-----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, Cm9SmRvz5L0UBCLzf2VAzHPXQbJEpr2Q+lZTM19VMCtkPmYFVAEqT4EtQW8TAIQr KlAAD/fDY0MS06N8pHx/PQ== 0000891618-99-003338.txt : 19990730 0000891618-99-003338.hdr.sgml : 19990730 ACCESSION NUMBER: 0000891618-99-003338 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990627 FILED AS OF DATE: 19990729 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: SEC FILE NUMBER: 001-10317 FILM NUMBER: 99672437 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 FORM 10-Q 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 JUNE 27, 1999 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 July 26, 1999 there were 147,391,417 of the registrant's Common Stock, $.01 par value, outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 LSI LOGIC CORPORATION FORM 10-Q FOR THE QUARTER ENDED JUNE 27, 1999 INDEX
PAGE NO. ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Condensed Balance Sheets -- June 30, 1999 and December 31, 1998........................................... 3 Consolidated Condensed Statements of Operations -- Three-Month and Six-Month Periods Ended June 30, 1999 and 1998........................................... 4 Consolidated Condensed Statements of Cash Flows -- Six-Month Periods Ended June 30, 1999 and 1998........................ 5 Management's Discussion and Analysis of Results of Operations and Financial Condition.......................... 6 PART II. OTHER INFORMATION Item 1. Legal Proceedings........................................... 29 Item 4. Submission of Matters to a Vote of Security Holders......... 29 Item 5. Other Information........................................... 29 Item 6. Exhibits and Reports on Form 8-K............................ 30
2 3 PART I ITEM 1. FINANCIAL STATEMENTS LSI LOGIC CORPORATION CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) ASSETS
JUNE 30, DECEMBER 31, 1999 1998 ---------- ------------ Cash and cash equivalents................................... $ 190,530 $ 210,306 Short-term investments...................................... 154,613 81,220 Accounts receivable, less allowance for doubtful accounts of $4,914 and $3,537......................................... 333,831 249,106 Inventories................................................. 191,485 181,440 Deferred tax assets......................................... 62,699 62,699 Prepaid expenses and other current assets................... 44,030 52,250 ---------- ---------- Total current assets.............................. 977,188 837,021 ---------- ---------- Property and equipment, net................................. 1,246,541 1,486,256 Goodwill and other intangibles.............................. 316,705 332,779 Other assets................................................ 215,281 167,749 ---------- ---------- Total assets...................................... $2,755,715 $2,823,805 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable............................................ $ 172,032 $ 195,228 Accrued salaries, wages and benefits........................ 67,632 47,988 Other accrued liabilities................................... 103,352 109,236 Income taxes payable........................................ 43,719 57,993 Current portion of long-term obligations.................... 72,051 187,852 ---------- ---------- Total current liabilities......................... 458,786 598,297 ---------- ---------- Long-term obligations and deferred income taxes............. 805,778 695,797 Minority interest in subsidiaries........................... 5,068 5,238 Commitments and contingencies............................... -- -- Stockholders' equity: Preferred shares; $.01 par value; 2,000 shares authorized............................................. -- -- Common stock; $.01 par value; 450,000 shares authorized; 145,967 and 143,867 shares outstanding................. 1,460 1,439 Additional paid-in capital.................................. 1,159,402 1,135,219 Retained earnings........................................... 290,445 368,378 Accumulated other comprehensive income...................... 34,776 19,437 ---------- ---------- Total stockholders' equity........................ 1,486,083 1,524,473 ---------- ---------- Total liabilities and stockholders' equity........ $2,755,715 $2,823,805 ========== ==========
See accompanying notes to unaudited consolidated condensed financial statements. 3 4 LSI LOGIC CORPORATION CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------- 1999 1998 1999 1998 -------- -------- -------- -------- Revenues.............................................. $501,012 $336,272 $964,629 $669,002 -------- -------- -------- -------- Costs and expenses: Cost of revenues.................................... 314,398 179,844 616,289 367,392 Research and development............................ 75,046 65,943 151,569 130,857 Selling, general and administrative................. 62,783 52,404 124,272 97,601 Acquired in-process research and development........ 4,600 -- 4,600 -- Restructuring of operations and other non-recurring charges.......................................... 7,848 -- 5,871 -- Amortization of intangibles......................... 11,815 1,386 23,022 2,772 -------- -------- -------- -------- Total costs and expenses......................... 476,490 299,577 925,623 598,622 -------- -------- -------- -------- Income from operations................................ 24,522 36,695 39,006 70,380 Interest expense...................................... (9,620) (95) (20,200) (175) Interest income and other expense..................... 2,459 5,470 4,195 13,480 -------- -------- -------- -------- Income before income taxes and cumulative effect of change in accounting principle...................... 17,361 42,070 23,001 83,685 Provision for income taxes............................ 7,530 10,691 9,160 20,890 -------- -------- -------- -------- Income before cumulative effect of change in accounting principle................................ 9,831 31,379 13,841 62,795 Cumulative effect of change in accounting principle... -- -- (91,774) -- -------- -------- -------- -------- Net income/(loss)..................................... $ 9,831 $ 31,379 $(77,933) $ 62,795 ======== ======== ======== ======== Basic earnings per share: Income before cumulative effect of change in accounting principle............................. $ 0.07 $ 0.22 $ 0.10 $ 0.44 Cumulative effect of change in accounting principle........................................ -- -- (0.64) -- -------- -------- -------- -------- Net income/(loss)................................... $ 0.07 $ 0.22 $ (0.54) $ 0.44 ======== ======== ======== ======== Dilutive earnings per share: Income before cumulative effect of change in accounting principle............................. $ 0.06 $ 0.22 $ 0.09 $ 0.43 Cumulative effect of change in accounting principle........................................ -- -- (0.61) -- -------- -------- -------- -------- Net income/(loss)................................... $ 0.06 $ 0.22 $ (0.52) $ 0.43 ======== ======== ======== ======== Shares used in computing per share amounts: Basic............................................... 145,622 143,168 144,883 142,868 ======== ======== ======== ======== Dilutive............................................ 151,947 144,719 149,614 144,377 ======== ======== ======== ========
See accompanying notes to unaudited consolidated condensed financial statements. 4 5 LSI LOGIC CORPORATION CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ---------------------- 1999 1998 --------- --------- Operating activities: Net (loss)/income........................................... $ (77,933) $ 62,795 Adjustments: Depreciation and amortization............................. 190,752 91,701 Write-off of unamortized preproduction costs.............. 97,356 -- Acquired in-process research and development.............. 4,600 -- Non-cash restructuring and other non-recurring charges.... 827 -- Changes in: Accounts receivable.................................... (87,639) (26,754) Inventories............................................ (11,499) (3,191) Prepaid expenses and other assets...................... 2,935 (29,363) Accounts payable....................................... (26,091) (33,690) Accrued and other liabilities.......................... 7,040 6,119 --------- --------- Net cash provided by operating activities................... 100,348 67,617 --------- --------- Investing activities: Purchases of debt and equity securities available-for-sale..................................... (198,577) (253,249) Maturities and sales of debt and equity securities available-for-sale..................................... 125,014 361,267 Purchase of equity securities............................. (117) (6,866) Acquisition of a non-public technology company............ (6,779) -- Purchases of property and equipment, net of retirements... (28,503) (148,274) --------- --------- Net cash used for investing activities...................... (108,962) (47,122) --------- --------- Financing activities: Proceeds from borrowings.................................. 345,000 -- Repayment of debt obligations............................. (368,302) (736) Debt issuance costs....................................... (9,488) -- Issuance of common stock, net............................. 24,204 12,356 --------- --------- Net cash (used for)/provided by financing activities........ (8,586) 11,620 --------- --------- Effect of exchange rate changes on cash and cash equivalents............................................... (2,576) (5,185) --------- --------- (Decrease)/increase in cash and cash equivalents............ (19,776) 26,930 Cash and cash equivalents at beginning of period............ 210,306 114,087 --------- --------- Cash and cash equivalents at end of period.................. $ 190,530 $ 141,017 ========= =========
See accompanying notes to unaudited consolidated condensed financial statements. 5 6 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE 1 -- BASIS OF PRESENTATION In the opinion of the Company, the accompanying unaudited consolidated condensed financial statements contain all adjustments (consisting only of normal recurring adjustments except as noted below for unamortized preproduction, acquired in-process research and development as discussed in Note 3 and the restructuring expenses as discussed in Note 5) 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/A for the year ended December 31, 1998. On June 22, 1999, the Company completed a merger of Stealth Acquisition Corporation, a wholly-owned subsidiary of the Company, with SEEQ Technology, Inc. ("SEEQ") in a transaction accounted for as a pooling of interests, and SEEQ became a wholly owned subsidiary of the Company. All financial information has been restated retroactively to reflect the combined operations of the Company and SEEQ as if the merger had occurred at the beginning of the earliest period presented (see Note 2). Prior to the merger, SEEQ's fiscal year-end was the last Sunday in September of each year whereas the Company operates on a year ending on December 31. For financial reporting purposes, the Company reports on a 13 or 14 week quarter with a year ending December 31. For presentation purposes, the consolidated condensed financial statements refer to the quarter's calendar month end for convenience. The results of operations for the quarter ended June 30, 1999 are not necessarily indicative of the results to be expected for the full year. On April 14, 1999, the Company acquired all of outstanding capital stock of ZSP Corporation. ("ZSP") in a merger transaction accounted for as a purchase. Accordingly, the results of operations of ZSP and estimated fair value of assets acquired and liabilities assumed were included in the Company's consolidated condensed financial statements as of April 14, 1999, the effective date of the purchase, through the end of the period (see Note 3). There are no significant differences between the accounting policies of the Company and ZSP. In April 1998, the Accounting Standards Executive Committee ("AcSEC") released Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of Start-up Activities." The SOP is effective for fiscal years beginning after December 15, 1998 and requires companies to expense all costs incurred or unamortized in connection with start-up activities. Accordingly, the Company has expensed the unamortized preproduction balance of $92 million associated with the Gresham manufacturing facility, net of tax, on January 1, 1999 and has presented it as a cumulative effect of a change in accounting principle in accordance with SOP No. 98-5. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated condensed financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Certain items previously reported in specific financial statement captions have been reclassified to conform with the 1999 presentation. During the second quarter of 1999, one customer represented 11% of the Company's consolidated revenues. There were no customers with revenues greater than or equal to 10% of total consolidated revenues for the six months ended June 30, 1999. This Current Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ significantly from those projected in the forward-looking statements as a result of a number 6 7 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) of risks and uncertainties, including the risk factors set forth in the Company's Annual Report on Form 10-K/A for the year ended December 31, 1998 as well as other periodic reports both previously and hereafter filed by the Company with the Securities Exchange Commission. Statements made herein are as of the date of the filing of this 10-Q with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. The Company expressly disclaims any obligation to update information presented herein, except as may otherwise be required by law. NOTE 2 -- ACQUISITION OF SEEQ As discussed in Note 1, on June 22, 1999, the Company completed a merger with SEEQ. SEEQ was formed in January 13, 1981 to engage in the development, production and sale of state-of-the-art, high technology semiconductor devices. The stock for stock transaction was approved by the shareholders of SEEQ. As a result of the merger, the separate existence of SEEQ ceased. Under the terms of the Agreement and Plan of Reorganization and Merger, SEEQ's shareholders received 0.0759 of a share of the Company's common stock for each SEEQ share. Accordingly, the Company will issue up to 2.5 million shares of its common stock for all the outstanding shares of SEEQ common stock. Additionally, outstanding options to acquire SEEQ common stock were converted to options to acquire 0.4 million shares of the Company's common stock. The merger was accounted for as a pooling of interests. Accordingly, the Company's financial statements have been restated retroactively to include the financial results of SEEQ for all periods presented. SEEQ's results of operations are insignificant to the combined financial results (less than 3% by income statement line item for the six months ended June 30, 1999), and accordingly, separate results of operations of SEEQ and LSI are not presented. Adjustments to conform accounting policies of SEEQ to those of LSI were not significant to the combined financial results. There were no inter-company transactions between the two companies for the periods presented. Restructuring and merger related expenses associated with the SEEQ merger In connection with the merger with SEEQ on June 22, 1999, LSI recorded $3 million in restructuring charges and $5 million in merger related expenses. The merger expenses relate primarily to investment banking and other professional fees directly attributable to the merger with SEEQ. The restructuring charge is comprised of $2 million in write-downs of fixed assets which are duplicative to the combined company, $0.5 million of exit costs relating to non-cancelable building lease contracts and $0.5 million provision for severance costs related to the involuntary termination of certain employees. The exit costs and employee severance costs were recorded in accordance with EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity". The fixed and other assets write-downs were recorded in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The restructuring actions as outlined by the restructuring plan are intended to be completed by June 30, 2000, one year from the date the reserve was taken. There was no activity against the SEEQ restructuring reserves in the second quarter of 1999. NOTE 3 -- ACQUISITION OF ZSP As discussed in Note 1, on April 14, 1999, the Company acquired all of outstanding capital stock of ZSP, a semiconductor company without a fabrication facility that designs and markets programmable digital signal processors ("DSPs"). The acquisition was accounted for as a purchase. Accordingly, the results of operations of ZSP and estimated fair value of assets acquired and liabilities assumed were included in the Company's consolidated condensed financial statements as of April 14, 1999, the effective date of the purchase, through 7 8 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) the end of the period. There are no significant differences between the accounting policies of the Company and ZSP. The Company paid approximately $7 million in cash which included direct acquisition costs of $0.6 million for investment banking legal and accounting fees and liabilities assumed of $4.3 million. The total purchase price of $11.3 million was allocated to the estimated fair value of assets acquired and liabilities assumed based on independent appraisals, where appropriate and management estimates as follows:
(In thousands) Fair value of tangible net (liabilities)/assets............. $ (301) In-process research and development......................... 4,600 Other current technology.................................... 2,600 Excess of purchase price over net assets acquired........... 4,370 ------- $11,269 =======
The Company accrued approximately $0.7 million of exit costs for a non-cancelable building lease contract and to prepare the building for sublease. The exit costs were accrued as a liability assumed in the purchase price allocation in accordance with EITF No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination." The Company expects no other additional liabilities that may result in an adjustment to the allocation of the purchase price. In-process research and development: In connection with the purchase of ZSP, the Company recorded a $4.6 million charge to in-process research and development during the second quarter of 1999. The amount was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed. The Company acquired ZSP's in-process DSP research and development project that was targeted at the telecommunications market. This product is being developed specifically for voice over net or voice over internet protocol applications and is intended to have substantial incremental functionality, greatly improved speed and a wider range of interfaces than ZSP's current technology. The value of the one project identified to be in progress was determined by estimating the future cash flows from the project once commercially feasible, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value. The percentage of completion for the project was determined using milestones representing management's estimate of effort, value added and degree of difficulty of the portion of the project completed as of April 14, 1999, as compared to the remaining research and development to be completed to bring the project to technical feasibility. The development process is grouped into three phases with each phase containing between one and five milestones. The three phases are (i) researching the market requirements and the engineering architecture and feasibility studies, (ii) design and verification milestones, and (iii) prototyping and testing the product (both internal and customer testing). Development of ZSP's digital signal processor project started in May 1998. As of April 14, 1999, the Company estimated that the project was 65% complete. However, development of the technology remains a substantial risk to the Company due to factors including the remaining effort to achieve technical feasibility, rapidly changing customer markets and competitive threats from other companies. Additionally, the value of other intangible assets acquired may become impaired. Company management believes that the in-process research and development charge of $4.6 million is valued consistently with the SEC staff's view regarding valuation methodologies. There can be no assurance, however, that the SEC staff will not take issue with any assumptions used in the Company's 8 9 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) valuation model and require the Company to revise the amount allocated to in-process research and development. Useful life of intangible assets: The amount allocated to current technology and residual goodwill is being amortized over their estimated weighted average useful life of seven years using a straight-line method. NOTE 4 -- LICENSE AGREEMENT The Company and Wafer Technology (Malaysia) Sdn. Bhd. ("WTM") are currently definitizing an agreement under which the Company will grant licenses to WTM with respect to certain of the Company's wafer fabrication technologies and will provide associated manufacturing training and related services. In exchange, the Company will receive cash and equity consideration preliminarily valued at $120 million over the period for which transfers and obligations of the Company are scheduled to occur. Pursuant to an interim agreement, the Company has performed certain obligations which were valued at $3.0 million. This amount was recorded as an offset to the Company's research and development expenses during the quarter ended June 30, 1999. NOTE 5 -- RESTRUCTURING SEEQ restructuring In connection with the merger with SEEQ on June 22, 1999, LSI recorded $3 million in restructuring charges and $5 million in merger related expenses (see Note 2). There were no changes to the SEEQ restructuring reserves in the second quarter of 1999. Restructuring reserve activity During the second quarter of 1999, the Company utilized $1.1 million in restructuring reserves which were originally established in the third quarter of 1998. The amounts utilized reflect severance payments of $0.6 million for approximately 130 employees terminated during the second quarter and $0.5 million for lease terminations and other exit costs primarily in the U.S. and Europe. See table below describing the 1998 restructuring. During the first quarter of 1999, the Company determined that $2.5 million of the restructuring reserve established in the third quarter of 1998 would not be utilized because of a change in management's estimate of the reserve requirements in the U.S., Europe and Japan. Accordingly, the restructuring reserve reversal was included in the determination of income from operations for the six month period ended June 30, 1999. The remaining restructuring reserve activity in the first quarter is described in the table below. Description of 1998 restructuring: The Company remains committed to improving profitability and strengthening competitiveness. As a result of identifying opportunities to streamline operations and maximize the integration of Symbios, Inc. ("Symbios") acquired on August 6, 1998 (see Note 6) into the Company's operations, the Company's management, with the approval of the Board of Directors, committed itself to a restructuring plan and recorded a $75.4 million restructuring charge in the third quarter of 1998. The action undertaken included a worldwide realignment of manufacturing capacity, the consolidation of certain design centers and administrative offices, and a streamlining of the Company's overhead structure to reduce operating expenses. The restructuring charge excludes any integration costs relating to Symbios. As discussed in Note 6 of Notes to the Unaudited Consolidated Condensed Financial Statements, integration costs relating to Symbios were accrued 9 10 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) as a liability assumed in the purchase in accordance with EITF No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination." Restructuring costs include $37.2 million related primarily to fixed assets impaired as a result of the decision to close a manufacturing facility in Tsukuba, Japan by the third quarter of 1999; $4.7 million for termination of leases and maintenance contracts primarily in the U.S. and Europe; $1.7 million for non-cancelable purchase commitments primarily in Europe; $13.1 million in fixed asset and other asset write-downs primarily in the U.S., Japan and Europe; approximately $2.4 million in other exit costs, which result principally from the consolidation and closure of certain design centers, sales facilities and administrative offices primarily in the U.S. and Europe; and work force reduction costs of $16.3 million. Other exit costs include $0.9 million related to payments made for early lease contract terminations and the write-down of surplus assets to their estimated realizable value; $0.7 million for the write-off of excess licenses for closed locations in Europe and $0.8 million of other exit costs associated with the consolidation of design centers worldwide. The workforce reduction costs primarily include severance costs related to involuntary termination of employment for approximately 900 employees from manufacturing in Japan, and engineering, sales, marketing and finance personnel located primarily in the U.S., Japan and Europe. The fair value of assets determined to be impaired in accordance with the guidance for assets to be held and used in SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," were the result of independent appraisals and use of management estimates. Severance costs and other above noted exit costs were determined in accordance with EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." The restructuring actions, as outlined by the plan, are intended to be executed to completion by September 30, 1999, one year from the date the reserve was taken. The following table sets forth the Company's 1998 restructuring reserves as of December 31, 1998 and activity against the reserve for the six month period ended June 30, 1999:
(IN THOUSANDS) RESERVE/ RESERVE/ BALANCE TRANSLATION BALANCE TRANSLATION BALANCE 12/31/98 UTILIZED ADJUSTMENT 3/31/99 UTILIZED ADJUSTMENT 6/30/99 -------- -------- ----------- ------- -------- ----------- ------- Write-down of manufacturing facility(a)........................ $ 1,500 $ -- $(1,100) 400 $ 400 Other fixed asset related charges.... -- -- -- -- Payments to employees for severance(b)....................... 11,600 (6,140) (820) 4,640 (640) 4,000 Lease terminations and maintenance contracts(c)....................... 4,600 (550) (83) 3,967 (367) 3,600 Noncancelable purchase commitments(c)..................... 1,600 (80) -- 1,520 1,520 Other exit costs(d).................. 1,200 (326) (530) 344 (124) 220 Cumulative currency translation adjustment......................... 1,512 -- (500) 1,012 -- (400) 612 ------- ------- ------- ------- ------- ----- ------- Total....................... $22,012 $(7,096) $(3,033) $11,883 $(1,131) $(400) $10,352 ======= ======= ======= ======= ======= ===== =======
- --------------- (a) The $1.5 million balance at 12/31/98 for the write-down of the facility related to machinery and equipment decommissioning costs. (b) Amounts utilized represent cash payments related to the severance of approximately 350 employees since 12/31/98 (approximately 130 in Q2 1999). (c) Amounts utilized represent cash charges. (d) Amounts utilized represent non-cash charges. The Company expects to complete the activities underlying the restructuring plan by September 1999. 10 11 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) NOTE 6 -- INTEGRATION OF SYMBIOS On August 6, 1998, the Company completed the acquisition of all of the outstanding capital stock of Symbios, Inc. from Hyundai Electronics America ("HEA"). HEA is a majority-owned subsidiary of Hyundai Electronics Industries Co., Ltd. ("HEI"), a Korean corporation. The transaction was accounted for as a purchase, and accordingly, the results of operations of Symbios and estimated fair value of assets acquired and liabilities assumed were included in the Company's consolidated financial statements as of August 6, 1998, the effective date of the purchase, through the end of the period. There are no significant differences between the accounting policies of the Company and Symbios. The allocation of the purchase price was disclosed in the Report on Form 10K/A for the year ended December 31, 1998 previously filed with the Securities and Exchange Commission. The Company has taken certain actions to combine the Symbios operations with those of LSI Logic and, in certain instances, to consolidate duplicative operations. Adjustments to accrued integration costs related to Symbios were recorded as an adjustment to the fair value of net assets in the purchase price allocation. The Company finalized the integration plan as of December 31, 1998. Accrued integration charges included $4 million related to involuntary separation and relocation benefits for approximately 300 Symbios employees and $1.4 million in other exit costs primarily relating to the closing of Symbios sales offices and the termination of certain contractual relationships. The Symbios integration related accruals were based upon management's current estimate of integration costs and are in accordance with EITF No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination." The following table sets forth the Company's Symbios integration reserve as of December 31, 1998 and activity against the reserve for the six month period ended June 30, 1999:
(IN THOUSANDS) DECEMBER 31, JUNE 30, 1998 1999 BALANCE UTILIZED BALANCE -------------- -------- -------- Payments to employees for severance and relocation(a)...................................... $2,360 $(1,624) $ 736 Other exit costs(a).................................. 1,002 (474) 528 ------ ------- ------ Total...................................... $3,362 $(2,098) $1,264 ====== ======= ======
- --------------- (a) The amount utilized represents cash payments related to the severance and relocation of approximately 160 employees. Utilization in Q2 1999 primarily reflects severance payments of $0.4 million for 29 employees and other exit costs of $0.5 million. No significant adjustments were made to the reserve during the periods presented. The Company expects to complete the activities underlying the integration plan by August 1999. NOTE 7 -- INVESTMENTS The Company classifies its debt and marketable equity securities into an available-for-sale category and values them at fair value in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," with unrealized gains and losses, net of taxes, reported in shareholders' equity until realized. For all investment securities, unrealized losses that are other than temporary are recognized in net income. Gains and losses on securities sold are based on the specific identification method and are reflected in net income. The Company currently does not actively trade securities. Short-term investments consist primarily of U.S. and foreign corporate debt securities, commercial paper, auction rate preferred stock, U.S. and foreign government and agency securities and time deposits. As of June 30, 1999 and December 31, 1998, the Company held $155 million and $81 million of available-for-sale 11 12 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) securities, respectively, that were classified as short-term investments on the consolidated balance sheet. Short-term investments are recorded at amortized cost, plus accrued interest, which approximates fair market value at June 30, 1999 and December 31, 1998. The contract maturities of these securities are within one year. Realized gains and losses were not significant during the quarters ended June 30, 1999 and 1998. The Company held marketable equity securities with an aggregate carrying value of $49 million that were classified as long-term assets on the consolidated balance sheet as of June 30, 1999. There were no significant investments in marketable equity securities as of December 31, 1998 as the companies became publicly traded during the six month period ended June 30, 1999. Unrealized gains, net of the related tax effect, of $28 million are included in accumulated other comprehensive income as of June 30, 1999. During the quarter, realized gains and losses were not significant. NOTE 8 -- DERIVATIVE FINANCIAL INSTRUMENTS The Company has foreign subsidiaries which 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 contract, currency swap, interest rate swap 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. As of June 30, 1999 and December 31, 1998, there were no interest rate swap or currency swap contracts outstanding. The Company enters into forward contracts and currency swaps to hedge firm intercompany asset and liability positions denominated in non-functional currencies. The following table summarizes by major currency the forward exchange contracts outstanding as of June 30, 1999 and December 31, 1998. The buy amounts represent the U.S. dollar equivalent of commitments to purchase foreign currencies, and the sell amounts represent the U.S. dollar equivalent of commitments to sell foreign currencies. Foreign currency amounts are translated at rates current at June 30, 1999 and December 31, 1998.
(IN THOUSANDS) JUNE 30, DECEMBER 31, 1999 1998 -------- ------------ Buy/(Sell): Japanese Yen.......................................... $ 8,954 $-- Japanese Yen.......................................... (3,264) --
These forward contracts are considered identifiable hedges and realized and unrealized gains and losses are deferred until settlement of the underlying commitments. They are recorded as other gains or losses when the underlying exposure materializes or the hedged transaction is no longer expected to occur. Deferred foreign gains and losses were not significant at June 30, 1999 and December 31, 1998. Foreign currency transaction gains and losses included in interest income and other were insignificant for the three and six-month periods ended June 30, 1999 and 1998. Currency option contracts were treated as hedges of third-party yen revenue exposures. At June 30, 1999, total outstanding purchased currency option contracts were $20 million. These contracts expire in September 1999. At December 31, 1998, total outstanding purchased currency option contracts were $130 million. These contracts expired quarterly through June 1999. The realized and unrealized gains and option premiums are deferred until the exposure underlying the option is recorded. The deferred premiums on all outstanding options were $0.3 million as of June 30, 1999 and $6 million as of December 31, 1998. The deferred premiums were included in other current assets. 12 13 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) On August 5, 1998, the Company recognized a loss of $1.5 million from the decision to close interest rate swap contracts which converted the interest associated with yen borrowings by LSI Logic Japan Semiconductor, Inc., a wholly owned subsidiary of the Company ("JSI"), from adjustable to fixed rates. The contracts were closed because the underlying debt was repaid as discussed in Note 10. Current period gains and losses associated with the interest rate swaps are included in interest expense, or as other gains and losses at such time as related borrowings are terminated. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow and foreign currency hedges and establishes respective accounting standards for reporting changes in the fair value of the instruments. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Upon adoption of SFAS No. 133, the Company will be required to adjust hedging instruments to fair value in the balance sheet, and recognize the offsetting gain or loss as transition adjustments to be reported in net income or other comprehensive income, as appropriate, and presented in a manner similar to the cumulative effect of a change in accounting principle. While we believe the adoption of this statement will not have a significant effect on our results of operations, the impact of the adoption of SFAS No. 133 as of the effective date cannot be reasonably estimated at this time. NOTE 9 -- BALANCE SHEET:
(IN THOUSANDS) JUNE 30, DECEMBER 31, 1999 1998 -------- ------------ Inventories: Raw materials........................................ $ 30,902 $ 32,347 Work-in-process...................................... 81,113 53,042 Finished Goods....................................... 79,470 96,051 -------- -------- Total...................................... $191,485 $181,440 ======== ========
The Company had $97 million of unamortized preproduction engineering costs at December 31, 1998 associated with the construction of a new manufacturing facility in Gresham, Oregon. This new facility became operational as of December 1, 1998, at which time capitalized preproduction began to be amortized over the expected useful life of the manufacturing technology of approximately four years. In April 1998, the AcSEC released SOP No. 98-5, "Reporting on the Costs of Start-up Activities." SOP No. 98-5 is effective for fiscal years beginning after December 15, 1998 and requires companies to expense all costs incurred or unamortized in connection with start-up activities. Accordingly, the Company has expensed the unamortized preproduction balance of $92 million, net of tax, on January 1, 1999 and has presented it as a cumulative effect of a change in accounting principle in accordance with SOP No. 98-5. NOTE 10 -- DEBT During March 1999, the Company issued $345 million of 4 1/4% Convertible Subordinated Notes (the "Convertible Notes") due in 2004. The Convertible Notes are subordinated to all existing and future senior debt, are convertible 60 days following issuance into shares of the Company's common stock at a conversion price of $31.353 per share and are redeemable at the option of the Company, in whole or in part, at any time on or after March 20, 2002. Each holder of the Convertible Notes has the right to cause the Company to repurchase all of such holder's Convertible Notes at 100% of their principal amount plus accrued interest upon the occurrence of certain events and in certain circumstances. Interest is payable semiannually. The Company 13 14 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) paid approximately $9.5 million for debt issuance costs related to the Convertible Notes. The debt issuance costs are being amortized using the interest method. The net proceeds of the Convertible Notes were used to repay borrowings under the Company's 364 day facility and the Revolver as described below. On August 5, 1998, the Company entered into a credit agreement with ABN AMRO Bank N.V. ("ABN AMRO"). The credit agreement was restated and superseded by the Amended and Restated Credit Agreement dated as of September 22, 1998 by and among the Company, JSI, ABN AMRO and thereafter syndicated to a group of lenders determined by ABN AMRO and the Company. The credit agreement consists of two credit facilities: a $575 million senior unsecured reducing revolving credit facility ("Revolver"), and a $150 million senior unsecured revolving credit facility ("364 day Facility"). On August 5, 1998, the Company borrowed $150 million under the 364 day Facility and $485 million under the Revolver. On December 22, 1998, the Company borrowed an additional $30 million under the Revolver. The credit facilities allow for borrowings at adjustable rates of LIBOR/TIBOR with a 1.25% spread. As of March 31, 1999 the spread changed to 1%. Interest payments are due quarterly. The 364 day Facility expires on August 3, 1999 at which time borrowings outstanding are payable in full. The Revolver is for a term of four years with the principal reduced quarterly beginning on December 31, 1999. The Revolver includes a term loan sub-facility in the amount of 8.6 billion yen made available to JSI over the same term. The yen term loan sub-facility is for a period of four years with no required payments until it expires on August 5, 2002. Pursuant to the restated credit agreement, on August 30, 1998, JSI repaid its existing 11.4 billion yen ($79.2 million) credit facility and borrowed 8.6 billion yen ($71 million at June 30, 1999) bearing interest at adjustable rates. In March of 1999, the Company repaid the full $150 million outstanding under the 364 day Facility and $185.5 million outstanding under the Revolver primarily using the proceeds from the Convertible Notes as described above. Borrowings outstanding under the Revolver including the yen sub-facility were $370 million as of June 30, 1999. As of June 30, 1999, the interest rate for the Revolver and the yen sub-facility were 5.96% and 1.14%, respectively. The debt issuance costs associated with these debt facilities were not significant. In accordance with the terms of its existing credit agreement, the Company must comply with certain financial covenants related to profitability, tangible net worth, liquidity, senior debt leverage, debt service coverage and subordinated indebtedness. As of June 30, 1999, the Company was in compliance with these covenants. NOTE 11 -- RECONCILIATION OF BASIC AND DILUTED EARNINGS PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted per share computations as required by SFAS No. 128, "Earnings Per Share ("EPS")."
(IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) THREE MONTHS ENDED JUNE 30, ------------------------------------------------------------- 1999 1998 ----------------------------- ----------------------------- PER-SHARE PER-SHARE INCOME* SHARES+ AMOUNT INCOME* SHARES+ AMOUNT ------- ------- --------- ------- ------- --------- Basic EPS: Net income available to common stockholders........................ $9,831 145,622 $0.07 $31,379 143,168 $0.22 Effect of dilutive securities: Stock options.......................... 6,325 1,551 Diluted EPS: Net income available to common stockholders........................ $9,831 151,947 $0.06 $31,379 144,719 $0.22
14 15 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) Options to purchase 704,863 and 7,477,499 shares were outstanding at June 30, 1999 and 1998, respectively, but were not included in the calculation of diluted shares for the three month periods ended June 30, 1999 and 1998 because the exercise prices were greater than the average market price of common shares in each respective quarter. The exercise price ranges of these options were $41.88 to $58.13 and $25.31 to $58.13 at June 30, 1999 and 1998, respectively. For the three months ended June 30, 1999, common equivalent shares of 11,003,732 and interest expense of $2 million, net of taxes, associated with the Convertible Notes (see Note 10) were excluded from the computation of diluted earnings per share as a result of their antidilutive effect on earnings per share
(IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) SIX MONTHS ENDED JUNE 30, -------------------------------------------------------------- 1999 1998 ------------------------------ ----------------------------- PER-SHARE PER-SHARE INCOME* SHARES+ AMOUNT INCOME* SHARES+ AMOUNT -------- ------- --------- ------- ------- --------- Basic EPS: Net income before cumulative effect of change in accounting principle......................... $ 13,841 144,883 $ 0.10 $62,795 142,868 $0.44 ------ ----- Cumulative effect of change in accounting principle.............. (91,774) 144,883 (0.64) -- -- -- ------ Net (loss)/income available to common stockholders...................... (77,933) 144,883 (0.54) 62,795 142,868 0.44 ------ ----- Effect of dilutive securities: Stock options........................ 4,731 1,509 Diluted EPS: Net income before cumulative effect of change in accounting principle......................... 13,841 149,614 0.09 62,795 144,377 0.43 ------ ----- Cumulative effect of change in accounting principle.............. (91,774) 149,614 (0.61) -- -- -- ------ Net (loss)/income available to common stockholders...................... $(77,933) 149,614 $(0.52) $62,795 144,377 $0.43 ------ -----
- --------------- * Numerator -- + Denominator Options to purchase 2,952,522 and 7,189,109 shares were outstanding at June 30, 1999 and 1998, respectively, but were not included in the calculation of diluted shares for the six month periods ended June 30, 1999 and 1998 because the exercise prices were greater than the average market price of common shares in each respective period. The exercise price ranges of these options were $32.13 to $58.13 and $25.31 to $58.13 at June 30, 1999 and 1998, respectively. For the six month period ended June 30, 1999, common equivalent shares of 6,243,690 and interest expense of $3 million, net of taxes, associated with the Convertible Notes (see Note 10) were excluded from the computation of diluted earnings per share as a result of their antidilutive effect on earnings per share 15 16 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) NOTE 12 -- COMPREHENSIVE INCOME Comprehensive income is defined as the 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 differences between net income and comprehensive income, for the Company, are due to foreign currency translation adjustments and unrealized gains on available-for-sale securities. Comprehensive income for the current reporting and comparable period in the prior year is as follows:
(IN THOUSANDS) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------- 1999 1998 1999 1998 ------- ------- -------- ------- Comprehensive income/(loss)........ $21,438 $15,168 $(67,963) $47,220
NOTE 13 -- SEGMENT REPORTING The Company operates in two reportable segments: the Semiconductor segment and the Storage Systems segment. In the Semiconductor segment, the Company designs, develops, manufactures and markets integrated circuits, including application-specific integrated circuits ("ASICs"), application-specific standard products ("ASSPs") and related products and services. Semiconductor design and service revenues include engineering design services, licensing of LSI's 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 Storage 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 Disks ("RAID") storage systems, subsystems and related software. The following is a summary of operations by segment for the three and six-month periods ended June 30, 1999.
(IN THOUSANDS) THREE MONTHS ENDED JUNE 30, 1999 -------------------------------------------- SEMICONDUCTOR STORAGE SYSTEMS TOTAL ------------- --------------- -------- Revenue...................................... $434,047 $66,965 $501,012 Income from operations....................... $ 17,317 $ 7,205 $ 24,522
SIX MONTHS ENDED JUNE 30, 1999 -------------------------------------------- SEMICONDUCTOR STORAGE SYSTEMS TOTAL ------------- --------------- -------- Revenue...................................... $830,154 $134,475 $964,629 Income from operations....................... $ 26,754 $ 12,252 $ 39,006
The Storage Systems segment was added in August 1998 with the purchase of Symbios, and therefore revenue and income from operations are not available for the three and six-month periods ended June 30, 1998. Intersegment revenues for the three and six-month periods ended June 30, 1999 were not significant. 16 17 LSI LOGIC CORPORATION NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED) The following is a summary of total assets by segment as of June 30, 1999 and December 31, 1998:
(IN THOUSANDS) JUNE 30, DECEMBER 31, 1999 1998 ---------- ------------ Assets by segment: Semiconductor.............................................. $2,616,391 $2,700,295 Storage Systems............................................ 139,324 123,510 ---------- ---------- Total assets............................................. $2,755,715 $2,823,805 ========== ==========
The Storage Systems segment did not meet the requirement for a reportable segment as defined in SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" as of December 31, 1998. However, for purposes of comparability, total assets by segment as of December 31, 1998 were included in the table. NOTE 14 -- LEGAL MATTERS A discussion of certain pending legal proceedings is included in Item 3 of the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1998. Except as set forth in this Note, the information provided therein remains unchanged. On February 26, 1999 a lawsuit alleging patent infringement was filed in the United States District Court for the District of Arizona by the Lemelson Medical, Education & Research Foundation, Limited Partnership against eighty-eight electronics industry companies, including us. The case number is CIV99-0377PHX RGS. The patents involved in this lawsuit generally relate to semiconductor manufacturing and computer imaging, including the use of bar coding for automatic identification of articles. The relief sought is an injunction and damages in an unspecified amount. While we cannot make any assurances regarding the eventual resolution of this matter, we do not believe it will have a material adverse effect on our consolidated results of operations or financial condition. The Company continues to believe that the final outcome of such matters discussed 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, particularly if viewed on a quarterly basis, for having an adverse effect on the Company's financial position or its results of operations. Certain additional claims and litigation against the Company have also arisen in the normal course of business. The Company believes that it is unlikely that the outcome of these claims and lawsuits will have a materially adverse effect on the Company's consolidated financial position or results of operations. 17 18 LSI LOGIC CORPORATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL We believe that our future operating results will continue to be subject to quarterly variations based upon a wide variety of factors. These factors include, among others: - Cyclical nature of both the semiconductor industry 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; 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 position 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 which operate and sell our products in various global markets. We purchase a substantial portion of our raw materials and equipment from foreign suppliers and incur labor and other operating costs in foreign currencies, particularly at our Japanese manufacturing facilities. As a result, we are exposed to international factors such as changes in foreign currency exchange rates or weak economic conditions of the respective countries in which we operate. We utilize forward exchange, currency swap, interest swap and option contracts to manage our exposure associated with currency fluctuations on intercompany transactions and certain foreign currency denominated commitments. With the exception of purchased option contracts and forward contracts, there were no currency swap or interest rate swap contracts outstanding as of June 30, 1999 and December 31, 1998. (See Note 8 to the Unaudited Consolidated Condensed Financial Statements.) Our corporate headquarters and some of our manufacturing facilities are located near major earthquake faults. As a result, in the event of a major earthquake, we could suffer damages which could significantly and adversely affect our operating results and financial condition. There have been no significant changes in the market risk disclosures during the second three months of 1999 as compared to the discussion in our 1998 Annual Report on Form 10-K/A for the year ended December 31, 1998. 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 Management's Discussion and Analysis included in our 1998 Annual Report on Form 10-K/A for the year ended December 31, 1998. 18 19 LSI LOGIC CORPORATION 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. The extent to which our plans for future cost reductions are realized also may impact our future financial performance. 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 1998 Annual Report on Form 10-K/A for the year ended December 31, 1998. YEAR 2000 DISCLOSURE The following statement is a Year 2000 Readiness Disclosure under the Year 2000 Information and Readiness Disclosure Act of 1998. As with many other companies, the Year 2000 computer issue presents risks for us. We use a significant number of computer software programs and operating systems in our internal operations, including applications used in our financial, product development, order management and manufacturing systems. There are areas in which the Year 2000 computer issue could negatively impact us and our business. If internal systems do not properly recognize and process date information for years into and beyond the turn of the century, there could be an adverse impact on our operations. Moreover, if critical suppliers' or customers' systems or products fail because of a Year 2000 malfunction, there could be an adverse impact on our operating results. Finally, our products could malfunction as a result of a failure in date recognition. A Year 2000 problem could arise if our systems were to fail to properly recognize and process date information for several reasons, including: they could fail to properly recognize years that begin with the digits "20" instead of "19"; they could attribute specially assigned meanings to certain date code digits, such as "99"; or they could fail to recognize the year 2000 as a leap year. The inability of computer software programs to accurately recognize, interpret and process date codes designating the year 2000 and beyond could cause systems to yield inaccurate results or encounter operating problems, including interruption of the business operations such systems control. We are engaged in a comprehensive program to assess our Year 2000 risk exposure and to plan and implement remedial and corrective action where necessary. We have reviewed all of our major internal systems, including human resources, financial, engineering and manufacturing systems, to assess Year 2000 readiness and to identify critical systems that require correction or remediation. Assessment of our design engineering systems and products was completed in the first quarter of 1999. Based on the results of this assessment, we anticipate that remediation of critical systems will be completed and tested by the end of the third quarter 1999. We believe that our existing HR, financial and business software systems are Year 2000 ready. We cannot assure you, however, that integration and testing of new, corrected or updated programs or systems with which they interface will not result in necessary corrective action to one or more critical systems. A significant disruption of our financial or business systems would adversely impact our ability to process orders, manage production and issue and pay invoices. Our inability to perform these functions for a long period of time could result in a material impact on our results of operations and financial condition. Our manufacturing facilities incorporate sophisticated computer integrated manufacturing systems which depend on a mix of our proprietary software and systems and software purchased from third parties. Failure of 19 20 LSI LOGIC CORPORATION these systems would cause a disruption in the manufacturing process and could result in a delay in completion and shipment of products. Our assessment of the Year 2000 readiness of our manufacturing systems is complete. Based on information currently available, we believe that our systems will not be materially impacted by Year 2000 issues. However, we cannot assure you that a significant disruption in systems resulting from a Year 2000 problem will not occur. If the computer integration system fails for this or any other reason, there could be a material adverse impact on our operating results and financial condition. We are working with critical suppliers of products and services to assess their Year 2000 readiness with respect both to their operations and the products and services they supply to us. Comprehensive inquiries have been sent and responses are being monitored, with appropriate follow-up where required. This analysis will continue well through 1999, with corrective action taken commensurate with the criticality of affected products and services. Our assessment program also has encompassed our own product offerings. Our ASICs are custom-designed chips which implement the customer's functional or engineering specifications. As designer and manufacturer of the physical implementation of a customer's design in silicon, we generally do not have specific knowledge of the role of the customer's ASIC within the complete system for which it is intended. Whether the chip will operate correctly depends on the system function and the software design and integration, which will be determined independently by the customer or other third party suppliers. Our ASSP and storage systems products, on the other hand, do implement chip and system functionality designed by us. Such functionality include graphics processing, audio/video signal decoding, data transmission, I/O control and data storage whose functionality generally is not date dependent. We have completed our assessment of the Year 2000 readiness of these products, and there is no information to indicate that Year 2000 issues will have a material impact on sales or functionality of our standard product offerings. Customers are seeking assurances of our Year 2000 readiness with increasing frequency, and we are endeavoring promptly and completely to address their concerns. However, we have no control over a customer's Year 2000 readiness. Customers who believe that the products they purchase from us may not be Year 2000 compliant may seek alternative sources of supply. A significant decline in new orders or increase in cancellations of existing backlog could have a material adverse impact on our results of operations or financial condition. We are at work on the development of various types of contingency plans to address potential problems with critical internal systems and third party interactions. Our contingency plans include procedures for dealing with a major disruption of internal business systems, plans for long term factory shutdown and identification of alternative vendors of critical materials in the event of Year 2000 related disruption in supply. Contingency planning will continue through at least 1999, and will depend heavily on the results of the remediation and testing of critical systems. The potential ramifications of a Year 2000 type failure are potentially far-reaching and largely unknown. We cannot assure you that a contingency plan in effect at the time of a system failure will adequately address the immediate or long term effects of a failure, or that such a failure would not have a material adverse impact on our operations or financial results in spite of prudent planning. Our costs to date related to the Year 2000 issue consist primarily of reallocation of internal resources to evaluate and assess systems and products as described above and to plan our remediation and testing efforts. We have not maintained detailed accounting records, but based on our review of department budgets and staff allocations, we believe these costs to be insignificant. We currently estimate that the total cost of ongoing assessment, remediation, testing and planning directly related to Year 2000 issues will amount to approximately $15 million. Of this, approximately $7 million is expected to consist of expenses attributed to redeployment of labor resources and overhead, $3 million for the cost of software and external consulting fees and $5 million for additional capital expenditures. The capital expenditures represent the early replacement of information technology equipment and software to obtain the full benefits of Year 2000 protections versus the normal technical obsolescence replacement cycle. The estimate is based on the current assessment of the projects and is subject to change as the projects progress. We cannot assure you that remediation and testing 20 21 LSI LOGIC CORPORATION will not identify issues which require additional expenditure of material amounts which could result in an adverse impact on financial results in future reporting periods. Based on currently available information, management does not believe that the Year 2000 issues discussed above related to internal systems or products sold to customers will have a material adverse impact on our financial condition or overall trends in results of operations. However, we are uncertain to what extent we may be affected by such matters. In addition, we cannot assure you that the failure to ensure Year 2000 capability by a supplier not considered critical or another third party would not have a material adverse effect on us. ADOPTION OF THE EURO In 1998, we established a task force to address the issues raised by the implementation of the European single currency (the "Euro"). Our primary focus has been the changes needed to address a mix of Euro and local denomination transactions during the transition period from January 1, 1999 through January 1, 2002. As of January 1, 1999, we began transacting business in Euros. We implemented a new bank account structure throughout Europe to accommodate customers and vendors and to improve liquidity management in Europe. We do not presently expect that the introduction and use of the Euro will materially affect our foreign exchange and hedging activities or our use of derivative instruments. We do not believe that the introduction of the Euro will result in any significant increase in costs to us, and all costs associated with the introduction of the Euro will be expensed in accordance with our policy. We do not expect that the transition to the Euro will result in any competitive pricing or will adversely impact any of our internal computer systems. While we will continue to evaluate the impact of the Euro introduction over time, based on currently available information, we do not believe that the introduction of the Euro currency will have a significant adverse impact on our financial condition or overall trends in results of operations. RESULTS OF OPERATIONS On June 22, 1999, we completed a merger of our wholly-owned subsidiary with SEEQ in a transaction accounted for as a pooling of interests and SEEQ became a wholly-owned subsidiary. All financial information has been restated retroactively to reflect SEEQ and our combined operations as if the merger had occurred at the beginning of the earliest period presented (see Note 2 to the unaudited consolidated condensed financial statements). Prior to the merger, SEEQ's fiscal year-end was the last Sunday in September of each year whereas we operate on a fiscal year ending on December 31. Where more than one material factor caused changes in results, we have quantified each material factor throughout the MD&A where practicable. Revenues Revenues for the second quarter of 1999 increased $165 million or 49% to $501 million compared to $336 million during the same period of 1998. The material factors contributing to this increase included additional revenues from the acquisition of Symbios in the third quarter of 1998 (see Note 6). The increase was also attributable to increased demand for products used in communications and networking applications. The increase was offset in part by decreased demand for our component products used in computer product applications. Revenues for the first half of 1999 increased $296 million or 44% to $965 million compared to $669 million for the same period of the prior year. The material factors contributing to the increase included additional revenues from the acquisition of Symbios in the third quarter of 1998. The increase was also attributable to increased demand for products used in communications and networking applications. The 21 22 LSI LOGIC CORPORATION increase was offset in part by the decreased demand and lower average selling prices for our component products used in computer and consumer product applications. One customer represented 11% of revenues for the three months ended June 30, 1999. There were no customers with revenues greater than or equal to 10% of total consolidated revenues for the six months ended June 30, 1999. OPERATING COSTS AND EXPENSES Key elements of the consolidated statements of operations, expressed as a percentage of revenues, were as follows:
THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, JUNE 30, ------------ ------------ 1999 1998 1999 1998 ---- ---- ---- ---- Gross margin............................................. 37% 47% 36% 45% Research and development expenses........................ 15% 20% 16% 20% Selling, general and administrative expenses............. 13% 16% 13% 15% Amortization of intangibles.............................. 2% -- 2% -- Income from operations................................... 5% 11% 4% 11%
Gross margin The gross margin percentage decreased to 37% during the second quarter of 1999 from 47% in the same period in 1998 and decreased to 36% during the first half of 1999 from 45% in the same period in 1998. The decrease reflected a combination of the following elements: - Changes in product mix primarily related to Symbios product additions from August 6, 1998; - Lower average selling prices, including the impact from currency fluctuations; and - Increased cost of revenues from commencing operations at our new fabrication facility in Gresham, Oregon in December of 1998. 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 margin in future periods. Changes in the relative strength of the yen may have a greater impact on gross margin than other foreign exchange fluctuations due to our large wafer fabrication operations in Japan. Although the yen strengthened (the average yen exchange rate for the second quarter and first half of 1999 increased 12% and 10%, respectively, from the same periods in 1998), the effect on gross margin and net income was not significant because yen denominated sales offset a substantial portion of yen denominated costs during the period. Moreover, we hedged a portion of our remaining yen exposure. (See Note 8 to the Unaudited Consolidated 22 23 LSI LOGIC CORPORATION Condensed Financial Statements.) Future changes in the relative strength of the yen or mix of foreign denominated revenues and costs could have a significant effect on gross margins or operating results. RESEARCH AND DEVELOPMENT Research and development ("R&D") expenses increased $9 million or 14% to $75 million and $21 million or 16% to $152 million during the three and six month periods ended June 30, 1999, respectively, compared to $66 million and $131 million in the same periods of 1998, respectively. The material factors resulting in this increase were the following: - Expenditures for research and development activities which were a continuation of research and development activities of the Symbios business included in our unaudited consolidated financial statements in the second quarter and the first half of 1999; - Expenditures related to the continued development of advanced sub-micron products and process technologies; - Salary increases during the second quarter of 1999. For the three and six months ended June 30, 1999, the above noted increases were offset in part by $3 million which is directly attributable to a technology transfer agreement entered into with a non-public technology company located in Malaysia during the second quarter of 1999. (See Note 4 of the Notes to the Unaudited Consolidated Condensed Financial Statements). As a percentage of revenues, R&D expenses decreased to 15% and 16% for the second quarter and the first half of 1999, respectively, compared to approximately 20% for the comparable periods in 1998. The effects of our restructuring programs in the third quarter of 1998 primarily accounted for the decrease (see Note 5 of Notes to the Unaudited Consolidated Condensed Financial Statements). As we continue our commitment to technological leadership in our markets and realize the further benefit of cost savings from our restructuring efforts, we are targeting our R&D investment in the second half of 1999 to be approximately 13% of revenues. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative ("SG&A") expenses increased $11 million or 20% to $63 million and $26 million or 27% to $124 million for the three and six months ended June 30, 1999, respectively, compared to $52 million and $98 million during the same periods in 1998, respectively. The increase was primarily attributable to the inclusion of current expenses relating to the former Symbios business acquired on August 6, 1998 and salary increases in the second quarter of 1999. As a percentage of revenues, SG&A expenses decreased to approximately 13% for the three and six month periods ended June 30, 1999 from 16% and 15% during the same periods in 1998, respectively. We expect that SG&A expenses as a percentage of revenues will decline to approximately 12% of revenues during the second half of 1999 as we continue to realize the benefits of cost savings from the restructuring programs established in the third quarter of 1998. RESTRUCTURING AND MERGER RELATED EXPENSES Restructuring and merger related expenses were $8 million and $6 million for the three and six month periods ended June 30, 1999, respectively. There were no restructuring or merger related expenses recorded in the same periods of 1998. In connection with the merger with SEEQ on June 22, 1999 (see Note 2 of the Notes to the Unaudited Consolidated Condensed Financial Statements), we recorded $3 million in restructuring charges and $5 million in merger related expenses. The merger expenses related primarily to investment banking and other professional fees directly attributable to the merger with SEEQ. The restructuring charge is comprised of $2 million in write-downs of fixed assets which were duplicative to the combined company, $0.5 million of exit costs relating to non-cancelable building lease contracts and $0.5 million provision for severance costs related to the involuntary termination of certain employees. The exit costs and employee severance costs were recorded in accordance with EITF No. 94-3 "Liability Recognition 23 24 LSI LOGIC CORPORATION for Certain Employee Termination Benefits and Other Costs to Exit an Activity." The fixed and other assets write-downs were recorded in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The restructuring actions as outlined by the restructuring plan are intended to be executed to completion by June 30, 2000, one year from the date the reserve was taken. The $6 million in restructuring and merger related expenses for the six months ended June 30, 1999 also included a $2.5 million reversal of restructuring reserves recorded in the first quarter of 1999. During the first quarter of 1999, we determined that $2.5 million of the restructuring reserve originally established in the third quarter of 1998 would not be utilized as a result of the completion of activities in the U.S., Europe and Japan, including the trade-in of certain software at a gain which was previously written down. For a description of the restructuring costs recorded in the third quarter of 1998 and changes to the restructuring reserves in the second quarter of 1999, refer to Note 5 of the Notes to the Unaudited Consolidated Condensed Financial Statements. The savings from the restructuring plan associated with the acquisition of SEEQ are not considered to be significant. As a result of the execution of restructuring plan announced in the third quarter of 1998, we expect to realize savings in 1999 of approximately $37 million in reduced employee expenses, $10 million in depreciation savings and $3 million related to reduced lease and maintenance contract expenses primarily associated with the reduction in the number of engineering design centers and sales facilities and administrative offices worldwide. As of June 30, 1999, the remaining cash requirements will be related primarily to severance payouts. The resources for such payments will come from cash on hand at the time the severance payouts are distributed. IN-PROCESS RESEARCH AND DEVELOPMENT On April 14, 1999, we acquired all of the outstanding capital stock of ZSP for a total purchase price of $11.3 million which consisted of $7 million in cash (which included approximately $0.6 million in direct acquisition costs), and assumed liabilities up to $4.3 million in accordance with the purchase agreement with ZSP. The merger was accounted for as a purchase (See Note 3 to the Notes to the Consolidated Condensed Financial Statements). ZSP, a development stage semiconductor company, was involved in the design and marketing of programmable Digital Signal Processors ("DSPs") for use in wired and wireless communications. The results of operations of ZSP and estimated fair value of assets acquired and liabilities assumed were included in our consolidated condensed financial statements as of April 14, 1999, the effective date of the purchase, through the end of the period. In connection with the purchase of ZSP, we recorded a $4.6 million charge to in-process research and development ("IPR&D") during the second quarter of 1999. The amount was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed. We acquired ZSP's in-process DSP research and development project that was targeted at the telecommunications market. This product is being developed specifically for voice over net or voice over internet protocol applications and is intended to have substantial incremental functionality, greatly improved speed and a wider range of interfaces than ZSP's current technology. The value of the one project identified to be in progress was determined by estimating the future cash flows from the project once commercially feasible, discounting the net cash flows back to their present value and then applying a percentage of completion to the calculated value as defined below. The net cash flows from the identified project are based on our estimates of revenues, cost of sales, research and development costs, selling, general and administrative costs and applicable income taxes for the project. These estimates were compared and found to be in line with industry analysts forecasts of growth in the telecommunications market. Estimated total revenues are expected to peak in the years 2002 and 2003 and then decline in 2004 as other new products are expected to become available. These projections are based on our estimates of market 24 25 LSI LOGIC CORPORATION size and growth, expected trends in technology, and the expected timing of new product introductions by us and our competitors. We applied a royalty percentage of 25% of operating income for the project in-process to attribute value for dependency on predecessor core technologies. The discount rate used was 25% for the project, a rate 1,000 basis points higher than the industry weighted average cost of capital estimated at approximately 15% to account for the risks associated with the inherent uncertainties surrounding the successful development of the IPR&D, market acceptance of the technology, the useful life of the technology, the profitability level of such technology and the uncertainty of technological advances which could impact the estimates described above. The percentage of completion for the project was determined using milestones representing management's estimate of effort, value added and degree of difficulty of the portion of the project completed as of April 14, 1999, as compared to the remaining research and development to be completed to bring the project to technical feasibility. The development process is grouped into three phases with each phase containing between one and five milestones. The three phases are: - Researching the market requirements and the engineering architecture and feasibility studies; - Design and verification milestones; and - Prototyping and testing the product (both internal and customer testing). Development of ZSP's digital signal processor project started in May 1998. As of April 14, 1999, we estimated the project was 65% complete. As of the acquisition date, the cost to complete the project is estimated at $1 million for the remainder of 1999. However, development of the technology remains a substantial risk to us due to the remaining effort to achieve technical feasibility, rapidly changing customer markets and competitive threats from other companies. Additionally, the value of other intangible assets acquired may become impaired. Our management believes that the in-process research and development charge of $4.6 million is valued consistently with the SEC staff's view regarding valuation methodologies. There can be no assurances, however, that the SEC staff will not take issue with any assumptions used in the valuation model and require us to revise the amount allocated to in-process research and development. AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES Amortization of goodwill and other intangibles increased $11 million to $12 million and $20 million to $23 million in the three and six months ended June 30, 1999, respectively, compared to $1 million and $3 million during the same periods in 1998, respectively. The increase was primarily related to amortization of goodwill and other intangibles associated with the acquisition of Symbios in the third quarter of 1998 and the acquisition of ZSP in the second quarter of 1999. INTEREST EXPENSE Interest expense increased $10 million and $20 million for the three and six month periods ended June 30, 1999 as compared to the same periods in the prior year. The increase was attributable to interest expense on the bank debt facility, which we entered into during the third quarter of 1998 to fund the purchase of Symbios, and the Convertible Notes issued in March 1999. (See Note 10 of Notes to the Unaudited Consolidated Condensed Financial Statements.) Additionally, in 1999, we did not capitalize any interest associated with the construction of the new fabrication facility in Gresham, Oregon, as operations of the facility commenced in December 1998. 25 26 LSI LOGIC CORPORATION INTEREST INCOME AND OTHER Interest income and other decreased $3 million to $2 million and $9 million to $4 million in the second quarter and the first half of 1999, respectively, as compared to $5 million and $13 million during the same periods in 1998, respectively. The decrease was primarily attributable to the following: - A reduction in interest income attributable to lower average balances of cash, cash equivalents and short-term investments during the first half of 1999 as compared to the same period in the prior year. The lower average balances of cash, cash equivalents and short term investments resulted primarily from cash outlays associated with the purchase of Symbios in the third quarter of 1998 and debt repayments, net of borrowings, primarily during the first quarter of 1999; and - The combination of slightly higher losses on both foreign exchange and fixed asset disposals during the three and six months ended June 30, 1999 compared to the same periods of 1998. PROVISION FOR TAXES The tax provision for the three and six months ended June 30, 1999 was at an effective rate of 43% and 40%, respectively, compared to 25% for the three and six months ended June 30, 1998, respectively. The rate in the first half of 1999 was impacted by the write-offs relating to IPR&D, SEEQ merger costs and restructuring charges during the second quarter of 1999. Our effective tax rate can be above or below the U.S. statutory rate primarily due to non-deductible IPR&D and merger and restructuring charges offset in part by earnings of our foreign subsidiaries taxed at lower rates and the utilization of prior loss carryovers and other tax credits. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE In April 1998, the Accounting Standards Executive Committee ("AcSEC") released Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of Start-up Activities." The SOP is effective for fiscal years beginning after December 15, 1998 and requires companies to expense all costs incurred or unamortized in connection with start-up activities. Accordingly, we expensed the unamortized preproduction balance of $91.8 million associated with the Gresham manufacturing facility, net of tax, on January 1, 1999 and presented it as a cumulative effect of a change in accounting principle in accordance with SOP No. 98-5. FINANCIAL CONDITION AND LIQUIDITY Cash, cash equivalents and short-term investments increased by $53 million during the first six months of 1999 to $345 million from $292 million at the end of 1998. The increase was primarily generated from operations partially offset by purchases of property and equipment, repayment of debt obligations, net of borrowings, and purchases net of sales of equity securities. Working capital increased by $279 million to $518 million at June 30, 1999 from $239 million at December 31, 1998. The increase in working capital was primarily a result of the following elements: - Lower current liabilities as a result of repayment of the short-term portion of the debt facility in the first quarter of 1999, lower accounts payable due to the timing of invoice receipt and payment, and lower income taxes payable primarily resulting from the timing of payments; and - Higher short-term investments, accounts receivable and inventories. The increase in accounts receivable was attributable to higher sales in the second quarter of 1999 as compared to the fourth quarter of 1998. The increase in inventories reflected the expectation of continued sales growth in 1999 that would be higher than the rate in 1998. The increase in working capital was offset in part by lower prepaids and other current assets and higher accrued salaries, wages and benefits as compared to December 31, 1998. The increase in accrued salaries and wages related to the timing of payments and accruals as of June 30, 1999 compared to December 31, 1998. 26 27 LSI LOGIC CORPORATION During the first six months of 1999, we generated $100 million of cash and cash equivalents from operating activities compared to $68 million during the same period in 1998. The increase in cash and cash equivalents provided from operations was primarily attributable to: - Higher net income (before depreciation and amortization, write-off of unamortized preproduction costs, non-cash restructuring charges and the gain on stock investments); and - A decrease in prepaids and other assets and an increase in accrued and other liabilities. The decrease in prepaids and other assets was primarily attributable to a $23 million increase in the accumulated amortization of goodwill and other intangibles during the first half of 1999 offset in part by timing differences of payments on prepaids and other current assets. The increase in accrued and other liabilities was primarily due to an increase in accrued salaries and wages and benefits offset in part by a decrease in income taxes payable. The increased cash from operations was offset in part by an increase in accounts receivable, inventories, and a decrease in accounts payable. The increase in accounts receivable was primarily a result of higher revenues in the first half of 1999 as compared to the first half of 1998. Inventories were primarily higher as revenues are expected to continue to be higher for the second half of 1999 as compared to 1998. The decrease in accounts payable was primarily as a result of timing of invoice receipt and the higher volumes of business in June 1999 compared to June 1998. Cash and cash equivalents used in investing activities during the first six months of 1999 were $109 million compared to $47 million during the same period in 1998. The primary investing activities during the first six months of 1999 included the following: - Purchases and sales of debt and equity securities available-for-sale; - The acquisition of a non-public technology company; and - Purchases of property and equipment. The increase in cash used in investing activities during the first six months of 1999 as compared to the same period in 1998 was primarily attributable to a decrease in the maturities and sales of debt and equity securities available-for-sale offset in part by a decrease in both the purchases of debt and equity securities available for sale and purchases of property and equipment. 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 $29 million and $148 million during the first six months of 1999 and 1998, respectively. The decrease in additions from 1998 was primarily attributable to reduced purchases of property and equipment related to construction of the new wafer fabrication facility in Gresham, Oregon. We expect to incur capital expenditures of no more than $250 million in 1999. Cash and cash equivalents used for financing activities during the first six months of 1999 totaled $9 million, compared to $12 million provided by financing activities in the same period of 1998. The increase in cash used during the first six months of 1999 was primarily attributable to repayment of the credit facility, net of proceeds, from the issuance of the new 4 1/4% Convertible Subordinated Notes (see Note 4 to the Unaudited Consolidated Condensed Financial Statements.) The increase in cash used is offset in part by proceeds from sale of common stock issued pursuant to our employee stock option and purchase plans. During March of 1999, we issued $345 million of 4 1/4% Convertible Subordinated Notes (the "Convertible Notes") due in 2004. The Convertible Notes are subordinated to all existing and future senior debt, are convertible 60 days following issuance into shares of our common stock at a conversion price of $31.353 per share and are redeemable at our option, in whole or in part, at any time on or after March 20, 2002. Each holder of the Convertible Notes has the right to cause us to repurchase all of such holder's Convertible Notes at 100% of their principal amount plus accrued interest upon the occurrence of certain events and in certain circumstances. Interest is payable semiannually. We paid approximately $9.5 million for debt issuance costs 27 28 LSI LOGIC CORPORATION related to the Convertible Notes. The debt issuance costs are being amortized using the interest method. We used the net proceeds from the Convertible Notes to repay debt obligations as outlined below. On August 5, 1998, we entered into a credit agreement with JSI and ABN AMRO. The credit agreement was restated and superseded by the Amended and Restated Credit Agreement dated as of September 22, 1998 and thereafter syndicated to a group of lenders determined by ABN AMRO and us. The credit agreement consists of two credit facilities: a $575 million senior unsecured reducing revolving credit facility ("Revolver"), and a $150 million senior unsecured revolving credit facility ("364 day Facility"). On August 5, 1998, we borrowed $150 million under the 364 day Facility and $485 million under the Revolver. On December 22, 1998, we borrowed an additional $30 million under the Revolver. The credit facilities allow for borrowings at adjustable rates of LIBOR/TIBOR with a 1.25% spread. As of March 31, 1999 the spread was 1%. Interest payments are due quarterly. The 364 day Facility expires on August 3, 1999 at which time borrowings outstanding are payable in full. The Revolver is for a term of four years with the principal reduced quarterly beginning on December 31, 1999. The Revolver includes a term loan sub-facility in the amount of 8.6 billion yen made available to JSI over the same term. The yen term loan sub-facility is for a period of four years with no required payments until it expires on August 5, 2002. Pursuant to the restated credit agreement, on August 30, 1998, JSI repaid it's existing 11.4 billion yen ($79.2 million) credit facility and borrowed 8.6 billion yen ($70.5 million at June 30, 1999) bearing interest at adjustable rates. In March of 1999, we repaid the $150 million outstanding under the 364 day Facility and $185.5 million outstanding under the Revolver primarily using proceeds from the Convertible Notes. Borrowings outstanding under the Revolver including the yen sub-facility were $370 million as of June 30, 1999. As of June 30, 1999, the interest rate for the Revolver and the yen sub-facility were 5.96% and 1.14%, respectively. Debt issuance costs were not significant. In accordance with the existing credit agreement, we must comply with certain financial covenants related to profitability, tangible net worth, liquidity, senior debt leverage, debt service coverage and subordinated indebtedness. As of June 30, 1999, we were in compliance with these covenants. We believe that our level of financial resources is an important competitive factor in our industry. Accordingly, we may, from time to time, seek additional equity or debt financing. 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 can provide no assurance that such additional financing will be available when needed or, if available, will be on favorable terms. Any future equity financing will decrease existing stockholders' equity percentage ownership and may, depending on the price at which the equity is sold, result in dilution. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow and foreign currency hedges, and establishes respective accounting standards for reporting changes in the fair value of the instruments. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. Upon adoption of SFAS No. 133, we will be required to adjust hedging instruments to fair value in the balance sheet, and recognize the offsetting gain or loss as transition adjustments to be reported in net income or other comprehensive income, as appropriate, and presented in a manner similar to the cumulative effect of a change in accounting principle. While we believe the adoption of this statement will not have a significant effect on our results of operations, the impact of the adoption of SFAS No. 133 as of the effective date cannot be reasonably estimated at this time. 28 29 PART II ITEM 1. LEGAL PROCEEDINGS Reference is made to Item 3, Legal Proceedings, of the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1998 for a discussion of certain pending legal proceedings. Except as set forth in Note 14, the information provided at such reference regarding those matters remains unchanged. The Company continues to believe that the final outcome of such matters will not have a material adverse effect on the Company's consolidated financial position or results of operations. No assurance can be given, however, that these matters will be resolved without the Company becoming obligated to make payments or to pay other costs to the opposing parties, with the potential for having an adverse effect on the Company's financial position or its results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Stockholders of LSI Logic Corporation was held on May 7, 1999 in San Francisco, California. Of the total 141,836,838 shares outstanding as of the record date, 129,885,603 shares (91.576%) were present or represented by proxy 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...................................... 126,222,216 3,663,387 T.Z. Chu................................................. 126,335,524 3,550,079 Malcolm R. Currie........................................ 126,264,422 3,621,181 James H. Keyes........................................... 126,236,190 3,550,413 R. Douglas Norby......................................... 126,324,602 3,561,001 Matthew J. O'Rourke...................................... 126,261,844 3,623,759
The stockholders approved an amendment to the 1991 Equity Incentive Plan to increase the number of shares reserved for issuance thereunder by 6,250,000. The proposal received 91,844,094 affirmative votes, 37,234,458 negative votes, 807,051 abstentions, and zero non-votes. The stockholders approved an Amended and Restated Employee Stock Purchase Plan to increase the number of shares reserved for issuance thereunder by 750,000, to change the enrollment dates, to reduce the length of the offering period and to grant the Board of Directors authority to alter the purchase price of the shares and make other administrative changes. The proposal received 17,965,530 affirmative votes, 11,087,704 negative votes, 832,369 abstentions, and zero non-votes. The stockholders approved an amendment to the 1995 Director Stock Option Plan to increase the annual grant of options to each non-employee director to 12,500, which fully vest six months after grant. The proposal received 116,788,049 affirmative votes, 12,146,671 negative votes, 117,950,883 abstentions, and zero non-votes. The stockholders approved the appointment of PricewaterhouseCoopers LLP as independent accountants of the company. The proposal received 128,755,565 affirmative votes, 432,362 negative votes, 657,676 abstentions and zero non-votes. ITEM 5. OTHER INFORMATION. STOCKHOLDER PROPOSALS Proposals of stockholders intended to be presented at the Company's 2000 annual meeting of stockholders must be received at the Company's principal executive offices not later than November 19, 1999 in order to be included in the Company's proxy statement and form of proxy relating to the 2000 annual meeting. 29 30 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27.1 Financial Data Schedules (b) Reports on Form 8-K On June 2, 1999, pursuant to Item 5 to report information set forth in the Registrant's press release dated May 19, 1999. On July 9, 1999, pursuant to Item 5 to report information set forth in the Registrant's press release dated July 1, 1999. On July 9, 1999, pursuant to Item 5 to report information set forth in the Registrant's press release dated June 22, 1999. On July 26, 1999, pursuant to Item 5 to report information set forth in the Registrant's press release dated July 21, 1999. 30 31 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: July 27, 1999 By /s/ R. DOUGLAS NORBY ------------------------------------ R. Douglas Norby Executive Vice President Finance & Chief Financial Officer 31 32 INDEX TO EXHIBITS
EXHIBIT NUMBER - ------- 27.1 Financial Data Schedule 27.2 Financial Data Schedule
32 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 141,017 278,111 239,302 2,641 106,073 846,425 1,782,902 (610,890) 2,163,950 404,727 0 0 0 1,432 1,636,140 2,163,950 669,002 669,002 367,392 367,392 231,230 0 (175) 83,685 20,890 62,795 0 0 0 62,795 0.44 0.43
EX-27.2 3 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 190,530 154,613 338,745 4,914 191,485 977,188 2,135,410 888,869 2,755,715 458,786 0 0 0 1,460 1,484,623 2,755,715 964,629 964,629 616,289 616,289 309,334 0 (20,200) 23,001 9,160 13,841 0 0 (91,774) (77,933) (0.54) (0.52)
-----END PRIVACY-ENHANCED MESSAGE-----