June 30, -------------------------------------------------------------------------------- 2001 2000 -------------------------------------- ------------------------------------ Per-Share Per-Share (In thousands except per share amounts) Loss* Shares+ Amount Income* Shares+ Amount -------- -------- -------- -------- -------- --------- Basic EPS: Net (loss)/ income available to Common stockholders $(343,729) 332,728 $ (1.03) $156,819 305,464 $ 0.51 -------- -------- Effect of dilutive securities: Stock options -- -- -- -- 23,683 -- 4 1/4% Convertible Subordinated Notes -- -- -- 5,498 22,008 -- Diluted EPS: Net (loss)/ income available to Common stockholders $(343,729) 332,728 $ (1.03) $162,317 351,155 $ 0.46 -------- --------
* Numerator + Denominator 14 15 Options to purchase approximately 71,395,129 shares were outstanding at June 30, 2001 and were excluded from the computation of diluted shares because of their antidilutive effect on earnings per share for the six months ended June 30, 2001. The exercise price of these options ranged from $0.01 to $72.25 at June 30, 2001. Options to purchase approximately 208,764 shares were outstanding as of June 30, 2000, but were excluded from the computation of diluted shares for the six months ended June 30, 2000 because the exercise price of these options was greater than the average market price of common shares for the six month period then ended. The exercise price of these options ranged from $58.50 to $72.25 at June 30, 2000. For the six months ended June 30, 2001, common equivalent shares of 22,003,317 and interest expense of $5.5 million, net of taxes, associated with the 1999 Convertible Notes were excluded from the calculation of diluted shares because of their antidilutive effect on earnings per share. Common equivalent shares of 7,113,944 and interest expense of $7.5 million, net of taxes, associated with the 2000 Convertible Notes were also excluded from the calculation of diluted shares because of their antidilutive effect on earnings per share. For the six months ended June 30, 2000, common equivalent shares of 5,258,169 and interest expense of $5.5 million, net of taxes, associated with the 2000 Convertible Notes were excluded from the calculation of diluted shares because of their antidilutive effect on earnings per share. NOTE 10 -- COMPREHENSIVE (LOSS)/ INCOME Comprehensive (loss)/ income is defined as a change in equity of a company during a period from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The primary difference between net (loss)/ income and comprehensive (loss)/ income for the Company arises from foreign currency translation adjustments, unrealized gains and losses on derivative instruments designated as and qualifying as cash-flow hedges and unrealized gains and losses on available-for-sale securities, net of applicable taxes. Comprehensive (loss)/ income, net of taxes for the current reporting period and comparable period in the prior year is as follows:
Three Months Ended Six Months Ended June 30, June 30, ------------------------- ------------------------- (In thousands) 2001 2000 2001 2000 --------- --------- --------- --------- Net (loss)/ income $(312,481) $ 70,576 $(343,729) $ 156,819 Change in unrealized gain on derivative instruments designated as and qualifying as cash-flow hedges 726 -- 4,926 -- Change in unrealized gain on available for sale securities 14,362 (10,050) (6,801) 12,454 Change in foreign currency translation adjustments (3,396) (2,165) (23,531) (9,444) ========= ========= ========= ========= Comprehensive (loss)/ income $(300,789) $ 58,361 $(369,135) $ 159,829 ========= ========= ========= =========
15 16 NOTE 11 --SEGMENT REPORTING The Company operates in two reportable segments: the Semiconductor segment and the Storage Area Network ("SAN") Systems segment. In the Semiconductor segment, the Company designs, develops, manufactures and markets integrated circuits, including application-specific integrated circuits, application-specific standard products and related products and services. Semiconductor design and service revenues include engineering design services, licensing of our advanced design tools software, and technology transfer and support services. The Company's customers use these services in the design of increasingly advanced integrated circuits characterized by higher levels of functionality and performance. The proportion of revenues from ASIC design and related services compared to semiconductor product sales varies among customers depending upon their specific requirements. In the SAN Systems segment, the Company designs, manufactures, markets and supports high performance data storage management and storage systems solutions and a complete line of Redundant Array of Independent Disk systems, subsystems and related software. The following is a summary of operations by segment for the three and six months ended June 30, 2001 and 2000:
Three months ended Six months ended June 30, June 30, --------------------------- --------------------------- (In thousands) 2001 2000 2001 2000 ---------- ---------- ---------- ---------- REVENUES: Semiconductor $ 413,870 $ 547,285 $ 868,859 $1,077,672 SAN Systems 51,349 97,043 113,559 181,842 ---------- ---------- ---------- ---------- Total $ 465,219 $ 644,328 $ 982,418 $1,259,514 ========== ========== ========== ========== (LOSS)/INCOME FROM OPERATIONS: Semiconductor $ (319,984) $ 76,435 $ (351,140) $ 149,436 SAN Systems (21,122) 7,882 (30,006) 19,481 ---------- ---------- ---------- ---------- Total $ (341,106) $ 84,317 $ (381,146) $ 168,917 ========== ========== ========== ==========
16 17 Intersegment revenues for the periods presented above were not significant. Restructuring of operations and other non-recurring items were included in the both segments for the applicable periods. One customer represented 19% and 13% of the Company's total consolidated revenues for each of the three month periods ended June 30, 2001 and 2000, respectively. In the Semiconductor segment, one customer represented 21% and 11% of total Semiconductor revenues for the three month periods ended June 30, 2001 and 2000, respectively. In the SAN Systems segment, there were three customers with revenues representing 21%, 17% and 14% and two customers with revenues representing 11% of total SAN Systems revenues, respectively for the three month period ended June 30, 2001. For the three month period ended June 30, 2000, there were four customers with revenues representing 28%, 20%, 17% and 14% of total SAN Systems revenues, respectively. One customer represented 17% and 13% of the Company's total consolidated revenues for each of the six month periods ended June 30, 2001 and 2000, respectively. In the Semiconductor segment, one customer represented 20% and 10% of total Semiconductor revenues for the six month periods ended June 30, 2001 and 2000, respectively. In the SAN Systems segment, there were four customers with revenues representing 20%, 19%, 16% and 12% of total SAN Systems revenues, respectively for the six month period ended June 30, 2001. For the six month period ended June 30, 2000, there were four customers with revenues representing 25%, 20%, 16% and 15% of total SAN Systems revenues, respectively. The following is a summary of total assets by segment as of June 30, 2001 and December 31, 2000:
June 30, December 31, (In thousands) 2001 2000 ---------- ---------- TOTAL ASSETS: Semiconductor $4,391,858 $3,851,849 SAN Systems 333,240 345,638 ---------- ---------- Total $4,725,098 $4,197,487 ========== ==========
Revenues from domestic operations were $256 million, representing 55% of consolidated revenues, for the second quarter of 2001 compared to $404 million, representing 63% of consolidated revenues, for the same period of 2000. Revenues from domestic operations were $539 million, representing 55% of consolidated revenues, for the first half of 2001 compared to $765 million, representing 61% of consolidated revenues, for the same period of 2000. 17 18 NOTE 12 --COMMITMENTS AND CONTINGENCIES In April 2001, the Company entered into a master lease and security agreement with a group of companies ("Lessor") for up to $230 million for certain wafer fabrication equipment. Each lease supplement pursuant to the transaction will have a lease term of five years with two consecutive renewal options at the Lessor's option. The Company may, at the end of any lease term, return, or purchase at a stated amount all the equipment. Upon return of the equipment, the Company must pay the Lessor a termination value. In April 2001, the Company has drawn down $60 million as the first supplement pursuant to the agreement. Subsequently, the Company drew down $33 million in May 2001 as the second supplement. Minimum rental payments under this operating lease, excluding option periods, are $24.2 million in 2002, $22.6 million in 2003, $20.9 million in 2004 and $19.3 million in 2005. Under this lease, the Company is required to maintain compliance with certain financial covenants. In March 2000, the Company entered into a master lease and security agreement with a group of companies ("Lessor") for up to $250 million for certain wafer fabrication equipment. Each lease supplement pursuant to the transaction will have a lease term of three years with two consecutive renewal options. The Company may, at the end of any lease term, return, or purchase at a stated amount all the equipment. Upon return of the equipment, the Company must pay the Lessor a termination value. Through June 30, 2001, the Company has drawn down a total of $250 million under five lease supplements pursuant to the agreement. Minimum rental payments under these operating leases, including option periods, are $53.5 million in 2002, $47.9 million in 2003, $40.6 million in 2004, $23.8 million in 2005 and $0.6 million in 2006. Under this lease, the Company is required to maintain compliance with certain financial covenants. NOTE 13 --LEGAL MATTERS Reference is made to Item 3, Legal Proceedings, of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000 for a discussion of certain pending legal proceedings. In addition, the Company is a party to other litigation matters and claims that are normal in the course of its operations. The information provided at such reference regarding those matters remains substantially unchanged except as set forth herein. Regarding the pending litigation initiated by the Lemelson Medical, Education & Research Foundation, Limited Partnership against certain electronics industry companies, including LSI, that was described in the Company's prior reports, the court has completed its review of motion papers filed in connection with Cypress Semiconductor's and plaintiff's cross-motions for summary judgment with respect to the 4,390,586 patent and granted a motion for oral arguments to be held in mid-December. These activities are ongoing and, as of yet, no trial date has been set. In addition, the Company is a party to other litigation matters and claims which are normal in the course of its operations. The Company continues to believe that the final outcome of such matters will not have a material adverse effect on the Company's consolidated financial position or results of operations. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company's financial position or its results of operations. The information in Item 3 pertaining to the proceedings that are pending in the Court of Queen's Bench of Alberta, Judicial District of Calgary (the "Court") between the Company, its Canadian subsidiary ("LSI Canada) and certain former shareholders of LSI Canada is updated as follows. Following a hearing held in March 2001, the Court dismissed the motion of the former shareholders that challenged the propriety of the fair value proceedings initiated by LSI Canada and the jurisdiction of the Court to adjudicate the matter. In addition, the Court ruled that the portions of the application of the former shareholders to initiate a claim based upon allegations that actions of LSI Logic Corporation and certain named (former) directors and a (former) officer of LSI Canada were oppressive of the rights of minority shareholders in LSI Canada are struck and the balance are stayed. The Court also directed the litigants to recommence preparation for trial in the fair value proceeding and advised the litigants of the Court's intention to schedule a date for trial of that matter as soon as practicable. While we cannot give any assurances regarding the resolution of these matters, we believe that the final outcome will not have a material adverse effect on our consolidated results of operations or financial condition. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company's financial position or its results of operations. 18 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL We believe that our future operating results will continue to be subject to quarterly variations based upon a wide variety of factors detailed in Risk Factors in Part I of our Annual Report on Form 10-K for the year ended December 31, 2000. These factors include, among others: - Cyclical nature of both the Semiconductor and the Storage Area Network ("SAN") Systems industries and the markets addressed by our products; - Availability and extent of utilization of manufacturing capacity; - Price erosion; - Competitive factors; - Timing of new product introductions; - Changes in product mix; - Fluctuations in manufacturing yields; - Product obsolescence; - Business and product market cycles; - Economic and technological risks associated with our acquisition and alliance activities; and - The ability to develop and implement new technologies. Our operating results could also be impacted by sudden fluctuations in customer requirements, currency exchange rate fluctuations and other economic conditions affecting customer demand and the cost of operations in one or more of the global markets in which we do business. We operate in a technologically advanced, rapidly changing and highly competitive environment. We predominantly sell custom products to customers operating in a similar environment. Accordingly, changes in the conditions of any of our customers may have a greater impact on our operating results and financial condition than if we predominantly offered standard products that could be sold to many purchasers. While we cannot predict what effect these various factors may have on our financial results, the aggregate effect of these and other factors could result in significant volatility in our future performance. To the extent our performance may not meet expectations published by external sources, public reaction could result in a sudden and significantly adverse impact on the market price of our securities, particularly on a short-term basis. We have international subsidiaries and distributors that operate and sell our products globally. Further, we purchase a substantial portion of our raw materials and manufacturing equipment from foreign suppliers and incur labor and other operating costs in foreign currencies, particularly in our Japanese manufacturing facilities. As a result, we are exposed to the risk of changes in foreign currency exchange rates or declining economic conditions in these countries. We utilize forward exchange and purchased currency option contracts to manage our exposure associated with net asset and liability positions and cash flows denominated in non-functional currencies. (See Note 6 of the Notes to Unaudited Consolidated Financial Statements referred to hereafter as "Notes.") There is no assurance that these hedging transactions will eliminate exposure to currency rate fluctuations that could affect our operating results. Our corporate headquarters and some of our manufacturing facilities are located near major earthquake faults. As a result, in the event of a major earthquake, we could suffer damages that could significantly and adversely affect our operating results and financial condition. Our operations depend upon a continuing adequate supply of electricity, natural gas and water. These energy sources have historically been available on a continuous basis and in adequate quantities for our needs. However, given the current power shortage in California, it is possible that the shortage may spread to other areas of the country, including Oregon. An interruption in the supply of raw materials or energy inputs for any reason would have an adverse effect on our manufacturing operations. 19 20 While management believes that the discussion and analysis in this report is adequate for a fair presentation of the information, we recommend that you read this discussion and analysis in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2000. Statements in this discussion and analysis include forward looking information statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. These statements involve known and unknown risks and uncertainties. Our actual results in future periods may be significantly different from any future performance suggested in this report. Risks and uncertainties that may affect our results may include, among others: - Fluctuations in the timing and volumes of customer demand; - Currency exchange rates; - Availability and utilization of our manufacturing capacity; - Timing and success of new product introductions; and - Unexpected obsolescence of existing products. We operate in an industry sector where security values are highly volatile and may be influenced by economic and other factors beyond our control. See additional discussion contained in "Risk Factors" set forth in Part I of our Annual Report on Form 10-K for the year ended December 31, 2000. ACQUISITION AND OTHER On March 26, 2001, we signed a definitive merger agreement ("Merger Agreement") to acquire C-Cube Microsystems Inc. ("C-Cube") in a transaction accounted for as a purchase (See Note 2 of the Notes). In accordance with the Merger Agreement, we commenced an exchange offer whereby we offered 0.79 of a share of common stock for each outstanding share of C-Cube common stock. Under the terms of the Merger Agreement, the exchange offer was followed by a merger in which we acquired, at the same exchange ratio, the remaining shares of C-Cube common stock not previously acquired in the exchange offer. The acquisition was effective as of May 11, 2001. On April 4, 2001, we announced a co-development and foundry supply agreement with Taiwan Semiconductor Manufacturing Company Ltd. ("TSMC") to combine their efforts for development of advanced process technologies and to collaborate on state-of-the-art manufacturing. Under the agreement, both companies will deploy a jointly developed 0.13-micron process technology. We will support customer design programs for leading-edge system-on-a-chip products using this advanced process. Resulting products will be produced in both ours and TSMC's manufacturing facilities. The two companies have also agreed to explore collaborative opportunities on next generation process technology nodes, which will be ahead of published industry roadmaps. RESULTS OF OPERATIONS Where more than one significant factor contributed to changes in results from year to year, we have quantified material factors throughout the MD&A where practicable. REVENUE: We operate in two reportable segments: the Semiconductor segment and the Storage Area Network ("SAN") Systems segment. In the Semiconductor segment, we design, develop, manufacture and market integrated circuits, including application-specific integrated circuits, (commonly known in the industry as ASICs), application-specific standard products and related products and services. Semiconductor design and service revenues include engineering design services, licensing of our advanced design tools software, and technology transfer and support services. Our customers use these services in the design of increasingly advanced integrated circuits characterized by higher levels of functionality and performance. The proportion of revenues from ASIC design and related services compared to semiconductor product sales varies among customers depending upon their specific requirements. In the SAN Systems segment, we design, manufacture, market and support high-performance data 20 21 storage management and storage systems solutions and a complete line of Redundant Array of Independent Disk ("RAID") systems, subsystems and related software. (See Note 11 of the Notes.) Total revenues for the second quarter of 2001 decreased $179.1 million or 28% to $465.2 million from $644.3 million for the same period of 2000 on a consolidated basis. Revenues for the Semiconductor segment decreased $133.4 million or 24% to $413.9 million for the second quarter of 2001 from $547.3 million for the same period of 2000. The decrease was primarily attributable to decreased demand for products used in broadband access and networks, networking infrastructure and storage infrastructure applications. Revenues for the SAN Systems segment decreased $45.7 million or 47% to $51.3 million for the second quarter of 2001 from $97.0 million for the same period of 2000 due to decreased demand for all products sold in the SAN Systems segment. There were no significant intersegment revenues during the periods presented. Total revenues for the first half of 2001 decreased $277.1 million or 22% to $982.4 million from $1,259.5 million for the same period of 2000 on a consolidated basis. Revenues for the Semiconductor segment decreased $208.8 million or 19% to $868.9 million for the first half of 2001 from $1,077.7 million for the same period of 2000. The decrease was primarily attributable to decreased demand for products used in broadband access and networks, networking infrastructure and storage infrastructure applications. Revenues for the SAN Systems segment decreased $68.2 million or 38% to $113.6 million for the first half of 2001 from $181.8 million for the same period of 2000 due to decreased demand for all products sold in the SAN Systems segment. There were no significant intersegment revenues during the periods presented. We expect revenues to decline approximately 10% to 15% in the third quarter of 2001 as compared to the second quarter of 2001. 21 22 OPERATING COSTS AND EXPENSES: Key elements of the consolidated statements of operations, expressed as a percentage of revenues, were as follows:
Three months ended June 30, Six months ended June 30, CONSOLIDATED: 2001 2000 2001 2000 -------- -------- -------- -------- Gross profit margin 16% 43% 28% 42% Research and development 27% 13% 25% 13% Selling, general and administrative 17% 12% 16% 12% (Loss)/income from operations (73)% 13% (39)% 13%
Key elements of the statement of operations for the Semiconductor and SAN Systems segments, expressed as a percentage of revenues, were as follows:
Three months ended June 30, Six months ended June 30, SEMICONDUCTOR SEGMENT: 2001 2000 2001 2000 -------- -------- -------- -------- Gross profit margin 15% 44% 28% 42% Research and development 29% 15% 27% 14% Selling, general and administrative 15% 12% 14% 11% (Loss)/income from operations (77)% 14% (40)% 14%
Three months ended June 30, Six months ended June 30, SAN SYSTEMS SEGMENT: 2001 2000 2001 2000 -------- -------- -------- -------- Gross profit margin 20% 39% 28% 38% Research and development 14% 7% 14% 7% Selling, general and administrative 34% 12% 30% 12% (Loss)/income from operations (41)% 8% (26)% 11%
GROSS PROFIT MARGIN: We have advanced wafer manufacturing operations in Oregon, California and Japan. This allows us to maintain our ability to provide products to customers with minimal disruption in the manufacturing process due to economic and geographic risks associated with each geographic location. The gross profit margin percentage decreased to 16% in the second quarter of 2001 from 43% in the same period of 2000 on a consolidated basis. The gross profit margin percentage for the Semiconductor segment decreased to 15% from 44% in the same period of 2000. 22 23 The gross profit margin percentage decreased to 28% in the first half of 2001 from 42% in the same period of 2000 on a consolidated basis. The gross profit margin percentage for the Semiconductor segment decreased to 28% from 42% in the same period of 2000. The decrease for the Semiconductor segment for the three and six month periods ended June 30, 2001 as compared to the same periods of the prior year are primarily a result of the following factors: - Decreased revenue for higher margin products; - Additional excess inventory charges of $102 million. The additional excess inventory charge was due to a sudden and significant decrease in forecasted revenue and was calculated in accordance with our policy, which is primarily based on inventory levels in excess of 12-month demand for each specific product and use of management judgement. The gross profit margin percentage for the SAN Systems segment decreased to 20% in the second quarter of 2001 from 39% in the same period of 2000. The gross profit margin percentage for the SAN Systems segment decreased to 28% in the first half of 2001 from 38% in the same period of 2000. The decrease was primarily attributable to decreased revenue for higher margin products and additional excess inventory charges of approximately $6 million recorded during the quarter. Our operating environment, combined with the resources required to operate in the semiconductor industry, requires that we manage a variety of factors. These factors include, among other things: - Product mix; - Factory capacity and utilization; - Manufacturing yields; - Availability of certain raw materials; - Terms negotiated with third-party subcontractors; and - Foreign currency fluctuations. These and other factors could have a significant effect on our gross profit margin in future periods. Changes in the relative strength of the yen may have a greater impact on our gross profit margin than other foreign exchange fluctuations due to our wafer fabrication operations in Japan. Although the yen weakened (the average yen exchange rate for the second quarter of 2001 depreciated 15% from the same period of 2000), the effect on gross profit margin and net income was not significant because yen-denominated sales offset a substantial portion of yen-denominated costs during the period. Moreover, we hedged a portion of our remaining yen exposure. (See Note 6 of the Notes.) Future changes in the relative strength of the yen or mix of foreign currency denominated revenues and costs could have a significant effect on our gross profit margin or operating results. RESEARCH AND DEVELOPMENT: Research and development ("R&D") expenses increased $40.6 million or 47% to $127.4 million during the second quarter of 2001 as compared to $86.8 million during the same period of 2000 on a consolidated basis. R&D expenses for the Semiconductor segment increased $40.3 million or 50% to $120.0 million in the second quarter of 2001 from $79.7 million in the same period of 2000. Research and development ("R&D") expenses increased $79.2 million or 47% to $246.2 million during the first half of 2001 as compared to $167.0 million during the same period of 2000 on a consolidated basis. R&D expenses for the Semiconductor segment increased $76.7 million or 50% to $230.6 million in the first half of 2001 from $153.9 million in the same period of 2000. The increase for the semiconductor segment for the three and six month periods as compared to the same periods of the prior year was primarily attributable to an increase in expenditures related to continued R&D activities of C-Cube's business included in our consolidated financial statements as of May 11, 2001 and continued development of our already existing advanced sub-micron products and process technologies. 23 24 The R&D expenses were offset in part by the research and development benefits associated with a technology transfer agreement entered into with Silterra in Malaysia during 1999. (See Note 4 of the Notes.) A benefit of $6.0 million was recorded during each of the three month periods ended June 30, 2001 and 2000, respectively. A benefit of $12.0 million was recorded during each of the six month periods ended June 30, 2001 and 2000, respectively. We will receive an additional $14.0 million in cash from Silterra over the remaining contract term of approximately one year as consideration for technology to be transferred. R&D expenses for the SAN Systems segment increased $0.3 million or 4% to $7.4 million in the second quarter of 2001 from $7.1 million in the same period of 2000. R&D expenses for the SAN Systems segment increased $2.5 million or 19% to $15.6 million in the first half of 2001 from $13.1 million in the same period of 2000. The increase for the three and six month periods reflect higher compensation related expenses due to an increase in average headcount during the periods presented in 2001 as compared to the prior year. As a percentage of revenues, R&D expenses increased to 27% in the second quarter of 2001 from 13% in the same period of 2000 on a consolidated basis. R&D expenses as a percentage of revenues for the Semiconductor segment increased to 29% in the second quarter of 2001 from 15% in the same period of 2000. R&D expenses as a percentage of revenues for the SAN Systems segment increased to 14% in the second quarter of 2001 from 7% in the same period of 2000. The increase in R&D expenses as a percentage of revenues for both segments are primarily a result of lower revenues for the periods presented in 2001 as compared to 2000 and the effects of R&D spending changes as discussed above. As a percentage of revenues, R&D expenses increased to 25% in the first half of 2001 from 13% in the same period of 2000 on a consolidated basis. R&D expenses as a percentage of revenues for the Semiconductor segment increased to 27% in the first half of 2001 from 14% in the same period of 2000. R&D expenses as a percentage of revenues for the SAN Systems segment increased to 14% in the second quarter of 2001 from 7% in the same period of 2000. The increase in R&D expenses as a percentage of revenues for both segments are primarily a result of lower revenues for the periods presented in 2001 as compared to 2000 and the effects of R&D spending changes as discussed above. SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative ("SG&A") expenses increased $2.4 million or 3% to $77.5 million during the second quarter of 2001 as compared to $75.1 million in the same period of 2000 on a consolidated basis. SG&A expenses for the Semiconductor segment decreased $3.3 million or 5% to $60.1 million in the second quarter of 2001 from $63.4 million in the same period of 2000. SG&A expenses for the SAN Systems segment increased $5.6 million or 48% to $17.3 million in the second quarter of 2001 from $11.7 million in the same period of 2000. The increase on a consolidated basis was primarily attributable to the following factors: - Continued SG&A expenses for the C-Cube business, which is part of the Semiconductor segment and included in our consolidated financial statements as of May 11, 2001, and - An increase in compensation related expenses for the SAN Systems segment due to an increase in average headcount during the second quarter of 2001. The above increases were offset in part by the positive effects of cost reduction programs in both segments in the second quarter of 2001. SG&A expenses increased $11.2 million or 8% to $156.5 million during the first half of 2001 as compared to $145.3 million in the same period of 2000 on a consolidated basis. SG&A expenses for the Semiconductor segment increased $0.2 million or 0.1% to $122.9 million in the first half of 2001 from $122.7 million in the same period of 2000. SG&A expenses for the SAN Systems segment increased $11.0 million or 49% to $33.6 million in the first half of 2001 from $22.6 million in the same period of 2000. The increase on a consolidated basis and by segment was primarily attributable to the same factors noted above. 24 25 As a percentage of revenues, SG&A expenses increased to 17% in the second quarter of 2001 from 12% in the same period of 2000 on a consolidated basis. SG&A expenses as a percentage of revenues for the Semiconductor segment increased to 15% in the second quarter of 2001 from 12% in the same period of 2000. SG&A expenses as a percentage of revenues for the SAN Systems segment increased to 34% in the second quarter of 2001 from 12% in the same period of 2000. The increase in SG&A expenses as a percentage of revenues for both segments are primarily a result of lower revenues for the periods presented in 2001 as compared to 2000 and the effects of SG&A spending changes as discussed above. As a percentage of revenues, SG&A expenses increased to 16% in the first half of 2001 from 12% in the same period of 2000 on a consolidated basis. SG&A expenses as a percentage of revenues for the Semiconductor segment increased to 14% in the first half of 2001 from 11% in the same period of 2000. SG&A expenses as a percentage of revenues for the SAN Systems segment increased to 30% in the first half of 2001 from 12% in the same period of 2000. The increase in SG&A expenses as a percentage of revenues for both segments are primarily a result of lower revenues for the periods presented in 2001 as compared to 2000 and the effects of spending changes as discussed above. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT: In connection with the acquisition of C-Cube during the second quarter of 2001 (See Note 2 of the Notes), we recorded a $77.5 million charge associated with acquired in-process research and development ("IPR&D"). The amount of IPR&D was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed as of the acquisition date. On March 26, 2001, we signed a definitive merger agreement ("Merger Agreement") to acquire C-Cube Microsystems Inc. ("C-Cube") in a transaction to be accounted for as a purchase. In accordance with the Merger Agreement, we commenced an exchange offer whereby it would offer 0.79 of a share of common stock for each outstanding share of C-Cube common stock. Under the terms of the Merger Agreement, the exchange offer was followed by a merger in which we acquired, at the same exchange ratio, the remaining shares of C-Cube common stock not previously acquired in the exchange offer. Upon completion of the merger, we assumed all options and warrants to purchase shares of C-Cube common stock and converted them into options and warrants to purchase shares of our common stock (See Note 2 of the Notes). We issued approximately 40.2 million shares of its common stock, 10.6 million options and 0.8 million warrants in exchange for the outstanding ordinary shares, options and warrants of C-Cube, respectively. The acquisition is intended to enhance and accelerate our DVD product offerings in the Semiconductor segment. The total purchase price for C-Cube was $893.7 million, which includes deferred compensation on unvested stock options and stock awards assumed as part of the purchase. The acquisition was accounted for as a purchase. Accordingly, the results of operations of C-Cube and estimated fair value of assets acquired and liabilities assumed were included in our consolidated financial statements as of May 11, 2001, the effective date of the purchase, through the end of the period. In connection with the purchase of C-Cube, we recorded a $77.5 million charge to in-process research and development. The amount was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed. As of the acquisition date, there were various projects that met the above criteria. The majority of the projects identified consist of Digital Video Disc Player ("DVD"), DVD Recorder ("DVD-R"), Consumer Set-Top Box and Cable Modem. The value of the projects identified to be in progress was determined by estimating the future cash flows from the projects once commercially feasible, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value. The net cash flows from the identified projects were based on estimates of revenues, cost of revenues, research and development costs, selling general and administrative costs and 25 26 applicable income taxes for the projects. These estimates do not account for any potential synergies that may be realized as a result of the acquisition and are in line with industry averages and growth estimates in the semiconductor industry. Total revenues for the projects are expected to extend through 2005, 2006, 2004 and 2003 for DVD, DVD-R, Consumer Set-Top Box and Cable Modem, respectively. These projections were based on estimates of market size and growth, expected trends in technology and the expected timing of new product introductions by our competitors and us. The discount rate used was 27.5% for the projects, a rate of 210 basis points higher than the industry weighted average cost of capital estimated at approximately 25.4% to account for the risks associated with the inherent uncertainties surrounding the successful development of the IPR&D, market acceptance of the technology, the useful life of the technology, the profitability level of such technology and the uncertainty of technological advances, which could impact the estimates described above. The percentage of completion for the project was determined based on research and development expenses incurred as of May 11, 2001 for the projects as a percentage of total research and development expenses to bring the project to technological feasibility. Development of these projects started in early 1999. As of May 11, 2001, we estimated the projects were approximately 84%, 62%, 61% and 69% complete for DVD, DVD-R, Consumer Set-Top Box and Cable Modem, respectively. As of the acquisition date, the cost to complete these projects is estimated at $22.7 million and $9.1 million for 2001 and 2002, respectively. RESTRUCTURING OF OPERATIONS AND OTHER NON-RECURRING ITEMS: The Company recorded approximately $60 million in restructuring and other non-recurring charges during the three months ended June 30, 2001. Total restructuring charges were $52 million and other non-recurring charges were approximately $8 million for the three months ending June 30, 2001. Restructuring: In April of 2001, we announced the closure of our Colorado Springs fabrication facility ("the facility") in August of 2001. In May of 2001, we entered into a definitive agreement to sell the facility to X-FAB Semiconductor Foundries AG ("X-Fab"), a German corporation. As part of the agreement, we agreed to purchase a minimum amount of production wafers and die from the facility for a period of 18 months following the close of the transaction. During the quarter ended June 30, 2001, we recorded an impairment charge of $71 million relating to the facility of which approximately $35 million was recorded in cost of sales and $36 million was recorded in restructuring charges. The restructuring charges consisted of fixed asset write-downs due to impairment, losses on an operating lease for equipment, severance for approximately 413 employees and other exit costs. On August 1, 2001, we announced the termination of the agreement to sell the facility because X-Fab was unable to secure the required funding to close the transaction. The facility is currently scheduled to close in October of 2001. We are continuing our efforts to dispose of the facility and estimate that our reserves as of June 30, 2001 are adequate to cover losses associated with the disposal of the facility. We reclassified approximately $96 million from property, plant and equipment to other current assets to reflect our intention to dispose of the facility within the next twelve months. We recorded approximately $16 million in additional restructuring charges primarily associated with the write-down of fixed assets in the U.S., Japan and Hong Kong that will be disposed of and severance charges for approximately 243 employees in the U.S., Europe and Asia Pacific. The fair value of assets determined to be impaired was the result of independent appraisals and use of management estimates. Given that current market conditions for the sale of older fabrication facilities and related equipment may continue to deteriorate, there can be no assurance that we will realize the current net book value for the assets. We will reassess the realizability of the carrying value of these assets at the end of each quarter until the assets are sold or otherwise disposed of and additional adjustments may be necessary. As a result of the restructuring actions taken during the second quarter of 2001, we expect to reduce employee expenses by $129.8 million during the remainder of 2001. As a result of the closure of the Colorado Springs facility, depreciation expense will be reduced by approximately $3 million during the remainder of 2001. 26 27 NOTE 4 -- LICENSE AGREEMENT The following table sets forth our restructuring reserves as of June 30, 2001:
(In thousands) Restructuring Balance Expense June 30, June 30, 2001 Utilized 2001 ------------- --------- --------- Write-down of excess assets(a) $ 22,920 $ (21,513) $ 1,407 Lease terminations and maintenance contracts 14,253 14,253 Other exit costs 7,742 7,742 Payments to employees for severance(b) 6,848 (2,764) 4,084 --------- --------- --------- Total $ 51,763 $ (24,277) $ 27,486 ========= ========= =========
(a) Amounts utilized in 2001 reflect a write-down of fixed assets in the U.S., Japan and Hong Kong due to impairment. The amounts were accounted for as a reduction of the assets and did not result in a liability. The $1.4 million balance as of June 30, 2001 relates to machinery and equipment decommissioning costs in the U.S. (b) Amounts utilized represent cash payments related to the severance of 230 employees during the second quarter of 2001. Other non-recurring: We recorded approximately $8 million in other non-recurring charges associated with the write-down of intangible assets due to impairment. The majority of the intangible assets were originally acquired in the purchase of a division of Neomagic in the second quarter of 2000. During the first quarter of 2000, we recorded other non-recurring net charges of $2.8 million. The net charges reflected the combination of the following: - On February 22, 2000, we entered into an agreement with a third party to outsource certain testing services performed by us at our Fremont, California facility. The agreement provided for the sale and transfer of certain test equipment and related peripherals for total proceeds of approximately $10.7 million. We recorded a loss of approximately $2.2 million associated with the agreement. (See Note 4 of the Notes.) - In March 2000, we recorded approximately $1.1 million of non-cash compensation related expenses resulting from a separation agreement entered into during the quarter with a former employee and a $0.5 million benefit for the reversal of reserves established in the second quarter of 1999 for merger related expenses in connection with the merger with SEEQ Technology, Inc. AMORTIZATION OF INTANGIBLES: Amortization of goodwill and other intangibles increased $29.7 million or 215% to $43.5 million in the second quarter of 2001 from $13.8 million in the same period of 2000. Amortization of goodwill and other intangibles increased to $70.6 million in the first half of 2001 from $25.7 million in the same period of 2000. The increase was primarily related to additional amortization of goodwill associated with the acquisitions of C-Cube in the second quarter of 2001 and ParaVoice and Syntax in the fourth quarter of 2000. AMORTIZATION OF NON-CASH DEFERRED STOCK COMPENSATION: Amortization of non-cash deferred stock compensation of $27.8 million and $49.1 million for the three and six month period ended June 30, 2001, respectively, is due to the amortization of non-cash deferred stock compensation recorded in connection with the acquisitions of C-Cube during the second quarter of 2001(See Note 2 of the Notes), Syntax in the fourth quarter of 2000 and DataPath in the third quarter of 2000. INTEREST EXPENSE: Interest expense decreased $0.4 million to $9.9 million in the second quarter of 2001 from $10.3 million in the same period of 2000. Interest expense decreased $1.4 million to $19.8 million in the first half of 2001 from $21.2 million in the same period of 2000. The decrease was primarily attributable to lower interest rates on outstanding debt in the first half of 2001 as compared to the same period in 2000. 27 28 INTEREST INCOME AND OTHER, NET: Interest income and other decreased $7.8 million to $3.7 million in the second quarter of 2001 from $11.5 million in the same period of 2000. The decrease was primarily attributable to the write-down of a marketable equity investment due to impairment and the time value of purchased option contracts in the second quarter of 2001. (See Notes 5 and 6 of the Notes.) Interest income and other decreased $5.9 million to $12.7 million in the first half of 2001 from $18.6 million in the same period of 2000. We recorded approximately $7 million higher interest income in the first half of 2001 as compared to the same period in 2000 due to higher average balances of interest-generating cash, cash equivalents and short-term investments which was offset in part by lower interest rates during the period. The increase in interest income and other was offset by the write-down of a marketable equity investment due to impairment and the time value of purchased option contracts. (See Notes 5 and 6 of the Notes.) GAIN ON SALE OF EQUITY SECURITIES: We did not sell marketable equity securities during the second quarter of 2001. During the first quarter of 2001, we sold certain marketable equity securities for $7.9 million in the open market, realizing a pre-tax gain of approximately $5.3 million. During the second quarter of 2000, we sold certain marketable equity securities for $15.8 million in the open market, realizing a pre-tax gain of approximately $15.3 million. During the first half of 2000, we sold certain marketable equity securities for $45.7 million in the open market, realizing a pre-tax gain of approximately $42.7 million. In the first quarter of 2000, we also recognized a $6.8 million pre-tax gain associated with equity securities of a certain technology company that was acquired by another technology company. PROVISION FOR INCOME TAXES: During the three and six months ended June 30, 2001, we recorded an income tax benefit of $34.7 million and $39.2 million, respectively, which represents an effective tax rate of 10%. This rate differs from the U.S. statutory rate primarily due to losses of our foreign subsidiaries, which are benefited at lower rates, and items related to acquisitions, which are non-deductible for tax purposes. For the three and six months ended June 30, 2000, an income tax provision was recorded at an effective rate of 30% and 27%, respectively. These rates differ from the U.S. statutory rate primarily due to merger and restructuring charges, the recognition of taxable gains offset in part by earnings of our foreign subsidiaries taxed at lower rates and the utilization of tax credits. FINANCIAL CONDITION AND LIQUIDITY Cash, cash equivalents and short-term investments increased $8.5 million or 0.8% to $1,141.7 million as of June 30, 2001 from $1,133.2 million as of December 31, 2000. WORKING CAPITAL: Working capital increased $23.7 million or 2% to $1,469.0 million as of June 30, 2001 from $1,445.3 million as of December 31, 2000. The increase was primarily a result of the following factors: - Higher cash and cash equivalents due to the C-Cube acquisition during the second quarter of 2001. (See Note 2 of the Notes.) - Higher inventory due to lower than expected sales in the second quarter of 2001 offset in part by a write-down of certain inventory. (See Note 7 of the Notes.) - Higher prepaid expenses and other current assets due to a reclassification of assets held for sale from property, plant and equipment to other current assets. (See Note 3 of the Notes.) - Lower accounts payable that primarily reflect lower purchases during the second quarter of 2001 as compared to the fourth quarter of 2000. - Lower accrued salaries, wages and benefits; and - Lower income taxes payable due to the timing of tax payments and the tax benefit recorded during the second quarter of 2001. The increase in working capital was offset in part by lower accounts receivable due to decreased revenue during the second quarter of 2001 as compared to the fourth quarter of 2000, lower short-term investments primarily 28 29 attributable to certain marketable equity securities reclassified into long-term assets and higher other accrued liabilities resulting primarily from restructuring related accruals and accruals related to tax liabilities associated with the acquisition of C-Cube. CASH AND CASH EQUIVALENTS PROVIDED BY OPERATING ACTIVITIES: During the six month period ended June 30, 2001, we generated $104.0 million of cash and cash equivalents from operating activities compared to $131.6 million generated during the same period in 2000. The decrease in cash and cash equivalents provided by operating activities was primarily attributable to a net loss for the six month period ended June 30, 2001 compared to net income for the same period of 2000, an increase in inventory and prepaid and other assets and a decrease in accounts payable, accrued salaries, wages and benefits and income tax payable. The increase in inventories reflects lower than expected sales in the first half of 2001, partly offset by a write-down of certain inventory. (See Note 7 of the Notes.) The increase in prepaid expenses and other assets was primarily attributable to a reclassification of assets held for sale from property, plant and equipment to other current assets (See Note 3 of the Notes) and a decrease in deferred tax assets during the period. The decrease in accounts payable reflects lower purchases during the first half of 2001 as compared to the same period of 2000 and the timing of invoice receipt and payments. The decrease in income tax payable is due to the tax benefit recorded during the first half of 2001. CASH AND CASH EQUIVALENTS USED IN INVESTING ACTIVITIES: Cash and cash equivalents used in investing activities was $66.2 million during the six months ended June 30, 2001, compared to $280.1 million in the same period of 2000. The decrease was primarily related to higher sales and maturities of debt and equity securities available-for-sale and others, net of purchases during the six month period ended June 30, 2001 compared to the same period of 2000. The decrease was offset in part by higher capital expenditures and lower proceeds from the sale of marketable equity securities during the six month period ended June 30, 2001 compared to the same period of 2000. The decrease was also offset by an increase in cash and cash equivalents due to the acquisition of C-Cube. We believe that maintaining technological leadership in the highly competitive worldwide semiconductor industry requires substantial ongoing investment in advanced manufacturing capacity. Net capital additions were $125.6 million during the six month period ended June 30, 2001 and $83.5 million in the same period of 2000. In order to maintain our position as a technological market leader, we expect the level of capital expenditures to be approximately $400 million in 2001. CASH AND CASH EQUIVALENTS PROVIDED BY FINANCING ACTIVITIES: Cash and cash equivalents provided by financing activities during the six month period ended June 30, 2001 was $43.5 million compared to $199.1 million in the same period of 2000. During the six month period ended June 30, 2001, we generated cash proceeds of $44.4 million from our employee stock option and purchase plans, which were offset in part by the repayment of debt obligations. During the six month period ended June 30, 2000, we generated cash proceeds of $124.2 million from the issuance of the 2000 Convertible Notes, net of repayment of the Revolver, and $90.2 million from our employee stock option and purchase plans, which was offset in part by the debt issuance costs associated with the 2000 Convertible Notes. (see Note 8 of the Notes) On March 14, 2001, the Second Amended and Restated Credit Agreement was amended to reduce the total revolving commitment by $165 million from $240 million to $75 million. On the effective date of this reduction, the revolving commitment of each lender was reduced accordingly. 29 30 In accordance with the terms of our existing credit arrangement, we must comply with certain financial covenants related to profitability, tangible net worth, liquidity, senior debt leverage, debt service coverage and subordinated indebtedness. In order to remain competitive, we must continue to make significant investments in new facilities and capital equipment. We may seek additional equity or debt financing from time to time. We believe that our existing liquid resources and funds generated from operations, combined with funds from such financing and our ability to borrow funds, will be adequate to meet our operating and capital requirements and obligations through the foreseeable future. However, we cannot be certain that additional financing will be available on favorable terms. Moreover, any future equity or convertible debt financing will decrease the percentage of equity ownership of existing stockholders and may result in dilution, depending on the price at which the equity is sold or the debt is converted. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (SFAS 141 and SFAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets." SFAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. SFAS 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. SFAS 141 and SFAS 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of SFAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under SFAS 141 will be reclassified to goodwill. Companies are required to adopt SFAS 142 for fiscal years beginning after December 15, 2001, but early adoption is permitted. The Company will adopt SFAS 142 on January 1, 2002, the beginning of fiscal 2002. In connection with the adoption of SFAS 142, the Company will be required to perform a transitional goodwill impairment assessment. The Company has not yet determined the impact these standards will have on its results of operations and financial position. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no significant changes in the market risk disclosures during the six month period ended June 30, 2001 as compared to the discussion in Part II of our Annual Report on Form 10-K for the year ended December 31, 2000. 30 31 PART II ITEM 1. LEGAL PROCEEDINGS Reference is made to Item 3, Legal Proceedings, of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000 for a discussion of certain pending legal proceedings. In addition, the Company is a party to other litigation matters and claims that are normal in the course of its operations. The information provided at such reference regarding those matters remains substantially unchanged except as set forth herein. Regarding the pending litigation initiated by the Lemelson Medical, Education & Research Foundation, Limited Partnership against certain electronics industry companies, including LSI, that was described in the Company's prior reports, the court has completed its review of motion papers filed in connection with Cypress Semiconductor's and plaintiff's cross-motions for summary judgment with respect to the 4,390,586 patent and granted a motion for oral arguments to be held in mid-December. These activities are ongoing and, as of yet, no trial date has been set. In addition, the Company is a party to other litigation matters and claims which are normal in the course of its operations. The Company continues to believe that the final outcome of such matters will not have a material adverse effect on the Company's consolidated financial position or results of operations. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company's financial position or its results of operations. The information in Item 3 pertaining to the proceedings that are pending in the Court of Queen's Bench of Alberta, Judicial District of Calgary (the "Court") between the Company, its Canadian subsidiary ("LSI Canada") and certain former shareholders of LSI Canada is updated as follows. Following a hearing held in March 2001, the Court dismissed the motion of the former shareholders that challenged the propriety of the fair value proceedings initiated by LSI Canada and the jurisdiction of the Court to adjudicate the matter. In addition, the Court ruled that the portions of the application of the former shareholders to initiate a claim based upon allegations that actions of LSI Logic Corporation and certain named (former) directors and a (former) officer of LSI Canada were oppressive of the rights of minority shareholders in LSI Canada are struck and the balance are stayed. The Court also directed the litigants to recommence preparation for trial in the fair value proceeding and advised the litigants of the Court's intention to schedule a date for trial of that matter as soon as practicable. While we cannot give any assurances regarding the resolution of these matters, we believe that the final outcome will not have a material adverse effect on our consolidated results of operations or financial condition. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company's financial position or its results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders of LSI Logic Corporation was held on May 2, 2001 in San Francisco, California. Proxies representing 275,713,617 shares of common stock or 85% of the total outstanding shares were voted at the meeting. The table below presents the voting results of election of the Company's Board of Directors:
Votes For Votes Withheld --------- -------------- Wilfred J. Corrigan 273,278,527 2,435,090 T.Z. Chu 273,342,721 2,370,896 Malcolm R. Currie 273,174,096 2,539,521 James H. Keyes 273,385,086 2,328,531 R. Douglas Norby 273,270,650 2,442,967 Matthew J. O'Rourke 273,307,670 2,405,947 Larry W. Sonsini 273,042,512 2,671,105
The stockholders approved an amendment to the Amended and Restated Employee Stock Purchase Plan to increase the number of shares of common stock reserved for issuance thereunder by 10,000,000. The proposal received 257,814,857 affirmative notes, 16,297,869 negative votes, 1,600,890 abstentions, and one broker non-vote. The stockholders approved an amendment to the 1991 Equity Incentive Plan to increase the number of shares of common stock reserved for issuance thereunder by 5,000,000. The proposal received 196,098,621 affirmative votes, 77,933,995 negative votes, 1,680,700 abstentions, and 301 broker non-votes. The stockholders approved the appointment of PricewaterhouseCoopers LLP as independent accountants of the Company for the fiscal year 2001. The proposal received 273,618,230 affirmative votes, 938,334 negative votes, 1,157,052 abstentions, and one broker non-vote. 31 32 ITEM 5. OTHER INFORMATION Proposals of stockholders intended to be presented at the Company's 2002 annual meeting of stockholders must be received at the Company's principle executive offices not later than November 26, 2001 in order to be included in the Company's proxy statement and form of proxy relating to the 2002 annual meeting. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - None (b) Reports on Form 8-K On April 4, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated March 26, 2001. On April 25, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated April 24, 2001. On May 21, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated May 11, 2001. On June 5, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated May 29, 2001. On June 15, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated June 11, 2001. On June 18, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated June 11, 2001. On June 26, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated June 18, 2001. On July 20, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated May 11, 2001. On July 20, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated June 11, 2001. On July 30, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated July 26, 2001. On August 6, 2001, pursuant to Item 5 to report information set forth in the Registrant's press release dated August 1, 2001. 32 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LSI LOGIC CORPORATION (Registrant) Date: August 14, 2001 By /s/ Bryon Look -------------------------------- Bryon Look Executive Vice President and Chief Financial Officer 33 -----END PRIVACY-ENHANCED MESSAGE-----